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The State of Canadian Mortgage Insurers

Canadian-Mortgage-Default-Insurers The Globe & Mail ran another controversial piece on AIG and Genworth last week.

The article suggested that Canada’s two private mortgage insurers have "unsustainable" business models and are writing virtually no new insurance. 

From the looks of it, the story was rushed to print without much confirmation. The Globe later issued a retraction.

This isn’t an article meant to bash the Globe & Mail. We have a great deal of respect for some of their writers.  But this particular story of theirs was unfair on multiple counts and really needs to be called out. 

For one thing, the authors provided little context and background on the underlying issues at hand. Worse, however, is that some people will read inaccuracies in the Globe story and then shy away–consciously or subconsciously–from doing business with the subjects of the article. If there’s a chance of harming a company you write about, you absolutely have to do extra homework on the topic.  (We’ve learned this lesson firsthand.)

In any event, what follows below is a deeper look into the core issue behind the Globe piece: the government’s unequal guarantee of mortgage insurers. But first some background information.

For those unfamiliar with how federally backed insurance works, here is the gist. People with less than 20% down are generally required to have mortgage insurance. There are 3 insurers in Canada: CMHC (a Crown corporation), Genworth, and AIG United Guaranty. The government backs CMHC insured mortgages 100% if CMHC fails. AIG and Genworth, however, receive only 90% federal backing.

To some people, that 10% difference may not seem like much, but in today’s gun-shy credit market, it’s the world.

Investors perceive risk in buying mortgages that are only 90% backed by the government.  With investor appetite diminished, lenders using Genworth or AIG insurance can’t resell their mortgages as easily as they can with CMHC-insured mortgages. This phenomenon is exacerbated in AIG’s case because they are the new kid on the block compared to CMHC and Genworth.

Looking at this from Genworth’s and AIG’s perspective, both insurers state the chances of their defaulting are extraordinarily remote. 

  • They have large sums of segregated capital and/or cross guarantees–as demanded by OSFI
  • They are required to recognize insurance premium revenue very slowly to match revenues with future potential liabilities (i.e. a portion of premiums stay in a protected “unearned premiums” kitty that isn’t touched)
  • They contribute a portion of every mortgage policy to a government mandated guarantee fund.

Mortgage-Insurance-Risk Despite this, investors consider “any risk a bad risk," said one expert we spoke with. Who wouldn’t prefer the risk-free option of doing business with CMHC? Investors have essentially no counterparty risk whatsoever with CMHC (the government itself covers all their claims if CMHC goes kaput).  Investors then ask themselves, why even contemplate the discussion of using a "less safe" insurer?

Keep in mind that banks and mortgage aggregators (like Deutsche Bank or Merrill Lynch) often sell mortgage securities to international investors. Many foreign investors fail to appreciate how stable Canada’s mortgage market is versus the rest of the world.  As a result, they’re leery of buying Canadian “paper” to begin with, let alone mortgages that aren’t fully backed by the government.  In turn, some aggregators and lenders are saying they simply do not want mortgages that are not 100% federally guaranteed.

Despite all this, Genworth and AIG are both still doing business–contrary to the Globe’s insinuations. Both also state clearly that they plan to keep doing business in Canada well into the future. Both are well-capitalized and sufficiently cash-flow positive to ride out the storm they say. Nonetheless, the credit crisis has made their jobs much tougher.

It was hoped that last week’s federal budget would announce 100% backing for Genworth and AIG, but disappointingly, it did not. Now we can only hope Ottawa reconsiders and realizes what’s at stake if the deck keeps being stacked against private insurers. Both Genworth and AIG are reportedly still talking with Ottawa and hopefully the government will sooner or later act on this issue.

But why is this so important anyway? Why do we need the government to fully back private insurers and foster competition? 

Andy Charles, President and CEO of AIG United Guaranty, says the reason is clear, “increased competition has greatly benefited the Canadian market.” 

He says this has “resulted in a number of positive changes within the mortgage default market, including more affordable premiums, the elimination of almost all mortgage insurance application fees, and product innovations that assist new immigrants and self-employed borrowers.”

A more complete rundown of the benefits of competition might be as follows:

  1. The main reason is that the consumer benefits economically. Since 2003 mortgage default insurance premiums have dropped 30%. Without Genworth to counter CMHC (AIG came into the picture later), it is unlikely this ever would have happened.
  2. Competition also spurs the creation of new insurance products. These programs benefit worthy borrowers (like new Canadians or BFS homeowners) who might otherwise not qualify for a mortgage with a traditional lender.
  3. Genworth and AIG put private capital at risk instead of government money. Theoretically, if something bad ever happened on a mass scale, lenders would eat through billions of dollars in private capital, instead of taxpayer dollars.
  4. Private insurers may have U.S. parents but they are otherwise Canadian companies. Genworth, for example, has 300 Canadians working for them. AIG has an all-Canadian staff as well and its parent company has been operating in Canada for over 45 years.
  5. From a borrowers’ standpoint, if you get declined at CMHC, and CMHC is your lender’s only insurer, that lender has no place else to take your application. We’ve seen countless examples of a borrower needing to go to CMHC, then Genworth, then AIG (or vice versa) to get insurer approval. This usually
    happens because one insurer fails to acknowledge a common sense underwriting exception. A single insurer would therefore force a lot of otherwise worthy borrowers out of the market.
  6. If you refinance a high-ratio mortgage and stick with the same insurer, you can usually port your premiums (i.e. not have to repay them). If Genworth and AIG were no longer in the picture, high-ratio borrowers who insured with them and then refinanced, would be charged insurance premiums all over again (from CMHC).
  7. Additional benefits of competition include improved efficiencies (insurer turnaround times and appraisals are way faster today than even five years ago) and added cost savings (insurer competition has driven application fees to $0).

Ottawa Should Canadians be worried about the government guaranteeing the extra 10% for private insurers?  Again, the risk of a private insurer failing is exceedingly remote feel most observers. “If an event was ever big enough to cause a private insurer to fail, that event would probably cause some 2nd tier Canadian banks to fail as well,” one analyst told us.

Genworth and AIG are strongly capitalized and OSFI, their regulator, is incredibly vigilant. OFSI does not want a failed insurer on its hands and it sets its rules accordingly. Genworth, for example, must keep an enormous $4.6 billion in assets to pay contingent claims. Only after that, and only after other auxiliary insurance, is the government on the hook for anything at all.

Just as relevant is the fact that Genworth and AIG are essentially writing the same policies as CMHC. So if something risky is happening at a private insurer, odds are, it’s happening at CMHC too. In essence, CMHC-insured mortgages present the same risk to the government as a Genworth-insured mortgage, for example.

Lastly, private insurers pay for their government guarantees. They’re not free. Our sense is that both private insurers would probably be willing to pay even more, if needed, to compete on the same plane as CMHC.

So why isn’t the government acting? We’re not exactly sure. It’s clear that protecting CMHC’s near-monopoly is important to Ottawa. Mortgage insurance is a huge money maker for the Federal government. It’s also a question of fiddling with a system that the government considers to be “working fine.” Why mess with the status quo some feel.

Unfortunately, for the reasons above, the status quo isn’t in Canada’s best interests. At the very least, a compromise of some sort should be evaluated. Perhaps the government can consider a temporary 100% guarantee in the interim, with the right to review this guarantee at predefined checkpoints.

Whatever the case, it is enormously difficult to bring new private insurers online in Canada. It is probably highly ill-advised to continue crippling the ones we already have.



For the record, we have nothing but the utmost respect and admiration for CMHC. They are a brilliantly run business. We merely hope that competition continues to thrive in the Canadian default insurance market. It is in every homeowner’s benefit over the long-run.