An Introduction to Private Mortgage Guaranty Insurance 2003 CAS Annual Meeting New Orleans, LA John Gaines, FCAS, MAAA Vice President – Structured Transactions

Agenda What is mortgage insurance (MI)? Types of mortgage insurance. Industry overview. Coverage and exposure. Claims. Cancellation.

What is Mortgage Insurance? What it is. –Protects lender against loss. What it is not. –Mortgage life insurance. –Mortgage disability insurance.

Types of Mortgage Insurance Insured Mortgages VA Government Insured Private Mortgage Insurance FHA

Types of Mortgage Insurance FHA Insurance–100% Coverage VA –Limited Guaranty Private Mortgage Insurance –Limited Guaranty

Distribution by Dollar Volume of Insured Mortgages

Private Mortgage Insurance Protects insured against loss in the event of borrower default. Generally required on original loan amounts greater than 80% of the appraised value or purchase price, whichever is less. A private sector alternative to government- insured mortgage loans (FHA / VA).

Industry Overview

PMI Industry History Roots go back to the late 1800s in NY. The Great Depression wiped out the entire PMI industry (>50 companies). The modern industry was founded in 1957 upon stringent statutory rules.

Statutory Requirements Monoline. Contingency reserve. Minimum 25:1 risk-to-capital ratio. Limit on maximum risk coverage per loan.

Private Mortgage Insurance Providers AIG - United Guaranty Corp. GE Mortgage Insurance Co. Mortgage Guaranty Insurance Corp. PMI Mortgage Insurance Co. Radian Guaranty, Inc. Republic Mortgage Insurance Co. Triad Guaranty Insurance Corp.

MI Industry Loss Ratios

Industry Income Statement – 2002 ($ Millions) Net Premiums Earned$3,836 Losses832 Expenses899 U/W Income2,104 Operating Income2,913

Industry Balance Sheet (as of 12/31/02 - $ Millions) Admitted Assets$19,761 UEPR451 Loss Reserves2,025 Contingency Reserves12,789 Policyholders Surplus3,273 Risk-to-Capital Ratio11.03:1

Importance of Secondary Markets Existing mortgages bought, sold, and traded. Ensures availability and uniformity of mortgage credit. The GSEs.

Importance of Secondary Markets (cont.) Private mortgage insurance allows mortgages to be sold on secondary market. Home loan funds would be severely strained if mortgages were not sold on secondary market.

GSEs The charters of Fannie Mae and Freddie Mac require primary MI or the lender to take a recourse position on loans with original LTV’s greater than 80%. The amount of primary MI depends on the loan program and underwriting feedback from Fannie Mae and Freddie Mac.

Loan-to-Value Ratio (LTV) High LTV = greater risk of default. –Homeowner has less to lose. –Homeowner has less financial stability. –Property does not have enough equity to cover drops in value and costs of selling. $100,000 value 20% down $80,000 loan amount 80% LTV 5% down $95,000 loan amount 95% LTV

Defining Risk Lender’s exposure: –Degree of risk the lender faces. –Without mortgage insurance, lender is exposed to 100% of risk.

Defining Risk (cont.) Coverage: –Determined by Fannie Mae, Freddie Mac, and private conduits. –Different investors require different amounts. –If not indicated, lenders often order required amounts by secondary investors in case loan is sold at a later date.

Coverage How MI Reduces Lender Exposure Purchase price Purchase price Loan amount (90% LTV) Loan amount (90% LTV) 74.7% exposure 67.5% exposure Lower coverage = higher exposure Higher coverage = lower exposure

Major Factors of Default Risk LTV – size of the down payment. Potential for property appreciation/depreciation. Borrower’s credit history. Loan purpose. Loan type. Loan term.

Understanding Claims Upon foreclosure, the mortgage insurer either: –Pays 100% of the claim amount and takes title for subsequent sale. –Pays percentage of claim amount based upon the coverage, and lender retains property. Lender’s Master Policy specifies amounts included in claim. Loss mitigation.

Understanding Claims

MI Cancellation Until 1998, MI cancellation was the lender/investor’s responsibility. Homeowner’s Protection Act of 1998: –MI automatically canceled when LTV ratio reaches 78% or less of original value. –Borrowers with good payment histories may initiate cancellation at 80% LTV ratio. –MI company is to refund any unearned premium within 30 days after notification of cancellation.

Questions?