“Now, here, you see, it takes all the running you can do, to keep in the same place,” stated the Red Queen to Alice in Lewis Carroll’s classic Through the Looking-Glass. From this sentence spawned an evolutionary hypothesis which proposes that organisms must constantly adapt and evolve to simply continue while pitted against ever-evolving organisms in an ever-changing environment.
This simple premise is easily transferable to the reinsurance industry and, in particular, the mortgage boom reported in Insurance Day in April 2017. This is due to the rapid increase in reinsurers’ participation across new, innovative mortgage transactions and, specifically, the growth in business from the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
The first ‘adaptation’ by the GSEs were their credit risk transfer (CRT) programmes. These were developed in 2013 in response to the need for alternative sources of capital to bear their original mortgage portfolio. They now represent the bulk of US mortgage reinsurance business. The CRT transactions, executed via Freddie Mac’s ACIS & STACR and Fannie Mae’s CAS & CIRT structures, place private capital in a second-loss position by transferring the tail risk on large portfolios of mortgage risk. These CRT programs have transferred credit risk to both reinsurance carriers and investors on $2.1 trillion of unpaid principal balance (UPB), with a combined Risk in Force of ~$69 billion, or 3.2% of UPB.
A second shift in the world of mortgage reinsurance and risk transfer was the acceptance of mortgage risk by the insurance-linked securities (ILS) market. The first post-crisis collateralized reinsurance transaction, in 2015, involved securitization of the risk and sale of notes to investors. It was created for United Guaranty, a then subsidiary of AIG, which was acquired by Arch for $3.4 billion in 2016. The notes issued from these transactions were exposed to the risk of reinsured losses on the policies issued by the ceding insurer on an underlying pool of mortgage loans. This Bellemeade transaction was the first of a few in the ILS space, with mortgage risk now making up 4.8% of all ILS risk capital.
The latest development, as of March 2018, occurred in the form of Freddie Mac’s IMAGIN program, created by Arch MRT and supported by Capsicum Re. This transaction attracts a diversified and robust capital base to the U.S. housing market, in a highly efficient structure, that will support market stability through economic cycles. IMAGIN places a diverse pool of pre-approved, highly rated reinsurance capacity in a first loss position that can support long-term stability in the US housing market. Freddie Mac CEO, Don Layton, highlighted this value chain benefit of the innovation by stating IMAGIN is “a more efficient business model, a better business model, and we think lenders will like it and we think borrowers benefit by it”. It’s a project Capsicum Re is excited to be part of.
Looking forward, it is difficult to predict how the next adaptation in mortgage reinsurance transactions will manifest itself. However, it is clear that it won’t be restricted geographically to the US, but will expand worldwide as the stimuli to which the market must respond will be plentiful. So too will the opportunities following the robust resurgence of the class over the past few years. In an era of extensive mortgage regulation following the financial crisis of 2008, mortgage indemnity risk has never been more rigorously underwritten, and unlike other specialty classes, there are decades’ worth of public data available to model today’s risks. Therefore, in this re-emerging class the scope of change is limited only by the capacity on offer and the innovative solutions we create.