An Introduction to Private Mortgage

Guaranty Insurance

2003 CAS Annual MeetingNew Orleans, LA

John Gaines, FCAS, MAAAVice President – Structured Transactions

Agenda• What is mortgage insurance (MI)?

• Types of mortgage insurance.

• Industry overview.

• Coverage and exposure.

• Claims.

• Cancellation.

What is Mortgage Insurance?

• What it is.– Protects lender against loss.

• What it is not.– Mortgage life insurance.– Mortgage disability insurance.

Types of Mortgage Insurance

Insured Mortgages

VA

GovernmentInsured

Private MortgageInsurance

FHA

Types of Mortgage Insurance

• FHA Insurance – 100% Coverage

• VA – Limited Guaranty

• Private MortgageInsurance – Limited Guaranty

Distribution by Dollar Volumeof Insured Mortgages

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

1999 2000 2001 2002

VA FHA Private

Private Mortgage Insurance

• Protects insured against loss in the event of borrower default.

• Generally required on original loan amounts greater than 80% of the appraised value or purchase price, whichever is less.

• A private sector alternative to government-insured mortgage loans (FHA / VA).

Industry Overview

PMI Industry History• Roots go back to the late 1800s in NY.

• The Great Depression wiped out the entire PMI industry (>50 companies).

• The modern industry was founded in 1957 upon stringent statutory rules.

Statutory Requirements

• Monoline.

• Contingency reserve.

• Minimum 25:1 risk-to-capital ratio.

• Limit on maximum risk coverage per loan.

Private Mortgage Insurance Providers

• AIG - United Guaranty Corp.

• GE Mortgage Insurance Co.

• Mortgage Guaranty Insurance Corp.

• PMI Mortgage Insurance Co.

• Radian Guaranty, Inc.

• Republic Mortgage Insurance Co.

• Triad Guaranty Insurance Corp.

MI Industry Loss Ratios

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

Industry Income Statement – 2002

($ Millions)• Net Premiums Earned $3,836• Losses 832 • Expenses 899 • U/W Income 2,104 • Operating Income 2,913

Industry Balance Sheet

(as of 12/31/02 - $ Millions)• Admitted Assets $19,761• UEPR 451• Loss Reserves 2,025• Contingency Reserves 12,789• Policyholders Surplus 3,273• Risk-to-Capital Ratio 11.03:1

Importance ofSecondary Markets

• Existing mortgages bought, sold, and traded.

• Ensures availability and uniformity of mortgage credit.

• The GSEs.

Importance ofSecondary Markets

(cont.)

• Private mortgage insurance allows mortgages to be sold on secondary market.

• Home loan funds would be severely strained if mortgages were not sold on secondary market.

GSEs

• The charters of Fannie Mae and Freddie Mac require primary MI or the lender to take a recourse position on loans with original LTV’s greater than 80%.

• The amount of primary MI depends on the loan program and underwriting feedback from Fannie Mae and Freddie Mac.

Loan-to-Value Ratio (LTV)

• High LTV = greater risk of default.– Homeowner has less to lose.– Homeowner has less financial stability.– Property does not have enough equity to cover

drops in value and costs of selling.

$100,000 value

20% down

$80,000loan amount

80% LTV

5% down

$95,000loan amount

95% LTV

Defining Risk • Lender’s exposure:

– Degree of risk the lender faces.– Without mortgage insurance, lender is

exposed to 100% of risk.

Defining Risk (cont.)• Coverage:

– Determined by Fannie Mae, Freddie Mac, and private conduits.

– Different investors require different amounts.

– If not indicated, lenders often order required amounts by secondary investors in case loan is sold at a later date.

CoverageHow MI Reduces Lender Exposure

$50,000

$60,000

$70,000

$80,000

$90,000

$100,000

$110,000

17% MI 25% MI

Purchaseprice

Purchaseprice

Loan amount(90% LTV)

Loan amount(90% LTV)

74.7%exposure

67.5%exposure

Lower coverage =higher exposure

Higher coverage =lower exposure

Major Factors of Default Risk

• LTV – size of the down payment.• Potential for property appreciation/depreciation.• Borrower’s credit history.• Loan purpose.• Loan type.• Loan term.

Understanding Claims • Upon foreclosure, the mortgage insurer

either:– Pays 100% of the claim amount and takes title for

subsequent sale.– Pays percentage of claim amount based upon

the coverage, and lender retains property.

• Lender’s Master Policy specifies amounts included in claim.

• Loss mitigation.

Understanding Claims

MI Cancellation• Until 1998, MI cancellation was the

lender/investor’s responsibility.• Homeowner’s Protection Act of 1998:

– MI automatically canceled when LTV ratio reaches 78% or less of original value.

– Borrowers with good payment histories may initiate cancellation at 80% LTV ratio.

– MI company is to refund any unearned premium within 30 days after notification of cancellation.

Questions?