Title insurance is an insurance policy that protects the holder from loss sustained by title defects. A title report indicates the current state of the title relative to easements, covenants, liens, and defects. Lenders make it manditory for buyers to obtain a title policy to qualify for a loan.
Skylie, good answer below from Oleg. To sum up simply. Title insurance which in my locale of Pennsylvania is a one-time fee and is based on the purchase-price of the real estate, protects you from the past, as all other insurances protect you from future events. When you close on a property or go to settlement/escrow, you and any lender want to make sure you are receiving clear title.
When a buyer acquires interest in a property - he or she want to be assured that at this point the property does not have any unknown claims on it from other individuals (such as relatives of the seller). Also, the seller wants to be assured that there is no fraud present.
Title insurance is protection against financial loss incurred by a buyer as a result of issues with the title that come to the surface. When a buyer purchases title insurance and pays a single premium, the risk of dealing with title issues transfers from him/her to the insurance company. Needless to say, an insurance company performs title search prior to collecting the premium and issuing the policy.
Lenders require title insurance since they do not want to be in a position to deal with unprotected title issues.