Fidelity National And The Title Insurance Industry: Boring Can Be Beautiful
Title Insurance is an industry everyone knows but few understand. It’s easy to write off as a relic of the “old” economy that blockchain, crypto, and web3 will surely pick off. However, reality is more nuanced. While title insurance may be an old school industry, it is well entrenched and provides real value. It is not going anywhere anytime soon.
My interest in title insurance began when I studied Bill Foley, who ran Fidelity National Financial (FNF), turned it into a cash cow, and went on to spinoff Black Knight and FIS. Privately, he also bought the Las Vegas Golden Knights, Carl’s Jr, Hardees, and Whitefish Mountain ski resort, among others.
Though title insurance may be boring, the industry has a number of the economic characteristics I look for in an investment:
Oligopoly with rational price competition between competitors;
Customers who are not price sensitive;
Mandatory, non-discretionary product;
Consistent profits;
Float;
High returns on tangible capital;
Revenues tied to the value of real estate, which inflates over time; and
Barriers to entry (scale, data, relationships).
That the four largest title insurers trade for 6-7x earnings (per Value Line) only added to my intrigue. It’s important to note that title insurance is notoriously cyclical and headline P/E ratios need to be normalized to be useful.
What Is Title Insurance?
Title insurance makes a buyer or lender whole in the event that there is a problem with a purchased property’s title. It assures the lender and buyer that the person selling a property actually has a clear title to transfer to the buyer.
Here are some potential issues that title insurance can protect policyholders from:
Documents executed under false, revoked, or expired powers of attorney
False impersonation of the true land owner
Undisclosed heirs
Improperly recorded legal documents
Failure to include necessary parties to certain judicial proceedings
Gaps in the chain of title
Mistakes and omissions resulting in improper abstracting
Forged deeds, mortgages, wills, releases of mortgages, and other instruments
Deeds by minors
Inadequate legal descriptions
There are two types of title insurance. Most real estate transactions require both.
Buyers pay for lender’s title insurance to protect the lender against any title defect affecting the priority of the mortgage. The face amount is equal to the outstanding balance of the mortgage loan.
Sellers (often) pay for buyer’s title insurance to indemnify the buyer against defects in the purchased property’s title. The face amount is equal to the purchase price. If a problem did arise with the title, the hometown would lose out on their property’s appreciation.
In a refinancing, ownership doesn’t change so new buyer’s policies aren’t necessary. Only a lender's policy is needed. In an all-cash purchase, no lender’s policy is issued but an owner’s title policy usually still is. The premium for refis are less than half of a purchase.
How Does Title Insurance Work?
A title insurance transaction begins when a customer, such as a real estate broker, escrow agent, attorney, or lender, contacts a title insurer to request a policy. Note that the person who selects the title insurer to be used is rarely the person paying for the policy.
Next, the title company conducts a title examination by compiling relevant historical data on the property. This involves searching for and examining documents such as deeds, mortgages, wills, divorce decrees, court judgments, liens, assessments and tax records. To accomplish this, title insurers maintain extensive “title plants” which are indexed compilations of public records, maps and other relevant historical documents. The Financial Accounting Standards Board (FASB) has ruled that a title plant is a unique asset that, if properly updated, does not diminish in value over time.
The title company will then issue a preliminary report to all parties involved in the real estate transaction. The preliminary report will highlight any title issues discovered. After all issues are resolved, the escrow agent will close the transaction and release funds to the seller, brokers, and title company.
Title insurance premiums are due in full at the closing of the real estate transaction. Premiums are based on the value of the underlying real estate. Like other forms of insurance, title insurance produces float. Title insurers invest the premiums they receive and keep their investment profits.
Distribution
Title insurance is distributed via captive and independent agents. Agents typically retain 70-85% of premiums, which is substantially more than the 10-25% agents in other lines keep. Title agents are paid more because they’re typically the ones doing the title search, examination and underwriting. Public records are usually only available locally so it’s tough for title insurers to make centralized underwriting decisions.
Relationships with real estate brokers, escrow agents, attorneys, and lenders are critical to sales. These people want a title insurer that they know and trust, is easy to work with, and which will not hold up the closing process. They don’t care about price, since their client, not them, pays the premium. Local relationships are difficult to replicate and provide a barrier to entry. They’re one reason the largest title companies have grown by acquisition instead of organically.
It is illegal for title insurers to pay for referrals. However, some states allow title insurers to offer non-monetary consideration. For example, a title company might pay for a real estate broker’s marketing, market analysis, or mailing list. Most forms of consideration, and gifts are illegal kickbacks.
Differences With Other Insurance Lines
Title insurance is different from most other types of insurance in that it protects against past losses, not future events. Fire, auto, health and life insurance protect against future losses and events. In contrast, title insurance generally insures against losses from past events.
Title insurers aim to eliminate losses during the title examination processes before issuing a policy. Issues are identified and resolved before the policy is written. Therefore title insurance loss ratios are usually in the mid single digits. For comparison, auto insurance loss ratios are usually above 70%.
Claims are typically driven by fraud, and the vast majority of claims arise in the first five years of a title policy. There was an increase in fraud on policies written between 2006 and 2008 which caused FNF’s claims to hit 15% in 2010. They’ve since declined to mid-single-digits.
What title insurers save on losses they pay out in expenses. Maintaining title plants and conducting title examinations is labor intensive and personnel are a title insurer’s main expense. Title insurance expense ratios average nearly 90%. For comparison, low-cost auto insurers like GEICO and Progressive average about 20%.
Title insurers have a higher proportion of fixed costs than other lines of insurance. Title plants must be updated daily, even in slow markets. If a title plant becomes outdated, it could lead to underwriting losses. The cost of maintaining a title plant is relatively fixed and contributes to the cyclical and lumpy nature of title insurance profits.
While title insurers generate float, they generate significantly less than other lines. Title insurers incur most of their costs up front, before they issue a policy, during the title examination. High expense ratios — normally 90% — mean only 10% of premiums become float. Less float means title insurers have less financial leverage than P&C insurers.
Title insurance is usually issued for a one-time premium and remains in force for as long as the owner owns the property or lender has a lien on the property. Other forms of insurance provide protection for a limited period of time and must be regularly renewed.
Since title insurance policies don’t have a definite beginning or end, title insurers generally don’t know which of their policies are still in force. Most other lines of insurance receive periodic premium payments and policy renewals to let them know which policies are still effective.
Royalty On The Appreciation Of American Real Estate
Title insurance operates like a royalty on the growth of American real estate. To be clear, the operative word in the last sentence is “like.” Title insurance isn’t a royalty in the strict sense, though it does have some similarities.
Title premiums are based on a percentage of the home sales price so rising home prices increase the cost of title insurance premium. Rising real estate prices provide the title industry a tailwind.
Title insurance is often mandatory. Virtually all mortgage lenders require borrowers to get title insurance. Title companies get paid a toll whenever real estate changes owners or gets refinanced. Transaction volumes are cyclical, which makes earnings lumpy.
Customers are not price sensitive. The person selecting the title insurance policy is rarely the one buying it, so the selection is made based on quality of service rather than price. The lenders that require title insurance are not the ones paying for it, so they’re indifferent to the price. The policy’s premium is usually bundled in with other closing costs and not obvious. The premium is small relative to the size of the transaction — about 0.5-1.0% for both a buyer’s and lender’s policies — and isn’t to receive push back.
Title insurers generate consistent underwriting profits. Since they insure against past events, their loss ratios are typically in the low single digits. Their primary costs are their personnel, which is entirely under their control. Matching workforce size to the current housing market’s volume isn’t trivial, but more straightforward than, say, predicting the frequency and severity of hurricanes.
The title insurance industry is an oligopoly dominated by a few large firms. In 2020 the top four firms captured 79% of net premiums written. FNF is the largest, followed by First American, Old Republic, and Stewart Guarantee. 34 companies accounted for the remaining 21%.
Local relationships and local data produce barriers to entry. Maintaining title plants is expensive, tedious work. Earning the trust of local real estate brokers, attorney’s, and lenders doesn’t happen overnight. There have been no new title companies formed last decade that have achieved any significant size
All of these factors manifest as high returns on tangible capital. FNF’s ROTE averaged 90% over the last five years and improved sequentially from 49% to 156%.
Risks
The primary risk facing the title insurance industry is obsolescence. It is a popular opinion that the US title system is archaic, a waste of money, and ripe for disruption. To understand this risk, it’s vital to understand why our current system exists and what other options exist.
The English System
The current U.S. title system has its roots in medieval English land law. Under common law, someone selling land needs to demonstrate their ownership of the land by tracing the chain of ownership back to the earliest grant of land by the Crown to its first owner. While it is no longer necessary to trace land ownership back to the Crown, the concept of a “chain of title” remains.
However, even an exhaustive title chain does not give a buyer complete security because of the principle of nemo dat quod non habet ("no one gives what he does not have"). The nemo dat rule means that an undetected mistake or omission in the title chain nullifies the title’s conveyance. If a sellers sells a property they don’t have title to — either fraudulently or mistakenly — the buyer is not entitled to the title, even if their money is gone. That’s why title insurance exists — to make sure you get your money back if you don’t get the property.
The U.S.’s deeds registration system is merely a registration of all important instruments (e.g. liens) related to the land. To establish title to the land, a person (or their attorney) must ascertain that:
all the title documents have been properly executed;
"a chain of title" is established, i.e. the proper ownerships from the granting of the land from the government to the current owner; and
there are no encumbrances on the land that probably will harm the title of the land.
The Torrens System
In 1858 Sir Robert Torrens devised and implemented a new title system in Australia. The Torrens title system did away with the “chain of title” requirement and the deeds registration system. The Torrens system is used in Australia, Canada, and Ireland, among others.
In the Torrens system the government guarantees the title and keeps a registrar of titles, not merely a registrar of instruments related to the land. The government register serves as conclusive evidence of title. Registration cannot be challenged or overcome by a court of law. This concept is known as the “indefeasibility of title.” Ownership is passed via registration, not deeds.
The Torrens system was designed to enhance a title’s certainty, speed up the transfer process by eliminating repetitive title searches, and thereby lower the cost of transferring property. However, Torrents never quite achieved these goals in the U.S. The Torrens system has several drawbacks.
The first drawback is the initial cost of registering the property. The system is most effective when unimproved land is subdivided for the first time because it reduces the number of deed entries an examiner must review.
The second drawback is government bureaucracy. When the government has a monopoly, they tend to move slowly and require a lot of paperwork. Government officials risk taxpayer money, not their own, and doesn’t have skin in the game. For example, in 1989 Chicago had a two-year backlog of Torrens title registration requests. More on that below.
The third and most important drawback is that lenders and investors don’t prefer it. When mortgages began trading on secondary markets in the 1970s, institutional investors would not accept a Torrens certificate as a guarantee of title. That meant lenders that wanted to sell their mortgages had to require private title insurance. Though private title insurance is more expensive, lenders, who are highly risk averse and not paying for it, are more comfortable with it.
Chicago
The drawbacks of the Torrens system are best seen through a case study of Chicago. The city transitioned from the English system to a Torrens system in 1897 and then back to the English system in 1992.
In 1871 the Chicago fire destroyed Cook County’s real-estate records. This made title verification difficult at a time of rapid growth for the city. In response, the Illinois legislature established the first Torrens Title Act in the United States in 1897.
However, use of the Torrens system began to decline as early as the 1930s. By then 60 years of public records were available to private insurance companies who competed vigorously with the Torrens system. Torrens registrations dwindled to just 163 for the ten years between 1967 and 1977.
Why? Lenders preferred the fast, efficient title insurance company methods to the slower administrative processes of the Torrens system. Private insurers could offer a guarantee of title faster than the government could. They could also pay claims faster than the government. Many lenders refused to issue loans unless a Torrens certificate was accompanied by a private title insurance policy.
In 1989 a 57-member Cook County special committee labeled Torrens ''archaic'' and recommended that the state legislature eliminate it. The special committee reported a two-year backlog in the Torrens section of the county recorder's office, where 20 percent of Cook County’s land was registered.
The Torrens system was undoubtedly cheaper than private insurance in Chicago, but price is not a concern for those buying title insurance. That’s one reason it is a great business. In 1989 in Chicago verification of land ownership cost only $52 under the Torrens system. However, since most lenders also required private title insurance which cost $300-500 the $52 Torrens certificate became a redundant added cost. The private market voted Torrens out, despite significant price savings.
Iowa
Iowa currently uses a (loose) form of the Torrens title system. In 1947 Iowa banned private title insurance after a spat of title insurance bankruptcies in Sioux City. It created a statewide title guarantee program and in 1985 it created a state-sponsored title guarantee company to ensure mortgages could be sold on the secondary market. Iowa homebuyers pay 20-30% less than the national average for title insurance primarily because the state title company pay agents commissions.
The Iowa system seems to have more staying power than the Chicago system because it is a hybrid. It’s not so much a Torrens system as a state-run monopoly title insurer.
Iowa’s current system came about after a wave of private insurance failures. Without widespread failures, Iowa’s actions would amount to a nationalization of the industry. While anything could happen, I can’t imagine that happening in the US to a healthy, profitable industry. The government has little incentive to do what private industry already does well just to save its citizens 20-30%.
Blockchain & Digital Disruption
It is not obvious to me that blockchain or new technology will disrupt the title insurance industry. A decentralized digital ledger would still have many of the downsides of the Torrens system.
For one, it would be extremely expensive and complicated to transition to such a system. Australia transitioned to Torrens when most of its land was undeveloped. Same for Canada — most of its provinces began with Torrens from day one. Chicago only transitioned to Torrens after the entire city, and all its records, burned down. Iowa isn’t so much a Torrrens system as it is a government-monopoly title insurer.
Second, lenders and institutional investors are extremely risk adverse and unlikely to prefer a new system. Banks don’t take risks on new tech. They want to work with firms they can trust who have skin in the game and deep enough pockets to stand behind their promises. Governments are not known for making people whole in a speedy and expeditious manner.
Plus, lenders don’t pay for title insurance, so they don’t care if it costs a little extra. Homebuyers don’t seem to care if they pay more either since the premiums are trivial in the scheme of the whole purchase. The market doesn’t value the lower costs a new system could provide.
So long as lenders and investors require title insurance, it’s likely to exist. The industry is too deeply entrenched to realistically disrupt. A state that banned title insurance would likely see itself cut off from secondary mortgage markets.
Fidelity National - The Best Of The Bunch
Fidelity National Financial (FNF) is the nation’s largest title insurance company. It owns Fidelity National Title, Chicago Title, Commonwealth Land Title, and Alamo. Bill Foley is its chairman and has overseen its Outsider capital allocation. For instance, Foley directed FNF to repurchase one-third of the company in 1994-95 at 4x earnings.
FNF has compounded at 15-20% annually since its 1987 IPO. Its record is little known because it is obscured by so many spinoffs (hence the ambiguity on FNF’s exact compound return).
Notably, FNF spun off Fidelity National Information Services (FIS) in 2006 and Black Knight in 2017. Combined, these have a market capitalization of $70 billion. As FNF’s CEO once said, “everything is always for sale.”
Today FNF owns 8% of Cannae Holdings (CNNE), where Bill Foley is also chairman, worth $160 million (~1% of FNF’s market value). The company is in the process of spinning out part of its stake in F&G, an annuity and life insurance company.
FNF is the most efficient operator in the industry. Over the past two decades, its pre-tax margins have consistently bettered its peers. FNF’s advantage is particularly obvious at market bottoms. In 2010 FNF’s 11.5% pre-tax margin was well ahead of First American’s 6.8%, Stewart’s 1.7%, and Old Republic’s 1.7%.
FNF has outperformed by focusing on minimizing costs rather than maximizing market share. Ironically, low costs have allowed FNF to weather cyclical downturns better than its peers and gain more market share over time. The title industry’s cyclicality has created lots of opportunities for Bill Foley to add value via capital allocation over the last thirty five years.
Since the title insurance is cyclical and most of a title company’s costs are personnel, it's paramount that senior managers match the size of their workforce to the industry’s current volume. FNF has done this best, which is one big reason their margins are best in class.
How does FNF do this? Not by forecasting revenue or the housing market. FNF doesn’t employ economists. Instead, FNF pays close attention to real time order counts and reacts to changes quickly. Managers meet every Monday morning to review the number of open orders, which is a leading indicator of future revenue. If orders are down, FNF begins to reduce headcount. If orders are flat or up, they do nothing. FNF only adds staff when orders rise significantly.
Four to five back office employees support each salesman. They’re the ones who research and examine titles. FNF flexes its back office staff up and down in response to changing volumes. FNF is much slower to flex its sales staff up or down because the salespeople are the ones who generate revenue and have the critical relationships with local real-estate agents, lawyers, and lenders.
Normalized Valuation
It’s critical to value a title insurer like FNF using normalized assumptions over an entire cycle. Currently, FNF looks dirt cheap at 6x earnings because earnings are likely near a cyclical high. They’re ramped from $3.83 per share in 2019 to $8.44 in 2021.
FNF’s management doesn’t waste time trying to predict the housing market’s future, so neither will I. Below I’ll briefly explain one way of normalizing FNF’s earnings. To be clear, the numbers I am using are for illustrative purposes only. I don’t have a lot of confidence in them. Feel free to substitute your own assumptions.
FNF’s business is driven by mortgage origination and refinancing volumes. While their margins are identical, the margin dollars are not. FNF charges three times more for an origination than a refi ($3,400 vs $1,100 in 2021). This is important to keep in mind as interest rates rise and refis, which have been white hot, dry up.
Over the past 30 years, about 13% of mortgage debt outstanding was refinanced each year. Purchase originations made up about 14% of mortgage debt outstanding. Counting refi’s as 1/3rd, total “housing velocity” was 18%. I’ll round to 20% for simplicity.
The Federal Reserve reported there was $16T of mortgage debt outstanding in 2019. Since the market has appreciated significantly since then, let’s assume that’s $20T now.
Here are my assumptions:
$20T mortgage market
20% housing velocity, meaning $3.6T per year in mortgage originations
38% market share for FNF
0.75% premium per policy as a percentage of the underlying real estate
13% pre-tax margins for FNF
The result is $1.5 billion of normalized pre-tax underwriting earnings, well below 2021’s $3.1 billion. Adding $200 million for investment income brings total pre-tax earning to $1.7 billion.
That places FNF at 15x normalized pre-tax earnings. 15x isn’t crazy, but it’s also no bargain. I’d expect the stock to trade for 10x pre-tax and would like to acquire it at a discount to that using conservative assumptions.
The Bottom Line
FNF is a wonderful company in a wonderful industry. Unfortunately, it is probably too cyclical for my tastes. I’ve learned that I am much more likely to stick with an investment for a long time and sleep well at night if it is non-cyclical or counter cyclical. They’re just easier to predict. Fortunately, there are plenty of those businesses exist.
That said, I’d never say never. I’d love to buy FNF at a cyclical low during a period of extreme housing pessimism. That would probably happen when title insurers look optically expensive and have high P/Es on trailing earnings. We have the opposite conditions today — lots of optimism, a (likely) cyclical peak, and optically low P/Es.
For me, FNF is one to keep watching and learning about. Perhaps one day I’ll get a fat pitch.
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no way! i was looking at this too!