Last 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