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
Lender Captive Mortgage Reinsurance
14
Lender Captive Mortgage Reinsurance
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
Lender Captive Mortgage Reinsurance
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
Lender Captive Mortgage Reinsurance
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
Lender Captive Mortgage Reinsurance
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
Lender Captive Mortgage Reinsurance
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
Source: Annual Statements
20
Lender Captive Mortgage Reinsurance
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
Source: Annual St at ement s
21
Lender Captive Mortgage Reinsurance
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
Source: Annual St at ement s
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
Lender Captive Mortgage Reinsurance
– 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
Lender Captive Mortgage Reinsurance
– 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
Lender Captive Mortgage Reinsurance
– 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
Lender Captive Mortgage Reinsurance
– 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
Lender Captive Mortgage Reinsurance
– 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
Lender Captive Mortgage Reinsurance
– 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
Lender Captive Mortgage Reinsurance
– 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
Lender Captive Mortgage Reinsurance
– 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
Unique Reserving Issues
– 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
Unique Reserving Issues
Source: Annual Statements
– 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
Unique Reserving Issues
– 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
Unique Reserving Issues
– 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
Impact of Economics on RMAD
– 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
Impact of Economics on RMAD
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
Impact of Economics on RMAD
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
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