Insurance

On the up – possessions and title claims

July 2007

BOX

Executive summary

o An increase in possessions will lead to more claims against lenders' title insurance policies for two reasons: many lenders use title insurance as a risk assignment tool; and problems with title or fraud are more likely to come to light.

o London & European has experienced an increase in claims volumes over the past three years at a time when possessions have been relatively low.

o There are around 25 different types of claims that can be made against a title insurance policy with fraud, including identity theft, representing a major proportion of current claims volumes.

o Other title defects likely to become more prevalent include lack of appropriate planning consent or regulatory approvals, restrictive covenants, undocumented rights of access, undiscovered title defects and Land Registry errors.

o Solicitor negligence is also contributing to the claims book and it is quite possible there will be a rise in right-to-buy title insurance claims.

The UK property market could be on the verge of catching a nasty cold. Many economists for some time now have been predicting that the boom is drawing to a close, yet market indices have continued to provide opposing evidence. Given the current economic climate, however, there really does seem to be a genuine air of concern now as to what the future holds - and the debate over the outlook for the UK housing market is hotting up.

At the end of April, the Bank of England issued an ominous warning that the era of booming house prices and low inflation could be coming to an end. This alert came a week after the Cost of Living index rose to 3.1 per cent, the highest for 15 years and way above the government's 2 per cent target. Bank of England governor Mervyn King conceded that rapid growth in the supply of money and credit in the economy may be a warning signal of inflationary risks.

High inflation means higher interest rates. We have seen rates creep up over recent months to reach a six-year high of 5.5 per cent in May. While the great and the good in our industry have been talking about a high of 6 per cent, a group of Britain's leading economists have warned that interest rates may have to climb to as high as 7.5 per cent to control inflation.

This would represent a massive blow to homeowners, many of whom have already stretched themselves to the limit to afford the ever increasing cost of buying a home.

Borrowing has reached record levels and the average house price has topped the £400,000 mark in London. Even in the areas of Britain with the cheapest properties, the average price has now risen above £100,000 according to the Halifax. Britain's debt mountain has reached a record £1.3 trillion, compared with just £500 billion when Labour came to power ten years ago. While the vast majority of this debt is linked to home ownership, the level of unsecured debt has also climbed.

Accountancy firm Ernst & Young recently published its Independent Treasury Economic Model (ITEM) Club spring forecast, in which it noted the UK saving ratio at just 3.7 per cent. This means that many households are borrowing more to finance current spending. The ITEM forecast also states that homeowners, under increasing pressure from rising tax and utility bills, are dipping into savings and increasing their mortgage to support their continued spending pattern. The Bank of England noted in its memo to the government that there is more evidence to suggest that the level of unsecured debt might be presenting problems.

Were interest rates to match the prediction made by Britain's leading economists in order to control inflation, the consequences on consumers and our industry would be dramatic and, I believe, result in some significant changes.

We would undoubtedly see possessions rise further - possibly not to the all-time high experienced in the early 1990s, but certainly enough to cause lenders to revise further their provisions for bad debt. The number of possession orders in England and Wales rose 1 per cent in the first quarter of the year. With over £100 billion-worth of fixed-rate mortgages set to end in 2007, borrowers could expect to experience average rises of over £1,000 a year if they have to move on to their lenders' SVR - and that could be enough to tip many over the edge into arrears.

[SUBHEAD]

Rise in title insurance claims

We believe this increase in possessions will undoubtedly lead to more claims against their title insurance policies for two reasons. Firstly, title insurance has been widely adopted by lenders since its introduction to the UK and many are using it as a true risk assignment tool. Secondly, it is a sad but true fact that problems with title or fraudulent acts are more likely to come to light as a result of a possession action by the lender.

It is difficult to predict what kind of claims volumes might be generated. However, lenders today have embraced the benefits that title insurance can deliver, and are far more likely to turn to their title insurance policy to investigate whether they can make a claim to help recoup their losses if they cannot achieve the full value on a property taken into possession than they were 12 years ago. It has gone from being a little-known solution to a legal snag, to now often being the first resort. We have certainly experienced an increase in claims volumes over the past three years at a time when possessions have been relatively low.

This is particularly true in the non-standard lending sector, where many lenders sell or securitise their mortgage portfolios. If an issue with the title arises or a fraudulent act by the borrower comes to light at the point of taking possession of a property, it is essential to the value of the investment vehicle to correct the title. And arguably, customers of non-standard lenders present a greater risk of going into arrears.

According to a new report by Standard & Poor, the number of borrowers classified as non-conforming and in arrears rose from 17 to 23 per cent during 2006. The sector also saw repossessions treble. For those borrowers coming out of a fixed-rate period into a higher-interest-rate market, there is significant potential for payment shock.

As well as an increase in the volume of title insurance claims, I believe that we are likely to see a shift in the types of claims received.

[SUBHEAD]

Types of claims

There are approximately 25 different types of claims that can be made against a title insurance policy, including adverse possession, defect on sale, Land Registry error, solicitor negligence, missing documents, undiscovered defects and fraud (including identity theft). The latter represents a major proportion of current claims volumes. There have been an increasing number of claims triggered by acts of fraud and forgery over the past few years. Borrower fraud represents a significant percentage of the claims we have processed between 2001 and 2005. Looking at our recent claims history, it would appear that this trend is continuing. Given the increase in identity theft - the UK's fastest growing crime costing almost £2 billion a year - this perhaps comes as no surprise.

[SUBHEAD]

Fraud

Specific statistics on the number of fraudulent mortgage applications are hard to come by, but there is no doubt that this is becoming a major risk for lenders - particularly if the case goes to court and the judge rules in favour of the defendant rather than the lender. In January this year, a man who illegally borrowed more than £200,000 by forging his wife's signature avoided paying compensation to the lender who, the judge decided, “brought it upon themselves”. In this case, the judge said he had no sympathy for mortgage companies “foolish” enough to lend money without thoroughly ensuring applications were genuine. At L&E, we have seen a growing number of borrowers forging the signature or identity of their partner to obtain a mortgage.

As possessions go up, more fraudulent acts are likely to come to light and so we may well see this type of claim continue to increase from both prime and sub-prime lenders – it is a myth that fraud only exists in the sub-prime sector. However, the impact of a big shift upwards in interest rates will catch more homeowners in the net and I believe that we will see other title defects become more prevalent and triggering a claim as a result. Over the period from 2001 to 2005, this type of claim represented less than 10 per cent of the total volume settled by L&E. Issues such as lack of appropriate planning consent or regulatory approvals, restrictive covenants, undocumented rights of access, undiscovered title defects and even Land Registry errors will come to light as more possession actions take place.

[SUBHEAD]

Solicitor negligence

Another significant contributor to the claims book is solicitor negligence; as possessions rise, we could well experience an increase in this type of claim whether a case of genuine sloppy conveyancing, or failure by lenders to release discharge documents. In the past, lenders have generally admitted the error if they have failed to provide a true redemption figure, but it can take years to obtain compensation from the solicitor's professional indemnity policy, and lenders are not so willing to put up their hand as times get tougher. At L&E, we have already seen evidence of this happening in recent months.

[SUBHEAD]

Right-to-buy

We could also see an increase in claims relating to right-to-buy properties. This type of claim has formed a relatively low percentage of our total claim volumes; however, many consumers have taken advantage of their ability to buy their home at a discount from their local authority over the past five years. Equally, many of these may well have stretched their finances to get a foot on the property ladder, or remortgaged the property to take out capital and turn their former council home into their dream castle. If prices slow or go into decline, lenders having to take possession of these properties could well be faced with a shortfall when they have to repay the local authority or housing association discount.

[SUBHEAD]

House price rises

With the huge leaps in property values in certain parts of the country, we could well see an exodus of prime borrowers into the sub-prime market as they struggle to keep up with payments should interest rates creep further upwards. Many could fall into the negative equity trap and struggle to remortgage should the predictions of economists at Morgan Stanley come to bear and house prices fall.

Growth in house prices slackened during April according to Hometrack, and it expects a slowdown in the rate of house price growth over the second half of the year. A Capital Economics spokesperson is quoted as saying that a drop in house prices in London next year is not impossible to imagine. Such a fall would cause shockwaves to be felt by many Londoners, thousands of whom have become 'property millionaires' as a result of soaring house prices.

Rising property values have also come hand in hand with the growth of automated valuation models (AVMs). While discrepancies in actual versus automated valuations can occur, it is notable that should a property develop a title defect, the title insurance policy will respond either to cure the problem or to compensate the lender, regardless of the true value of the property.

There is no doubt that it is going to become more important than ever for lenders to use title insurance as a true risk assignment tool, and so it will be equally important that this valuable product continues to deliver.

The higher interest rates imposed over recent months would appear to be having some influence on borrowing. Recent figures published by the British Bankers’ Association indicate that net lending has risen less sharply and, compared to the same time last year, the number of mortgages approved was lower. Figures recorded by the Council of Mortgage Lenders show a record low 110,000 approved mortgages in April this year. A cooling in the marketplace could help stem the need to push rates up further; however, there is no doubt that we are in for some challenging times ahead.

From my own perspective, it is going to be interesting to see what differences we start to see in the types of title insurance claims L&E is called on to manage over the coming months. MFG

[BIO - ITALS]

Christopher Taylor is CEO of London & European