Private Mortgage Insurance

Private Mortgage Insurance

Beyond Carriers and Actuarial Opinions

Prepared for: 2008 CLRSPrepared by: Kyle Mrotek, FCAS, MAAA

Consulting ActuaryMilliman, Inc.

2

Outline

Mortgage Insurance (MI) Background

Lender Captive Mortgage Reinsurance

Unique Reserving Issues

Impact of Economics on RMAD

Closing Thoughts

3

MI Background Types of MI

– Government

• FHA

– Provides insurance to lenders on loans for one- to four-family houses

– 100% coverage

• VA

– Guarantees loans made to eligible veterans

– Limited coverage

• Dept of Agriculture

– Private

• Provides insurance to mortgage originators and investors on conventional first-lien high LTV loans

• Limited coverage

Source: Residential Mortgage Lending, Fourth Edition and Mortgage Insurance Companies of America (MICA)

4

MI Background

Primary Mortgage Insurance ActivityMarket Share %

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2002 2003 2004 2005 2006 2007 2008 H1

Calendar Period

Mar

ket S

hare

%

PMIFHAVA

Source: Inside Mortgage Finance, August 15, 2008

5

MI Background

BORROWER INSURER

LENDER

LO

AN

$

PMI PROTECTION

PMI P

REMIU

MPM

I PREMIUM

6

MI Background

– Private MIs

• CMG Mortgage Insurance Company (CMG)

• Genworth Mortgage Insurance Corp. (Genworth)

• Mortgage Guaranty Insurance Corp. (MGIC)

• PMI Mortgage Insurance Company (PMI)

• Radian Guaranty, Inc. (Radian)

• Republic Mortgage Insurance Company (RMIC)

• Triad Guaranty Insurance Corp. (Triad)

• United Guaranty Residential Insurance Company (UGC)

7

MI BackgroundPrivate MI Industry Market Share1H2008 Direct Premiums Earned

MGIC

PMI

Radian

Genworth

UGC

RMIC

TGIC CMG

MGIC

PMI

Radian

Genworth

UGC

RMIC

TGIC

CMG

Source: Annual Statements

8

MI Background

– Relevance of MI Ratings• MI rating accompanies credit risk of loan to investor/lender

• GSE policy– According to Freddie Mac Private Mortgage Insurer Eligibility Requirements,

January 2008:» “Freddie Mac may purchase mortgages guaranteed or insured by a qualified approved insurer.”

» Approved insurers are further classified into Type I Insurers or Type II Insurers:

» * Type I Insurer: An approved insurer that is rated by at least two of the followingthree rating agencies – S&P, Moody’s, and Fitch – and no rating is less than AA-/Aa3 by any listed rating agency

» * Type II Insurer: An approved insurer that is 1) unrated or 2) rated by less thantwo of the following rating agencies – Fitch, S&P, or Moody’s or 3) rated lowerthan AA-/Aa3 by any listed rating agency

» Additional requirements for Type II Insurers:

» * Liquidity of assets (90% of admitted assets)

» * Risk-to-capital (15:1)

» * Combined ratio (85% for consecutive calendar years)

» * Captive reinsurance (“The ceding approved insurer must at all times be a Type I insurer.”)

9

MI Background

Source: Fitch, Moody’s, S&P

MI Fitch Moody's S&PCMG AA Not rated AA-Genworth AA Aa2 AA-MGIC AA+ Aa2 AA-PMI AA+ Aa2 AA-Radian AA Aa3 AA-RMIC AA Aa3 AA-Triad AA Aa3 AA-UGC AA+< Aa2 AA+<

> Outlook positive< Outlook negative

Rating Agency

Ratings as of

MI Fitch Moody's S&PCMG AA< Not rated AA-<Genworth AA< Aa3< AA<MGIC A+< A1< A<PMI A+< A3< A-<Radian Not rated A2< BBB+<RMIC AA-< A1< A+<Triad Not rated Not rated Not ratedUGC AA+< Aa3< AA+<

> Outlook positive< Outlook negative

Rating Agency

September 4, 2008March 2006

10

MI Background

– Coverage• Accumulated interest during delinquent period

• Legal fees

• Home maintenance and repair expenses

• Real estate broker’s fees and closing costs

• Property resold for less than original sales price

• Limited to about 20% to 30% of original loan amount

• Coverage depends on many factors, but primarily LTV

Source: MICA

About 15% of UPB

11

MI Background

– Cancellation

• Private MI policies non-cancellable by MI

– Exceptions include non-payment of premium or fraud

• Borrower-initiated cancellation possible, in general, if:

– LTV < 80%, and

– No other loans on house, and

– Borrower current on payments

• Automatic termination occurs, in general, if:

– LTV < 78%, and

– Borrower current on payments

• Automatic termination occurs at the mid-point of the loan

Source: MICA

12

MI Background

Mortgage Insurance Industry Loss Ratios

0%

25%

50%

75%

100%

125%

150%

175%

200%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Calendar Year

CY

Incu

rred

Los

s R

atio

Source: MICA

– Profitability

13

MI Industry Participants

The Borrower

Fannie / Freddie

The Servicer

The Lender

The MI

Applies for Loan Selects MI

Sells The ServicingSells TheLoan

Pays the Premium

Makes theLoan

PaymentincludingMI fee

Pays the Claims

ForwardsInterest Yieldand MI Claim Checks

Investors

Packages loans as MBS

Lender Captive

Owns

Reinsures


14


TRUST FUND

(Beneficiary = Primary Co.)

Primary Company

Lender Captive Reinsurer

Admin. Expenses

Premium Tax

Capital Dividends

Unearned PremiumLoss ReservesContingency ReservesCapital

Premium Ceding Comm. Losses

15


Number of Lender Reinsurer Trusts w ith Ceded PremiumIndustry (Excluding PMI)

1998-2007

0

50

100

150

200

250

300

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Calendar Year

Num

ber o

f Cap

tives Total

TrustsLenderReinsurers

Source: Annual St at ement s

16


Average Number of Lender Reinsurer TrustsIndustry (Excluding PMI)

1998-2007

0.0

0.5

1.0

1.5

2.0

2.5

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Calendar Year Source: Annual St at ement s

17


Dollars of MI Premium Ceded to Lender ReinsurersIndustry (Excluding PMI 1998-1999)

1998-2007($000's)

0100,000200,000300,000400,000500,000600,000700,000800,000900,000

1,000,0001,100,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Calendar Year Source: Annual St at ement s

18


Percentage of MI Premium Ceded to Lender ReinsurersIndustry (Excluding PMI 1998-1999)

1998-2007

0%

5%

10%

15%

20%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Calendar YearSource: Annual St at ement s

19

Lender Captive Mortgage ReinsuranceMarket Share Of CY 2006 Assumed Premium

By Top Ten Lender Captive Reinsurers In Descending Order

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8 9 10

Lender Captive Reinsurer Count In Descending Order

Mar

ket S

hare

Of C

Y 20

06 A

ssum

ed P

rem

ium


20


Distribution of Lender Reinsurers by Domicile Weighted by CY 2007 Earned Premium

65%11%

0%

0%

11%

5%

3%

3%1% 0% 0%

0%

0% Vermont

Arizona

Haw aii

South Carolina

New York

Turks & Caicos

Bermuda

Michigan

Texas

Other On Shore

Other Off Shore

Rhode Island

Florida


21


40%

36%

7%

6%

5%

2%

1% 1%

1%

1%

1%Turks & Caicos

Vermont

Haw aii

Bermuda

South Carolina

New York

Michigan

Arizona

Texas

Rhode Island

Florida


Distribution of Lender Reinsurers by Domicile Weighted by CY 2007 Counts

22

Lender Captive Mortgage Reinsurance– Loss Reserving

• Option 1: Reserve for delinquent loans only

– Advantages:

» Reserve for payments in near term

» NAIC authorized reserving method

– Disadvantages:

» Mismatch between incurred loss and earned premium

» Reserve not adequate for future paid claimsIllustrative Distribution of Accruals for Mortgage Reinsurer

Reserve only for delinquencies

0%

5%

10%

15%

20%

25%

30%

1 2 3 4 5 6 7 8 9 10 11

Years since origination

Perc

enta

ge

Incurred LossEarned Premium

Source: Milliman, Inc.

23


– Loss Reserving (continued)

• Option 2: Reserve for all loans insured

– Advantages:

» Attempts to match incurred loss and earned premium

» Requires more actuarial involvement

– Disadvantages:

» Requires auditor and regulator approval

» Requires more actuarial involvement

24


– Option 1: Reserve for delinquent loans only

• Date of default = Incurred loss date (SSAP No. 58):

– Known delinquencies (case reserve)

– Incurred but not reported (IBNR reserve)

– * Reserve for pipeline delinquencies

• Frequency-Severity Method:

– Frequency = Probability of claim

– Severity = Loss given claim

• Reserve = Reinsurer incurred loss less Reinsurer paid loss

– Calculation performed for each book year in each trust

– Reinsurer incurred loss equals cumulative ground-up paid loss plus calculated reserve (both case and IBNR) in excess of reinsurer attachment point

25


– Option 1: Reserve for delinquent loans only

Illustration of Calculating Reinsurer Reserve5% Limit xs 5% Attachment Point

% of Original Coverage

Book Year 2000 Book Year 2001

MI Gross Paid Loss RateMI Gross Reserve

Reinsurer Reserve

5%

10%

26


– Option 2: Reserve for all loans insured

• Ultimate Loss Ratio Method - Reinsurer incurred loss equals ultimate loss ratio times cumulative earned premium, where ultimate loss ratio equals ultimate loss divided by ultimate premium

Illustrative Calculation of Reinsurer Reserve

A B C= D E= F G=A/B C*D E-F

Reinsurer ReinsurerReinsurer Reinsurer Ultimate Cumulative Reinsurer Reinsurer

Book Ultimate Ultimate Loss Earned Incurred Paid ReinsurerYear Loss Premium Ratio Premium Loss Loss Reserve2000 50.0 120.0 41.7% 100.0 41.7 0.0 41.72001 70.0 125.0 56.0% 80.0 44.8 10.0 34.8

Total 120.0 245.0 49.0% 180.0 86.5 10.0 76.5

A and B estimated using projection methods

27


– Premium/risk assumption limits• GSE 2008 guidance

• “…Freddie Mac’s express written approval must be obtained for any risk sharing transaction which involves ceding over 25% of the gross aggregate risk or premium with respect to a loan or pool of loans and which is entered into with a mortgage enterprise, or an affiliate of a mortgage enterprise, other than a qualified reinsurer that is not a captive reinsurer.”

Source: Freddie Mac’s “Private Mortgage Insurer Eligibility Requirements”, January 2008

28


– Revised Underwriting Guidelines

Simplified Example of the Effect of a Change In Underwriting

DistributionProperty Type Before After Risk Weight1

Single Family 85% 100% 1.002-4 Family 5% 0% 1.10Condo 10% 0% 1.50

Total 100% 100%

Indicated Risk Relativity 1.06 1.00

Indicated Change -5%

1 Moody's Approach to Rating Residential Mortgage Pass-Throughs

29


– RESPA (Real Estate Settlement Procedures Act)• HUD’s 1997 letter to Countrywide

• Two tests must be met:– Transfer of risk

– Price commensurate with risk

30


– Restricted Markets• More stringent eligibility

– Varies by MI, evolving with time

– Lower maximum LTV

» (5% lower or 90%-95%)

» Lower for condos

– Higher credit score (680)

31

Lender Captive Mortgage ReinsuranceIllustration of restricted markets

32


– Contingency Reserve• SSAP No. 58 – “The purpose of this reserve is to protect policyholders against

loss during periods of extreme contraction”

• Statutory only, not GAAP

• Liability

• 50% of earned premium

• Held ten years

• Early withdrawals allowed– Insurance Commissioner approval

– CY incurred loss ratio > 35%

– FIFO

• Not explicitly in scope of actuary’s SAO

33



– Contingency Reserve

Early/Extraordinary Releases of Contingency Reserve($ Millions)

MI CY 2007 1H 2008CMG $0 $0Genworth $470 $245MGIC $1,536 $657PMI $503 $879Radian N/A N/ARMIC $312 $0Triad N/A N/AUGC $876 $317Total $3,697 $2,098

34


– Premium Deficiency Reserve• SSAP No. 58 – “When the anticipated losses, loss adjustment expenses,

commissions and other acquisition costs, and maintenance costs exceed the recorded unearned premium reserve, contingency reserve, and the estimated future renewal premium on existing policies, a premium deficiency reserve shall be recognized by recording an additional liability for the deficiency with a corresponding charge to operations.”

• SSAP No. 53 – “For purposes of determining if a premium deficiency exists, insurance contracts shall be grouped in a manner consistent with how policies are marketed, serviced and measured. A liability shall be recognized for each grouping where a premium deficiency is indicated. Deficiencies shall not be offset by anticipated profits in other policy groupings.”

• Not explicitly in scope of actuary’s SAO

35


– Example Calculation of Lender Captive Reinsurer StatutoryPremium Deficiency

– GAAP Premium Deficiency Reserve• No contingency reserve

MI1 MI2 MI3 MI4 TotalA PV Future Paid Loss $50 $100 $75 $25 $250B PV Future Admin Expense $10

C = A+B Uses $260D PV Future Written Premium $40 $70 $60 $20 $190E Loss Reserve $10F Unearned Premium Reserve $5G Contingency Reserve $75

H = Sum (D:G) Sources $280I = Max (0, C-H) Premium Deficiency $280

MI @12/07 @ 6/08 LOBMGIC $1,211 $788 Bulk

Radian $196 $584 Second-Lien

Examples of MI GAAP PDR($ Millions)

Source: Company SEC Filings

36


– Home Price Appreciation (HPA)

– Interest Rates

– Unemployment

– Affordability

– Others

37

Impact of Economics on RMADComparison of Delinquency Rate and HPA

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1979-1 1981-1 1983-1 1985-1 1987-1 1989-1 1991-1 1993-1 1995-1 1997-1 1999-1 2001-1 2003-1 2005-1 2007-1

Yr-Qtr

Del

inqu

ency

Rat

e

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

HP

A DelqHPA

Source: OFHEO, MBA

38


Source: Milliman, Fitch

Illustration of Frequency of Foreclosure Versus Cumulative Home Price Appreciation

-35% -30% -25% -20% -15% -11% -6% -1% 4% 8% 13%

Cumulative Home Price Appreciation

Freq

uenc

y of

For

eclo

sure

FICO 620-LTV 95FICO 660-LTV 90FICO 700-LTV 85

39

Impact of Economics on RMADYear Over Year HPA By CBSA

-20%

-10%

0%

10%

20%

30%

40%

1985

-2

1986

-2

1987

-2

1988

-2

1989

-2

1990

-2

1991

-2

1992

-2

1993

-2

1994

-2

1995

-2

1996

-2

1997

-2

1998

-2

1999

-2

2000

-2

2001

-2

2002

-2

2003

-2

2004

-2

2005

-2

2006

-2

2007

-2

2008

-2

2009

-2 f

2010

-2 f

2011

-2 f

Yr-Qtr

Yea

r Ove

r Yea

r HP

A%

Las VegasMilwaukeeRiverside, CASpringfield, ILWashington, DC

Source: Historical OFHEO, Forecast Moody's Economy.com

40

Impact of Economics on RMADCase Shiller Historical HPI and CME Futures @ Sept 13, 2008

0

50

100

150

200

250

300

Jan-0

0Ju

l-00

Jan-0

1Ju

l-01

Jan-0

2Ju

l-02

Jan-0

3Ju

l-03

Jan-0

4Ju

l-04

Jan-0

5Ju

l-05

Jan-0

6Ju

l-06

Jan-0

7Ju

l-07

Jan-0

8Ju

l-08

Jan-0

9Ju

l-09

Jan-1

0Ju

l-10

Jan-1

1Ju

l-11

Jan-1

2Ju

l-12

Year-Month

HP

I

Wash DCMiamiLas VegasComposite 10

Source: Standard & Poor's, CME Group

41


0% - 10%

10% - 20%

20% - 40%

40% - 60%

60% - 100%

Geographic Distribution of Market Risk IndexSM @ Summer 2008Probability That House Prices will be Lower in Two Years

Source: PMI Group

42

Closing Thoughts

– Inflection point for MIs

• Survival

• Pricing

• Underwriting

• Accounting?

– Inflection point for lender captive mortgage reinsurers

• Survival

• Structures

• Volatile

• Interests aligned

– Correlated risks tied to economics

Private Mortgage Insurance

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