More on Default Insurance Pricing

mortgage-insurance-premiumsLast week we looked at one man’s mission to reduce default insurance fees by 15%. (See: Cutting Insurance Premiums).

Since then, we’ve had a chance to speak with industry insiders for their take on this debate. Insurance executives expressed three other considerations worth noting: capital requirements, yields and economic cycles.

Regulatory capital requirements

  • Private default insurers have had to significantly increase their required capital since 2008.
  • Higher capital requirements produce a lower return on equity (ROE).
  • On 5% down payment mortgages, for example, the return on equity has shrunk to a measly single digit according to one insurer source. (For perspective, most astute investors are looking for ROE’s of 15%+.)
  • An insurer’s cost of capital can escalate if investor returns are not sufficient. Lowering premiums would directly hurt ROE.

Yields have plunged

  • Insurers must invest their premiums, but today they’re stuck earning only 2-3% — which is much less than in the past.
  • Worse yet, yields will likely stay low for the foreseeable future.

Future business and housing cycles

  • Today’s borrowers are stronger than before, but they still must ride out 1-2 more economic cycles while their mortgage is insured.
  • Today’s 720 credit score may become a 580 during a recession with job losses. Therefore, insurers cannot price based solely on the current benign economic environment.
  • Historic house price appreciation has clearly benefited mortgage insurers. There are very few instances of negative equity. However, the future rate of price appreciation is unlikely to continue at historic levels.

Sources in the industry say there is no desire among regulators to cut insurance premiums and reduce the capital and net income (shock absorbers) of our default insurers. For these reasons, while we’d never say never, cutting insurance premiums is an idea that’s seemingly dead in the water.

If anything, one could argue that premiums are too low on some products, namely mortgages with only 5% down.

Rob McLister, CMT

  1. It’s no shock that those in the industry aren’t interested in lowering the premiums, but I do agree that those who are taking the biggest risk of default, such as those with only a 5% down, should be paying higher premiums. Just as those that are at higher risk for an auto accident have to pay higher premiums for car insurance.

  2. Well, this article thoroughly and logically puts the “dead on arrival” stamp on the idea of lower default premiums.

  3. the yield issue is a problem for all insurers, not just mortgage. Historic returns come not just from the premiums but also from the investments these premiums create. These are obviously dramatically lower with little to no investment return. However, I don’t I buy the fear factor of future dropping of real estate values as if this is something new. Actuarial models have factored these potentials in for a long time, and the house price growth has far outstripped previous projections, so the industry has won for a long time. Whether premiums can be lowered is not something I have knowledge to quote on, but I would say the “false” argument of a future doom as the reason why not, ignores years of plus forecasts, in which consumers were paying more than they should have been, when using those same long term forecasts that factor in good and bad scenarios

  4. @Bruce
    No actuary could foresee the rate of home price appreciation we’ve had since 2000. We are 3 standard deviations above fundamental value, yet insurance premiums haven’t increased in over a decade. There is no way they will drop.

  5. No question that the default insurers have done well but some of us remember 1989 – 1990 when I believe we saw a default insurer effectively bankrupted by the plunge in house values. I realize the current iteration of Genworth stepped in and reconstituted the company but I find it difficult to believe a substantial drop in property values would not have an adverse effect on default insurers. likely survivable but still a major effect.

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