Many conventional reinsurance lines are under extreme pricing pressure, prompting reinsurers to look to new classes to find profitable, diversifying business. One such line is mortgage risk.
I can almost hear the sharp intake of breath: yes, transferred mortgage risk was the trigger of the 2007/8 financial crisis but things are different now. Based on lessons learned, building regulations are almost always strengthened after windstorms. In much the same way, mortgage underwriting criteria have been strengthened dramatically following the crisis of 2007-8. Sub-prime mortgages are no longer a risk – under much stricter guidelines and regulation, they have been nearly eradicated.
Credit Risk Transfer (CRT)
The market has plenty of collective experience in this area. Property Reinsurers began to write quota-share treaties for monoline mortgage insurers decades ago, and in 2013 began to back the Credit Risk Transfer (CRT) programme of the US ‘Government Sponsored Enterprises’ (GSEs) Fannie Mae and Freddie Mac. These state-backed guarantors of US mortgage risk have been instructed to diversify their sources of contingent capital, and have ceded retained mortgage risk to reinsurers and others ever since.
This has created a new opportunity for reinsurers to participate in the American housing market. Up to 30 reinsurers now participate regularly in the GSEs’ CRT transactions. Competition has increased, but margins are still relatively attractive compared to other risk classes.
Mortgage Risk Transfer (MRT)
A new opportunity lies in Mortgage Risk Transfer (MRT), which brings mortgage insurance risk from the GSEs into the reinsurance market through a dedicated protected cell captive. In the US, any mortgage with less than a 20% down payment (>80% Loan to Value Ratio) needs a form of credit enhancement (typically Private Mortgage Insurance) before the mortgage credit risk will be guaranteed by Fannie Mae or Freddie Mac. That makes MRT risk comparatively low, and accurately measureable.
In 2018, both Freddie Mac and Fannie Mae launched front-end, pilot transactions, (respectively called IMAGIN and EPMI). Quota share placements were completed by Capsicum Re. The deals ceded up to $5.5 billion of mortgage insurance risk to reinsurers, but already these pilot MRT transactions attracted more than 100% of the target capacity required from the reinsurance community, signalling an opportunity for expansion should the need arise. It is noteworthy that these two pilots barely scratched the surface of a mortgage insurance market which typically exceeds $250 billion annually, with just 2% anticipated penetration.
Mortgage Market Growth
Should growth occur, MRT presents a significant opportunity in a challenging reinsurance market environment, even before cessions from non-US GSEs and private mortgage indemnity insurers are considered. Reinsurers that make the necessary investment of time, talent, and capital will not saturate the market quickly: premium volumes will expand with reinsurers’ appetite, for a risk, which boasts a historical loss ratio of less than 20% since 2009.
In a tough reinsurance market, mortgage risk presents an opportunity for reinsurers to achieve stable, long-term, profitable income in a market which is set only to grow.
Steven Rance, managing director, Capsicum Re