home prices

Behind CMHC’s Premium Hike

On June 1 higher insurance premiums kick in for those buying a home with less than 10% down. These folks will cough up another 0.45 percentage points of their home’s value to get an insured mortgage.

That’s got some wondering, why are insurers picking on people with small down payments? Why not raise default premiums on all insured borrowers?

We posed that question to CMHC and here’s the answer we got:

As we continue to refine and improve our stress-testing and capital modelling capabilities in line with global and industry trends, recent improvements have allowed us to be more refined in our pricing decisions and modelling has indicated a greater sensitivity to the level of down payment.

In order to achieve a reasonable rate of return on its capital holding target, premiums for all segments were considered for potential increases and given the relative strength of the higher equity segments, we are able to continue to offer mortgage insurance premiums at their existing levels for the lower LTV tiers.

Source: CMHC Spokesperson, Charles Sauriol

In other words, borrowers with down payments less than 10% deserve to pay more as the arrears performance of higher loan-to-values isn’t as “strong.” In turn, said mortgages require CMHC to apportion more capital to cover potential losses.

Speaking of capital, “…mortgage insurers, including [Genworth Canada], have been advised by OSFI to maintain a minimum capital test holding target of 220% until a new framework for regulatory capital is finalized,” according to a recent National Bank Financial (NBF) report. What’s interesting is that CMHC hiked premiums avowedly to boost its capital. Yet its capital ratio (294% as of Sept. 2014) is well above that 220%. That’s led NBF to suggest that the price hike was “designed to help private insurers” boost their revenue (since they are price takers, not price setters, and they don’t have as big of a capital buffer).

You’d think that if this were the case the privates might have known about CMHC’s premium hike in advance. But a high-level Genworth executive assured me that the insurer was unaware of CMHC’s coming premium increase, citing competition rules as the reason.

Whatever the case, CMHC’s new fee incentivizes bigger down payments and spares 10%+ down borrowers from higher premiums. Much like pay-per-use models, default insurance works most equitably under a “pay-per-risk” model.

home prices
  1. Thanks Rob for your attempt at clarifying CMHC s attack on the 5% downers.
    I dont see a clear response or any direct risk analysis presented other than “modelling has indicated a greater sensitivity to the level of down payment”. This is perhaps affirming Appraisers previous comments that this is more political; an action with hopes higher premiums would slow the market down in the heated up areas.
    I am sure their “modeling” would suggest there are greater dollar risks to CMHC in a (potentially) declining house market; I would like to have backup that suggests low downpayment borrowers have presented a greater risk in losses attributable to that group vs any other group. My gut says that on any one default, a 5% er would create greater losses; but that historically, the 5% ers do not represent a proportionately higher loss in dollars than the other groups to warrant the higher premiums, other than their already assessed higher premiums.

    1. Hi Bruce, It’s hard to say how much they did this to slow hot markets but many policy-makers would consider that a welcome side effect at the very least. As for the pricing of 95% LTV premiums, wouldn’t it be grand if CMHC shared its models? The higher the current LTV, the greater the probability of default and the larger the loss severity. That much we know. What we don’t know is how underwriting models have changed given higher home prices, higher debt levels, higher sensitivity to interest rates and economic shocks, etc.

      1. This may very well have been political, but “the model told us to do it” is a plausible explanation also.

        It’s known that high LTV is associated with both increased loss given default and increased probability of default. If you want to read more, “Credit Scoring for Risk Managers” by Elizabeth Mays is approachable and covers the topic.

        This doesn’t mean the old premium level was too low (CMHC would have to be more open with their data to make that kind of assessment) but hopefully it makes the moving parts a little more clear.

  2. Very perspicacious observation, Robert, about CMHC already exceeding the 220% capital ratio – leading one to wonder if this premium hike was more to help the “privates”.

    Thanks for your excellent work.

  3. Great follow-up Rob. I wonder why it seems as though monetary incentives are always negative or punitive in nature. For example, if there are LTV tiers within CMHC’s portfolio that are performing better, why not lower insurance premiums for those? If the goal is to promote higher down payments, then lowering the premiums for having more skin in the game, would seem to be a reasonable strategy.

    1. Thanks Appraiser. I guess it depends on whether lower LTV premiums were already fairly valued, actuarially speaking. CMHC certainly appears fixated on stockpiling capital while times are good.

  4. Hi Rob,

    Great insight, as always. Aside from risk management and loss prevention concerns (which are real issues), my view is that CMHC will eventually be privatized. Since the value of a business is usually a multiple of its profits, revenues or cash flows, it makes sense that CHMC is trying to improve these figures, so the Feds will get a better price when the sale happens.

    Cheers!

    Philippe

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