Remember to Ask 'What If?'

 by Albert Rush

(Revised and reprinted from Title News, published by the American Land Title Association.)

Around 50 B.C., Heraclitus of Greece said that you can't step twice into the same river. The river changes constantly and so, ventured Heraclitus, does the person.

Change has been a recurring theme in business and title industry circles in recent years. The message is clear: Those who do not prepare to participate in "electronic commerce" will be left behind.

With this as background many of us have begun to wonder where our claims experience will be headed.

Barely 10 years ago claims resulting from title and settlement operations were considered a serious threat to profitability within our industry. At the time, actual loss payments were averaging about 9-11 percent of gross revenues annually. Viewed from the standpoint of the life of a policy it was estimated that claims consumed 12-15 percent of every premium dollar received by title underwriters.

Through increased claims awareness, training and professionalism, industry claims experience has improved significantly in recent years. But now, in light of coming changes, many of us are concerned that claims may increase, our gains may be reversed, and profitability may be threatened once again.

Electronic Data Interchange (EDI)

Many businesses (although not many title companies) are now using EDI to exchange documents and data with other businesses. EDI is a standard by which computers communicate with each other in formats called "transaction sets."

When these exchanges take place over private dedicated telephone lines, they are faster and more secure than mail, fax or Internet transmissions; although they can also be done on the Internet. Over the past few years, EDI standards for the title industry have been designed through joint efforts of ALTA and the Mortgage Bankers Association of America. Everyone expects use of EDI to mushroom in the title and mortgage lending industries in the next few years.

Will reliance on EDI cause an increase in our claims experience? I don't think so.

As more and more lenders, title companies and related service providers implement EDI, we should see a speeding up of title order processing, but this should not necessarily create an accident-prone environment. Title and settlement service providers have traditionally been judged in terms of turnaround times and ability to handle volumes of business on short notice. We should be able to do just fine with EDI.

On the other hand, where EDI is implemented, claims experience should improve to the extent personnel are no longer pressured to close relying on miscommunicated or misunderstood verbal messages, or information and releases "to come."

Automated Loan Origination

With the combined capabilities of loan origination software programs and EDI, lenders today have systems available to automate most of the loan origination process.

With a laptop computer, the loan originator can interview a prospect at home, a shopping mall, or any place of business, and within about an hour may prequalify the borrower, shop for mortgage terms, lock in a rate, and complete a loan application. In some cases the entire process from application to closing can be completed within 24 hours.

An important feature of these systems is that the borrower's personal and financial data is entered only once, then stored for later uses such as loan underwriting, ordering title work, and document preparation. These systems permit fast and accurate preparation of both standard and custom forms, which are formatted to accommodate government regulations and lender requirements.

While some lenders have been slow to convert to automated systems, others are enthusiastically implementing and forming business strategies around them.

Fannie Mae and Freddie Mac have led the way in exploiting this technology by endorsing use of loan origination systems, and Fannie even offers its own system under the "Desktop Originator" brand name.

Noting the efficiencies these systems provide, Fannie and Freddie are urging lenders to reduce loan processing times to five days or less, and Fannie seeks to cut costs to the consumer by an average of $1,000 per deal.

These developments have greatly changed the mortgage lending business, making it much more competitive and cutting profit margins. As a result, mortgage lenders have become more creative than ever in searching for ways to market their products, reduce overhead, and increase their volumes of business.

All of this has ramifications for title companies and our claims experience. Here are some thoughts: First, there has been, and will continue to be, great pressure on title and settlement service providers to process transactions faster and cheaper. "Faster and cheaper" has become a mantra for mortgage lenders. It is the key to their ability to compete and remain profitable, and it is a trend strongly promoted by Fannie Mae and Freddie Mac.

The effects of this trend vary from place to place. In urban areas, where platted subdivisions are common and computerized title plants are in place, there appears to be little or no problem in servicing a lender's order for title insurance in two or three days. Among the reasons many orders do not close within this time frame are delays in obtaining payoff demands from existing lenders, as well as homeowner or fire insurance.

In other areas, such as small communities or outlying rural areas which are typically not served by a reliable computerized title plant, more time may reasonably need to be taken. Among the factors determining turnaround times in these areas are condition and availability of local public records, availability of reliable prior title examinations (sometimes known as a "starter," "base," or "prior"), difficulty in interpreting legal descriptions, and the need for a current survey, water test, or other information requiring on-site inspection.

With the passage of time, and it won't be long, we should expect that lenders will demand faster and cheaper service even in rural and outlying areas. As an inducement, they may eliminate requirements involving on-site inspections.

The tougher question is how title and settlement service providers might cut costs without taking shortcuts likely to increase claims. Certainly, the growth of electronic commerce may foster efficiencies which may then justify cost reductions. For now, title companies are responding to cost-consciousness in the marketplace by offering cheaper alternative title insurance products which pare down coverages and re-allocate risks to the lender.

In California, for example, First American offers a lender's limited coverage policy insuring only vesting information (as shown on the last deed of record purporting to affect property under search), property tax information (as shown by the latest assessment roll), and that no lien or mortgage affects the land other than as shown in the policy.

Recently, we issued such a policy for a $100 premium, covering a home in Berkeley. The vestees of record were two men, Alan and Cornelio, as joint tenants. The lender parted with $100,000 in exchange for a mortgage signed only by Alan, relying on a grant deed from Cornelio to Alan on which Cornelio's signature was forged. This risk is not covered by the limited coverage policy. Alan has relocated to Amsterdam. The loan is nonperforming. Since their mortgage is only enforceable against his one-half interest in the property, the lender was alarmed by a rumor that Alan is HIV-positive. If he dies before Cornelio, Alan's interest will automatically pass to Cornelio as the surviving joint tenant, entirely free of the lender's security interest.

A second concern we may have as mortgage lenders trend toward automated loan originations is that contacts between the property owner/borrower and the title company may be further minimized in ways that encourage fraud or permit mistakes and misunderstandings leading to claims.

The present trend envisions two points of contact with the borrower in the loan origination process: First, when the loan originator takes the loan application and enters data required for the transaction and, second, at or in connection with closing when the settlement officer obtains signatures on mortgage documents. The second step, closing, may further be streamlined or eliminated as lenders may choose to do their own closings in-house, or accomplish closings using EDI.

In this scheme of things it should be clear that the loan originator, making initial contact, should be more than a salesperson. He or she should be well-trained to understand mortgage products and the fundamentals of loan underwriting.

Likewise, it's important to us that these individuals understand the fundamentals of title underwriting so they are alert to such risks as impersonation and forgery (particularly between spouses), questions of competency and capacity (inviting claims based on mental incompetency, inability to understand the English language, or illiteracy), the existence of off-record matters (such as access problems or claims of adverse possession), and problems arising from property descriptions which involve more than one neatly surveyed and subdivided lot.

In this environment, title companies may want to know something about the practices and professionalism of their lender customers. Likewise, they may be interested to see that settlements continue to be performed by reliable and qualified personnel. In some areas, additional training of settlement officers may be needed to improve understanding of title insurance coverages and underwriting issues.

It may also be a good idea upon receipt of each title order to routinely mail a letter to the property owner, at the address shown on the local property tax roll, thanking them for "selecting" the title company in connection with their pending transaction. Where this procedure is followed it has prevented some frauds and forgeries.

Automated Loan Underwriting

The last function to be automated in mortgage origination has been loan underwriting, but now it's here. Automated or "electronic" loan underwriting systems employ artificial intelligence to weigh factors traditionally considered by human underwriters. Proponents of automated underwriting systems say they are faster and more objective than humans. Both Fannie Mae and Freddie Mac generally endorse such systems as reliable predictors of loan performance.

Although no two systems are alike, automated underwriting systems are of two basic types: some provide a "credit score" or "mortgage score," while others decide to "approve or refer" an application.

A credit score rates the probability that a borrower will be able to repay a given loan, considering such variables as number of open loan accounts, number of active accounts, past delinquencies, length of credit history and current levels of indebtedness. A mortgage score adds to the equation such considerations as loan-to-value ratio and real estate market conditions. Mortgage scoring systems are being offered by such companies as Mortgage Guaranty Insurance Corp., PMI, GE Capital, Citicorp, TRW/ Mortgage Resource Group and United Guaranty Residential Insurance Company.

Lenders can use credit and/or mortgage scores to price loans at point-of-sale, as well as to identify borrowers whose applications may qualify for streamlined processing and minimal documentation. A high score is a green light for streamlined processing, a lesser score is the yellow light which should cause the application to be given to a human underwriter.

"Approve or refer" systems are offered by Freddie Mac ("Loan Prospector") and Fannie Mae ("Desktop Underwriter"). Like the scoring systems described above, these systems are designed to help loan originators quickly identify which applications may qualify for streamlined processing and minimal documentation.

The acceptance and use of automated underwriting systems is growing fast. In July 1996, Freddie Mac and the FHA undertook a pilot program using a special version of Loan Prospector to underwrite FHA loans. And, originally designed to score only "prime" or "A" loans, a newer version of Freddie's Loan Prospector is now offered for scoring jumbo and "subprime" loans (for low and moderate-income borrowers).

Much effort and expense has gone into development of automated underwriting systems. Since they are intended to supplement rather than replace human judgment, there is no reason to believe their growing use will have a negative impact on loan portfolios or title claims experience.

Mortgage Electronic Registration System (MERS)

The organization and incorporation of the Mortgage Electronic Registration System (MERS) is a project spearheaded by the Mortgage Bankers Association of America, with input from the title industry. MERS will operate as an electronic registry of mortgage ownership and servicing rights, nationwide.

As MERS begins operations this spring, whenever a mortgage is originated by a participating lender it will be automatically assigned to MERS. MERS will give each mortgage an identifying number so that no mortgage within the registry will ever be confused for another. During the life of each mortgage, all assignments of ownership or beneficial interest and/or servicing rights will be tracked electronically.

MERS should eventually enable settlement officers to quickly and reliably verify loan ownership and servicing rights in many cases. Since confusion over such matters occasionally results in claims, conceivably it may help our claims experience. By itself, MERS will not speed transactions because it will still be necessary for settlement officers to contact existing lenders for payoff information.

Electronic Recording

With the growth of EDI, it may be just a matter of time until county recording offices are set up to record documents electronically.

In California's San Bernardino County, tax lien and release information has been exchanged electronically between the recorder's office and county and state taxing authorities for more than a year.

The success of this pilot program has resulted in new legislation (effective January 1, 1997) to allow county recorders to accept for recording purposes digitized images of otherwise recordable instruments. Prior law defined a recordable instrument as "a written paper." The new law permits electronic recordings only by local, state or federal government agencies.

The California Land Title Association has formed a committee to study San Bernardino's pilot program, as well as a similar program now begun in Orange County. Fannie Mae has expressed interest in electronically recording mortgage releases, but has not yet done so.

Assuming these pilot programs prove successful, in order for electronic recordings to grow beyond government agencies some way must be devised to guard against recording of forged documents and false releases. How such issues as authentication and legal authority of signing parties might be handled is uncertain, but the title industry will likely play an important role in research and development of electronic recording systems.

Understand and Anticipate

Several years ago, a tragic accident killed two workers and paralyzed yet another during construction of a 593-foot-tall building in downtown Toronto. When something broke in the mechanism of a construction elevator, counterweights attached to a pulley at the top of the elevator shaft fell, causing the elevator cage to be hurtled from the ground upward until it crashed into the 41st floor. The elevator was designed so that in the event of a system failure gravity brakes would automatically prevent it from falling down, but no one, apparently, considered the possibility the elevator might fall up.

With land title claims, the problem more often than not is that the title or settlement person involved was blindsided. As we see changes in our working environment, we should be careful to understand new technologies and systems being implemented, and try to anticipate what can go wrong. We should not hesitate to ask, "What if?"

By anticipating risks and finding solutions compatible with customer needs, we will remain profitable and hopefully attain new levels of customer satisfaction in the coming era of "electronic commerce."

Albert Rush is Senior Vice President and National Counsel, First American Title Insurance Company, Santa Ana, California.

Table of Contents | Next Story