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Presented by: Michael C. Schmitz, F.C.A.S., M.A.A.A. Principal and Consulting Actuary Milliman USA, Brookfield, Wisconsin. Mortgage Insurance and Lender Captives 2002 Casualty Loss Reserve Seminar (CLRS) September 24, 2002. Overview of Presentation. - PowerPoint PPT Presentation
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Milliman USA 1
Mortgage Insurance and Lender Captives
2002 Casualty Loss Reserve Seminar (CLRS)
September 24, 2002
Presented by:Michael C. Schmitz, F.C.A.S., M.A.A.A.Principal and Consulting ActuaryMilliman USA, Brookfield, Wisconsin
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Overview of Presentation
Background on Milliman’s typical role for lender reinsurers
Types of Reinsurance companies and structures/features
Regulatory issues Accounting issues
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Milliman Role-Mortgage Reinsurance Front-End Role
Request lender’s historical MI data from the primary insurers
Conduct a portfolio risk analysis Determine benchmark risk assumptions Evaluate alternative structures Conduct feasibility study – assist in set-up Regulatory assistance Risk transfer/pricing opinions
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Milliman Role-Lender Reinsurers - Ongoing Role
If Milliman not involved in up-front, consider: Request lender’s historical MI data from the primary
insurers Conduct a portfolio risk analysis Determine benchmark risk assumptions
Loss reserve analysis/opinion Reinsurance Performance Metrics (RPM) services
Loan Reconciliation Reinsured Risk Analysis/Segmentation Economic Analysis Benchmarking of experience Forecasting of premium and losses
Miscellaneous assistance Sounding board – ad hoc requests Mortgage Reinsurance Conference (MRC)
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Types of Reinsurance Companies
Single parent captives
Sponsored Captives
Licensed Insurers
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Sponsored Captives The sponsored captive allows lenders, through a
participation agreement, to assume risk on loss performance of the mortgage loans the participant has insured with the sponsored captive’s parent company.
Sponsored captives are capitalized by mortgage insurers (parent) for participation by several lenders.
Lenders must contribute capital to support losses on their loans
Parent provides mortgage insurance to specific lenders who enter into participation agreements with the sponsored captive.
The lender receives a percentage of the mortgage insurance premium as a participation fee in return for assumption of part of the insured risk.
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Sponsored Captives
Each lender has a protected cell which separates the risks assumed by an individual lender from the risks of other participants (lenders).
Structure is different, but sponsored captives operate essentially the same as wholly-owned subsidiaries of lenders.
Sponsored captive enters into a reinsurance agreement with its parent, and assumes business written by its parent for the mortgage lender.
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Reinsurance Structures
Quota-share: pro-rata sharing of premium and losses
Excess of Loss: Reinsurer covers a layer of losses once the primary carrier's direct losses exceed an attachment point for a book year
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Reinsured LayerIn Relation to Gross Risk
100%
Limit
Attachment
100%
Quota-Share Excess of Loss
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Risk Characteristics-Claims
Lifetime Claim Rate Probability Distributions
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
1.4%
1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0% 16.0% 17.0% 18.0% 19.0%
Claim Rate
% P
rob
ab
ility
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MI Reinsurance Regulations
Due to potential size of ceded reserves, it is important for MIs to be able to obtain reinsurance credit.
Contingency Reserve is currently largest issue
Security - Licensed or trust accounts or LOC’s with unaffiliated financial institutions.
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Trust Accounts
Reinsurer establishes a separate trust account for each mortgage insurer
Essentially all capital infusions, premiums, losses and expense cash flows go through the trust account.
Reinsurers typically maintain reinsurance arrangements with several different mortgage insurers
Separate trust for each
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Trust Accounts
Assets restricted for the sole use and benefit of the ceding mortgage insurer.
Cannot be drawn down to cover losses reinsured on behalf of other mortgage insurers.
If trust account depleted by losses, certain important remedies apply.
Excess funds in the trust account are eligible for release (and dividended to parent) subject to various restrictions.
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TRUST FUND
(Beneficiary = Primary Co.)
Primary Company
Captive Reinsurer
Admin. Expenses
Premium Tax
Capital Dividends
Unearned Premium
Loss Reserves
Contingency Reserve
Capital
Premium Ceding Comm. Losses
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Complex Regulatory Environment
OCC/OTS/Federal Reserve regulate the ability of banks & thrifts to form captives
HUD regulates mortgage transactions and administers RESPA and TILA
The NYID regulates MI companies licensed in NY and most are
The captive’s state of domicile (e.g. Vermont) Normal FASB & Tax rules - not unique to
MI captives Fannie Mae and Freddie Mac through
eligibility guidelines
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RESPA (HUD) The Real Estate Settlement Procedures Act is enforced by HUD and,
more effectively, by the threat of specified civil remedies that include treble damages.
RESPA is broadly written: “no person shall give and no person shall accept any fee, kickback or thing of value [that is] incident to or part of a real estate settlement service…”
Exempts secondary market transactions which might include reinsurance. However, both the captive owner and the ceding MI are parties to the home purchase transaction itself.
August 6, 1997 letter from Nicolas Retsinas to Countrywide Funding (no legal standing but suggests how HUD may analyze captives under RESPA).
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HUD – August 6, 1997Letter from Nicolas Retsinas to
Countrywide Funding Two tiered approach to determining if specific
reinsurance deals permissible Red Flags - features that may cause HUD to
scrutinize a deal more closely, e.g.,: Consumer pays higher premium? Lack of consumer disclosure? Reinsurance conditioned on agreement to refer
business Two Part Test - for those deals where HUD
determines more scrutiny is required: I. Reinsurance actually provided - Risk Transfer II. Compensation (net premium) commensurate
with risk
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Risk Transfer FASB 113: Reasonable possibility of
substantial loss AICPA task force\
Attempted to develop a standard through Accounting Standards Executive Committee (AcSEC)
Informal sub-group
Reserving and Matching
Accounting Issues
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Primary loss incurred when loan defaults (delinquent)
Primary company reserves only for current delinquencies Known delinquencies (case reserves) Unreported current delinquencies
(IBNR) Statutory contingency reserve
Reserving Practices for Mortgage Insurance
Financials For Primary Company
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Reserving Practices for Mortgage Insurance - Reinsurance
Excess of loss coverage on a book year basis
Reinsurers generally follow primary modelReinsurer accrues when Primary (ground-
up) incurred losses exceed attachment point
Cumulative paid losses + reserve for current delinquencies = cumulative incurred losses
Likely no losses for first 3-5 years for each aggregate excess of loss book year
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Deferred losses for excess of loss structures
However, premium is front loaded Reflects declining insurance in-force for
book year Poor matching Contingency reserve mitigates this on a
statutory basis Premium Deficiency Reserve if extreme on
a cumulative run-off basis
Reserving Practices for Mortgage Insurance - Matching
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Illustrative Premium Earnings Pattern vs. Incurred Loss PatternIncremental
One Book Year
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
1 2 3 4 5 6 7 8 9 10
Run-off Year
Per
cen
t o
f U
ltim
ate
Premium Earnings Pattern Incurred Loss Pattern
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One way to better match would be to defer some of the premium in an UEPR Has generally been rejected
Some reinsurers have considered booking an IBNR reserve for book year pooled projected losses to better match premium and losses (particularly on GAAP Statements)
Example: Loss ratio approach Set aside a % of earned premium based on
actuarial ultimate loss and premium expectations for each book year
Adjust based on revised projections Mixed responses as to appropriateness of this
approach Must seek auditors feedback
Reserving Practices for Mortgage Insurance