SubmiSSion to Competition poliCy Review panel€¦ · SubmiSSion to Competition poliCy Review panel JanuaRy 11, 2008 Page of 15 one first Canadian PlaCe • P.o. Box 456 • 100 King

SubmiSSion to Competition poliCy Review panel

JanuaRy 11, 2008

SubmiSSion to Competition poliCy Review panelJanuaRy 11, 2008

www.pmicanada.ca Page � of 15

one first Canadian PlaCe • P.o. Box 456 • 100 King street West, suite �610 • toronto, ontario • M5x 1e4 • Canada

PMI Mortgage Insurance Company Canada 1 First Canadian Place, 100 King Street West

P.O. Box 456Toronto, Ontario M5X 1E4

Tel: (416) 607-4400Fax: (416) 607-4465

January 11, 2008

Mr. L.R. Wilson, ChairCompetition Policy Review Panel280 Albert Street, 10th FloorOttawa, ON K1A 0H5

Dear Mr. Wilson,

Re: Reviewing Canadian Competition policy

introduction

PMI Canada is pleased to have the opportunity to provide input to the Competition Policy Review Panel.

PMI Mortgage Insurance Company Canada (PMI Canada) is a subsidiary of The PMI Group, Inc. (NYSE:PMI). We serve the needs of residential mortgage lenders and investors across the country. PMI Canada offers loan-level primary mortgage insurance for resi-dential mortgages as well as portfolio insurance, also known as mortgage insurance which is applied to a specific group of loans. PMI’s products protect lenders and investors against losses associated with borrower default on residential mortgage loans. We are rated AA by Dominion Bond Rating Service.

As a global company, having recently entered the Canadian market, we applaud the federal government’s decision to review current competition policy practices and are very eager to contribute to the valuable work that the Panel is undertaking in order to identify current issues surrounding competition policy in Canada.

As such, we call upon the panel to consider the following key recommendations which are further outlined in the body of our accom-panying submission.

provide the same level of guarantee to private insurers as CmHC

One change that we feel would have an important impact in better balancing the competitive environment would be to ensure that both CMHC’s mortgage insurance operations and those of private insurers are eligible for the same level of government guarantee. This could be done by either raising the level of government guarantee for private insurers to 100% or setting up CMHC’s mortgage insurance business as a separate Crown corporation and explicitly ensuring that the government provides no backing to the corpora-tion should it face bankruptcy. It is our feeling, however, that this may only be partially successful in leveling the playing field since financial institutions often assume that even without a guarantee the government would still provide financial support to CMHC were it to face difficulty. Therefore, we strongly urge the government to move immediately to provide a 100% guarantee to private insurers so they can compete more effectively with CMHC.

Create a Separate Crown Corporation for the mortgage insurance business

We urge the government to open access to emili® (CMHC’s online risk assessment and processing platform) and default data and consider removing the Mortgage Insurance Fund and other related businesses (e.g., emili®, data, valuation, MBS, etc.) from CMHC




and have them managed by separate Boards of Directors and management. We propose that the government determine whether the new corporation should continue to be explicitly guaranteed by the government. Even if the government decided that the new corporation would carry no guarantee, the market might still assume that CMHC would receive some level of government backing if it were to face financial difficulty.

There are clear precedents to this approach. Canadian National Railway and Air Canada, before their privatization, were both Crown corporations whose obligations were not guaranteed by the government. As a result, when the corporations were privatized, there was no need for the government to restructure their debt because it did not carry an explicit government guarantee.

privatize CmHC’s mortgage insurance business

We feel that the Government of Canada should consider whether it needs to be involved with the mortgage insurance business. It is our belief that the private sector could effectively provide this function. Canada has privatized other businesses when it deter-mined that there was no longer a strong public policy rationale for the government to continue in those businesses. The current Con-servative government has stated that part of its economic development policy is to, “privatize crown corporations that compete directly with comparable services from existing private sector institutions”.

mandate Review of CmHC

It has been over 20 years since the government has held a comprehensive mandate review of the CMHC, and clearly much has changed in the housing and mortgage insurance markets since then. In addition, for other major financial Crown corporations – EDC and BDC – public reviews are required every ten years. These reviews provide an opportunity to examine the capacity of the private sector to provide the services currently provided by the Crown corporation and help assess whether there is an on-going need for a government role or whether a competitive private sector could provide the service without government intervention.

Conclusion

As a global company with local market expertise, we feel that we are well positioned to provide valuable insight on the issues.

It is our firm belief that by creating a more level playing field for private mortgage insurers in Canada, we will help make the dream of homeownership a reality for more Canadians.

We would be pleased to provide the Commission with more specific recommendations on how to create a level playing field in the Canadian marketplace in order to offer more choice to Canadians.

We look forward to hearing from you to discuss how we can effectively contribute to the Panel’s work on this important matter. Please contact Janet Martin, CEO, PMI Canada, at 416.607.4401 or [email protected].

Yours truly,

Janet Martin CEO PMI Mortgage Insurance Company Canada


www.pmicanada.ca Page 4 of 15


introductionIn its consultation document, the Competition Policy Review Panel asks the question, “What further could be done in Canada to pro-mote an ongoing review of Canadian competition, investment and productivity performance aimed at Canada’s sustained competitive-ness?” This submission focuses on competition issues in a market where the government competes directly with the private sector and addresses the effect of government policies relative to public involvement in areas where private companies compete.

PMI Mortgage Insurance Company Canada (“PMI Canada”) has recently entered the mortgage insurance market in Canada following Parliamentary approval and a policy decision by the Department of Finance granting qualified new private sector companies access to a government guarantee needed to compete in the Canadian market. Mortgage insurance protects mortgage lenders and investors against financial losses arising from borrower default. The availability of mortgage insurance is a significant factor in mortgage lending, and therefore makes homeownership more broadly available to Canadians.

In entering the Canadian market, PMI Canada has faced and continues to face significant challenges competing with the Mortgage Insurance Fund (MIF) of the Canada Mortgage and Housing Corporation (CMHC), an agent corporation of the Crown. CMHC has a controlling position in the market. This situation raises fundamental questions about the appropriate role that government should play in a market such as mortgage insurance where a competitive private sector can meet the needs of Canadian homeowners and mortgage lenders.

Contrasted to other financial services in Canada, such as banking and life insurance, the mortgage insurance market is unique because government holds the controlling market position providing a financial service that the private sector can provide. In other financial service sectors, significant efforts have been made to remove barriers to entry, both for Canadian and foreign financial institutions, to encourage as much competition among private sector providers as possible. Where the government has identified situations that significant market players abuse their dominant positions, such as in the debit card service business, the Competition Bureau has taken specific action to encourage more competition (e.g., the Consent Agreement involving the Interac Association).

In the case of other Crown corporations involved in the financial sector, such as Export Development Canada and the Business De-velopment Bank, the government conducts regular mandate reviews that examine whether there is an on-going need for government involvement in the specific financial services those Crown corporations provide (e.g., export insurance and financing and high-risk small business lending).

PMI Canada’s submission provides background on the development of the mortgage insurance market in Canada and compares the current market to those in the United States and Australia, which represent the two most highly developed markets outside Canada. A description of the Mexican mortgage insurance market is included to provide an example of how public and private institutions inter-act there. This submission argues that changes are needed in Canada’s mortgage insurance market to improve market efficiency and to provide customers with increased choice and features.

Using this information, we respond to several of the Panel’s questions for guiding the discussion regarding Canada in a global context, investment policies, sectoral investment regimes, competition law and Canada as a destination for talent, capital and innovation. We provide our overall conclusions in the final section.

about pmi

PMI Canada, a subsidiary of The PMI Group, Inc. (PMI), serves the needs of residential mortgage lenders and investors in Canada. PMI Canada offers primary, or loan level, mortgage insurance for residential mortgages as well as portfolio insurance, which is mort-gage insurance applied to a specific group of loans. PMI’s products protect lenders and investors against losses associated with borrower default on residential mortgage loans. PMI Canada is rated AA by Dominion Bond Rating Service.

The PMI Group, Inc. is headquartered in Walnut Creek, California. Through its wholly and partially owned subsidiaries, PMI offers residential mortgage insurance and credit enhancement products, financial guarantee insurance and financial guarantee reinsurance in Asia, Australia and New Zealand, Canada, Europe, and the United States.




Credit enhancement solutions succeed when they are sensitive to the unique character of each country’s market. Throughout the world, PMI is known as a global company with a local focus and management, recognized for understanding the conditions of each market we serve and tailoring products to the needs of those individual markets.

PMI Canada brings these attributes to the Canadian market and offers residential mortgage lenders and investors customized solutions to their credit enhancement needs, thereby increasing their ability to:

• Transfer risk and grow profitability

• Increase home ownership opportunities and reach non-traditional borrowers

• Manage liquidity

• Participate in the high loan-to-value ratio market and obtain regulatory capital relief

pmi’s timeline in Canada

March 31, 2006 – PMI Canada filed an application with the Office of the Superintendent of Financial Institutions (OFSI) to provide mortgage insurance in Canada.

May 29, 2006 – PMI Canada testified at the House of Commons Standing Committee on Finance about the benefits of competition in the mortgage insurance market.

April 24, 2007 – PMI Canada received its Order to Commence and Carry on Business from OSFI. This Order enabled PMI Canada to begin actively marketing its products, pending receipt of provincial licenses.

May 10, 2007– PMI Canada was issued a Financial Strength rating of AA by Dominion Bond Rating Service.

July 12, 2007 – PMI Canada received a government guarantee that will benefit PMI Canada customers by providing them with capital relief afforded by mortgage insurance. Under the guarantee the federal government has guaranteed payment on 90 percent of certain of PMI Canada’s mortgage insurance obligations in the extremely unlikely event of insolvency1.

November 3, 2007 – PMI Canada received approval from Canada Mortgage and Housing Corporation (CMHC) to insure mortgages in Canada’s National Housing Act Mortgage-backed Securities program.

December 2007 – PMI Canada has to this point received licences from all provinces and territories except Quebec to offer mortgage insurance. An application to offer mortgage insurance in Quebec is currently pending.

purpose of Submission

Prior to entering the Canadian mortgage insurance market, PMI Canada recognized the existence of factors that limit the potential to be fully competitive in the Canadian market. The mortgage insurance market control by CMHC, a Crown corporation, is the main factor that has and continues to limit competitiveness due to significant special advantages that CMHC enjoys over private sector insurers.

Based upon experience in other jurisdictions, PMI believes that a more competitive mortgage insurance market would benefit Canadian homebuyers. Prior to 2006, only one private sector mortgage insurer, Genworth Financial, operated in the Canadian market. With only a government insurer and one private insurer, the lack of competition has limited innovation, benefits and reach to consumers. With the policy decision to allow new private mortgage insurers into the market, the time has come to assess how the mortgage insur-ance needs of homebuyers can best be met through a highly competitive market where the private sector plays the dominant role. This will require changes in government policies to foster the entry and opportunities for private sector firms. The continuing control-ling presence of the federal government through CMHC will need to be addressed.

1 This guarantee is limited to conforming mortgages of the nature insurable by CMHC. One principal benefit of the guarantee is that is affords regulated mortgage lenders with capital relief with respect to insured conforming mortgages.




Development of the Canadian mortgage insurance marketthe beginning

In 1946, the government created the Central Mortgage and Housing Corporation2 (CMHC) to assist in housing returning war veterans and to lead the nation’s housing programs.

the Fifties

The Mortgage Insurance Fund (MIF) was created in 1954 as an integral part of CMHC with the objective of making home ownership more accessible to Canadians. As the MIF is a part of an agent Crown corporation, its obligations were effectively guaranteed by the federal government.

Under the loan insurance program, the MIF insured mortgage loans made by banks and other lenders and reimbursed them for princi-pal and interest on the loan in the event of a default. CMHC was responsible for reviewing mortgage loan applications. Coinciding with the establishment of the MIF, the Bank Act was amended to make loan insurance mandatory for mortgages with a down payment of less than 25%.

From the outset, two key policies guided the activities of the MIF:

• The MIF was required to be self-financing and to break even over the business cycle (i.e., the “break-even mandate”).

• The MIF was expected to insure loans in all regions of Canada at the same premium rate, regardless of location (i.e., the “equal access mandate”).

CMHC has maintained that as part of its equal access mandate, it insures mortgages in more risky single-industry communities and in First Nations reserves where lenders cannot take security. In fact, the MIF insures in single-industry communities, but requires co-insurance from the community, the company or the province. Similarly, mortgages insured in First Nations reserves are guaranteed by the Minister of Indian Affairs. Thus, in both cases, the additional risks taken by the MIF are minimal.

the Sixties

In 1969, the NHA was amended to encourage banks to provide mortgages by reducing the minimum term of a mortgage from 25 years to five years. This minimum term was reduced to one year in 1980, and mortgages with variable mortgage rates became eligible in 1982. The interest rate ceiling on MIF-insured loans was eliminated and banks were allowed to make uninsured loans. These changes helped to increase the banks’ share of the mortgage business from less than 1% in the mid-sixties to over 60% by the end of 2000.

the Seventies

In 1970, lenders were allowed to obtain mortgage insurance from either a private or public mortgage insurer. As a result, the Mortgage Insurance Company of Canada (MICC), which entered the mortgage insurance market in 1963, recorded strong growth in its business, and two additional companies (later taken over by MICC) entered the mortgage insurance market in the early 1970s.

During the seventies, CMHC decided to provide interest subsidies to first-time homebuyers for the first five years of the mortgage. High interest rates led to a significant level of defaults and the government decided to refund to CMHC about $800 million for losses it incurred under this subsidy program. After the refunding, CMHC tightened up on its mortgage insurance program and increased premium rates.

the eighties

In 1987, the government asked CMHC to review its overall mandate including its mortgage insurance business. While this review brought significant changes to CMHC’s social housing program, the government reaffirmed the continuation of CMHC insurance without substantive changes to its policies and role.

2 In 1979, the name of the Corporation was changed to the Canada Mortgage and Housing Corporation.




The year 1987 also marked the introduction of mortgage securitization in Canada. The Mortgage-backed Securities (MBS) program was created to allow the packaging of mortgages in smaller denominations to attract a broader range of investors. It was anticipated that the creation of a secondary market in mortgages would exert some downward pressure on mortgage rates.

In 1988, Canada’s implementation of the Basel Accord required chartered banks to hold capital based on the risk of their assets. Without government action the implementation would have had a significant effect on the competitiveness of the mortgage insurance market. While banks were not required to hold any capital against mortgages insured by CMHC, they were required to put up capi-tal against privately-insured mortgages, making privately-insured mortgages significantly more expensive for the banks to hold than CMHC-insured mortgages. To allow MICC to remain in the market, the federal government agreed to provide a 90% guarantee of MICC-insured mortgages in return for a guarantee fee and the requirement to build up a contingency fund against default.

the nineties

In the early nineties, losses on commercial real estate forced MICC to exit the mortgage insurance market and in 1995, the General Electric Capital Mortgage Insurance Corporation (later Genworth Financial Canada) bought the “back book” of MICC and began operating in 1997.

To respond to a stronger competitor in the mortgage insurance market, the government announced the “commercialization” of the MIF in the 1996 Budget. The key elements of the “commercialization” were:

• The MIF was required to earn “a reasonable rate of return”, rather than to break even over the business cycle;

• The MIF was allowed to modify its programs and to introduce new mortgage insurance products without Cabinet approv-al. This was intended to allow CMHC to respond promptly to market conditions. CMHC was also authorized to reduce its premium rates in specific markets to respond to private sector competitors; and,

• The MIF was required to pay a guarantee fee to the government and to build and maintain policy reserves. These require-ments are similar but not identical to the rules applied to private sector insurers.

A significant change in government accounting in the mid-nineties required that the accounts of the Crown corporations be partly consolidated with the Public Accounts. Because of this policy change, the profits of the MIF are shown in the Public Accounts as an asset and any attempt to spend the accumulated MIF profit would be a cost to the federal government.

Recent Developments

Mortgages insured by CMHC’s private sector competitors are eligible for the Mortgage-backed Securities program as well as the Canada Mortgage Bond program. As program administrator, CMHC seeks to ensure that mortgages insured by the private sector insurers are similar in risk to those insured by CMHC. Foregoing this program is not a viable option for insurers because Canada’s largest lend-ers participate and expect support from their mortgage insurance providers. As a result, private sector insurers are forced to submit commercially sensitive information, including policies, strategies and business plans to their largest competitor if they want to become approved insurers in the program.

To participate as insurers in the Mortgage Backed Securities Program, CMHC’s competitors are also required to settle claims to CMHC’s standard, regardless of the private insurers’ contract wording and without access to documentation of CMHC contracts or procedures. Through this requirement CMHC effectively can dictate loss mitigation, contract enforcement and interpretation, and the commercial decision making of its competitors.

Canada is viewed as an attractive market for private sector mortgage insurers because of the opportunity to innovate and better reach customers. With a decision of the Department of Finance to extend the government guarantee to new mortgage insurers, PMI and sev-eral other major mortgage insurers have recently entered the Canadian mortgage insurance market. However, the full potential to serve the market cannot be reached without restructuring the government role in the industry. The issue of a level playing field between CMHC and its private sector competitors has become a question of fundamental concern.




Competition issues in the Current market

international Comparisons

Canada’s mortgage insurance market is unique. Unlike the situation in Canada, in other countries with developed mortgage insurance markets, the government is a reluctant, minor or nonexistent participant. Three markets that offer interesting comparisons to the Cana-dian mortgage insurance market are the United States, Australia and Mexico (the first two because they are large and developed; the latter because it shows policy decisions made by a government after assessing the effectiveness of the various models deployed around the world).

Countries in Europe, such as the United Kingdom and France, were not chosen for comparison because these and other European governments have chosen not to legislate specifically around mortgage insurance.

united States

The U.S. market is comprised of both private and public mortgage insurance participants. The market share of private mortgage insur-ance companies has increased recently as they expanded in the affordable housing segment in conjunction with efforts of government-sponsored enterprises like Fannie Mae and Freddie Mac. This segment was previously insured mainly by the public sector mortgage insurer. Private sector mortgage insurers have also supported community re-investment and on-reserve native housing programs. The Federal Housing Authority (FHA) carries out the government’s social housing policy through its mortgage insurance activity and the Department of Veterans Affairs (VA) serves the specialized needs of armed forces veterans.

There is very little competition between public and private mortgage insurers in the United States. The U.S. government has taken the approach that:

(1) private capital will optimize the outcome for all stakeholders; and,

(2) the FHA’s role is best reserved to affect social policy as opposed to serving markets that can be well-served by private entities.

In the U.S., mortgage insurance is mandatory for loans purchased by the government-sponsored enterprises (GSEs) with down pay-ments of less than 20%. The market is dominated by monthly premium payment with coverage on only the top portion (typically 20-35%) of loan balances. The market contains both flow primary and pool/structured finance mortgage insurance, and includes both prime and non-prime segments. The U.S. market is also restricted to mono-line insurers.

PMI estimates the U.S. private mortgage insurance premium market at approximately $US4.6 billion in 2006.

australia

The Australian mortgage insurance market is served only by private insurers. From 1965 to 1998, Housing Loan Insurance Corporation (HLIC) was a public sector player modeled on CMHC until the government decided the mortgage market could be best served by the private sector. HLIC was sold to Genworth Financial and the Australian government has since remained out of the mortgage insur-ance market.

The Australian mortgage insurance market features single premium payment products with full (100%) coverage of original loan bal-ance – this is the same as in the Canadian market. The market is also restricted to mono-line insurers and the capital markets demand AA ratings. The Australian market contains both flow primary and pool/structured finance mortgage insurance, and is predominately comprised of prime segments.

The Australian mortgage insurance premium market is estimated at approximately $A500 million annually.

mexico

Mortgage insurance is relatively new to the Mexican market. It was originally created by the government entity Sociedad Hipotecaria Federal (SHF) to enable low down payment borrowers access to mortgage credit. SHF focuses on first time home buyers and the lower income borrower segment which have more difficulty providing adequate down payments.




From the beginning the government intended to exit the mortgage insurance market once the private sector developed the capacity to provide this service. Recognizing that private mortgage insurers are reluctant to enter an emerging market without government support (data accumulation, standardization, regulatory endorsement, etc.), the government decided to participate until the private sector can develop capacity to provide this service. Government and industry have jointly developed reporting and data standards. Using these, the industry has begun to produce statistical information that all competitors can use.

The Mexican government has a strategy that involves four steps:

(1) form SHF and begin taking risk;

(2) encourage private mortgage insurers to reinsure some of the risk ;

(3) establish a licensing and regulatory framework for private mortgage insurers; and,

(4) have SHF retreat from the market, ceding most of the market to the private mortgage insurers once they better under-stand the risks and are prepared to provide the insurance without government support.

In 2007, government passed legislation creating a mortgage insurance framework and SHF and private insurers have filed for licenses. After the private sector is well-established, the government sees SHF evolving into an FHA-like role in the U.S., where its insurance activities support social housing policy.

Comparison of mortgage insurance market in Canada, united States, australia and mexico

CanaDa uniteD StateS auStRalia mexiCo

Size of market (premiums paid per year)

$C 1.� billion $us 4.6 billion $a 500 million small

Role of GovernmentCrown Corporation has controlling position in the Canadian market

Private sector has largest part of the overall mortgage insurance market.

government enterprises are

complementary and insure mortgages to

further social housing policy

government exited the australian market

since 1��

government created market but is planning for transition to private

mortgage insurers

number of private Sector providers

4 (with additional licences pending) � � � (with more entrants

encouraged)

premium payment single premium Monthly premium single premium Monthly premium

insurance Coverage full outstanding principal

first �0-�5% of outstanding principal

full outstanding principal

first �5% of outstanding principal

Government entity Share of mortgage insurance market

approximately �0% approximately �0% 0%Currently 100%,

but private sector is moving into market




Current Government Guarantee to private Sector players

In contrast to the mortgage insurance markets examined, Canada has taken a different approach with a very high level of government involvement. CMHC’s 100% guarantee from the federal government eliminates all capital a bank would normally be required to hold against a mortgage. To approximate this benefit of CMHC insurance, the Government of Canada has also had to extend guarantees to private sector insurers.

Until 2006, Genworth Financial Canada was the only private mortgage insurer, but in 2006, the Department of Finance agreed to extend its guarantee program to other mortgage insurers to allow them to enter the Canadian market. The Department of Finance is currently reviewing its guarantee program for private mortgage insurers, in part because these guarantees represent one of the largest, if not the largest, contingent liability to the private sector on the Government of Canada’s books.

As noted previously, the federal government has decided to guarantee only 90% of the liabilities of private insurers. Although this closes the competitive gap with CMHC somewhat, mortgage lenders continue to see a benefit in using CMHC-insured mortgages because of their 100% federal government guarantee and the associated regulatory capital benefit.

In other markets around the world, mortgage lenders assess the quality of the insurance by the financial strength of the insurer. This financial strength is most easily measured by the companies’ ratings from internationally recognized rating agencies. A bank’s ability to benefit from the mortgage insurance in terms of the capital they must hold usually derives from specific capital requirements (like Basel II) tied to these ratings. The most critical factor in these ratings is the MI’s ratio of its available capital to its risk in force. Sovereign entities rarely retain capital ratios at the conservative levels of private entities.

Competitive advantages CmHC has over private Sector insurers

The controlling presence of the federal government, through its wholly-owned Crown corporation, CMHC, is a unique feature of Canada’s mortgage insurance market contrasted to other countries with mature mortgage insurance markets. In addition, CMHC competes directly with the private sector across the whole range of mortgage-related products, not just in assuming credit risk of higher risk mortgages.

Competition issues

In contrast to its private sector competitors, CMHC has the following advantages that give it a significant competitive edge and limit private sector competition:

• Because of its status as an agent of the federal government, CMHC’s insurance comes with a 100% guarantee from the government – by contrast, the Department of Finance will only provide private sector insurers with a 90% guarantee. This provides CMHC with financial advantage over private sector insurers because lenders need to hold additional capi-tal – and incur an additional cost – for mortgages insured by private sector insurers.

• As a condition of their government guarantee, private insurers have limits on the amount of business they can do with financial institutions that CMHC has not approved for mortgage insurance. Furthermore, only certain types of mort-gages defined by CMHC and originated by CMHC approved lenders are eligible for this government backing. As a result, CMHC has an unfair and unfettered market power to limit competition from private insurers. Additionally, CMHC’s con-trolling role in approving lender eligibility for mortgage insurance reduces competition in mortgage lending because access to mortgage insurance and the capital relief from the government guarantee are key success factors for mortgage lenders. However, for each new mortgage insurer to comply with terms of the government guarantee, it must insure significant amounts of bank business. As a result, banks, Canada’s dominant mortgage lenders, have enhanced bargaining power.

• With roughly 70% market share derived from and sustained through special competitive advantages, CMHC dominates Canada’s mortgage insurance market. Private insurers will need to make a major effort to break into the market where CMHC already has long-established business relationships with many mortgage lenders.

• Private sector insurers are subject to regulation and supervision by the Office of the Superintendent of Financial Institu-tions (OSFI), whereas CMHC does not face the same regime. Because of this discrepancy, private sector insurers incur regulatory costs to which CMHC is not subject. In addition, because of their lack of a track record in the Canadian




market, OSFI sets higher capital requirements for new mortgage insurers that add additional costs compared with CMHC or Genworth, even though all private insurers must comply with OSFI minimum capital standards.

• Because OSFI-regulated institutions must file quarterly statements, CMHC has a further advantage over its competitors since it can access detailed information about its competitors but does not make the same information publicly available. Data on CMHC’s defaults would be particularly useful because of its large market share. Without this default data, other mortgage insurers have more difficulty accurately pricing market risk. In addition, this lack of transparency on the part of the controlling entity in the mortgage insurance industry is very troublesome, particularly at a time when events in the U.S. serve as a reminder to all market participants that residential mortgages do carry risk.

• Private sector insurers are subject to the discipline of financial markets, particularly in terms of their rates of return and reporting on their results – CMHC must meet some financial goals established by the government, but these are lower and less binding than those private insurers must meet. CMHC also is not required to meet the high standards for finan-cial reporting that private sector firms need to provide.

• Through its long standing market control, CMHC has created an enormous property valuation database and a methodol-ogy that it considers proprietary and that is commercially available only to its customers. Because of CMHC’s long-term central position in mortgage lending, this data has become the de facto standard in property valuation, and an integral part of lenders’ loan approval processes. New entrants are unable to replicate this advantage even with considerable investment. Therefore, the cost and risk of error of a private insurer’s valuation will significantly exceed that of CMHC. The impact is that higher costs can get passed on to consumers and there can be an adverse impact on underserved consumers with the greatest need for mortgage insurance, namely self-employed, new Canadians and Canadians with non-traditional credit histories.

• CMHC must approve private insurers that wish to participate in the Mortgage-backed Securities and Canada Mortgage Bonds programs. To gain this approval CMHC examines confidential business plans, customer lists, insurance policies and procedures, products, and pro forma financial statements of its competitors. This creates a significant conflict of interest since it gives executives managing the mortgage insurance fund at CMHC direct access to confidential informa-tion on competitors’ customers and strategy. The CMHC Head of Securitization serves a dual role as General Manager of Ontario, which includes mortgage insurance activity.

The broad scope of CMHC’s operations in mortgage insurance, mortgage-back securities, valuation, housing policy, affordable housing, data, and international consulting is unprecedented in any developed mortgage market. CMHC has special market powers and an unusual level of control that disadvantage competitors in all of these areas, including MI. These factors provide CMHC with a significant competitive advantage in the Canadian mortgage insurance market. This makes it difficult for new private sector insurers to gain market share and provide Canadian homeowners with the benefits that increased competition could bring to the market and Canadian homebuyers.

Corporate Governance issues

Under the CMHC Act, the corporation’s Board of Directors consists of a Chairperson, president and eight other members. All directors, including the Chairperson and the President are appointed by the Minister Responsible for Housing with the approval of the Governor-in-Council (the Cabinet) for a term of not more than four years. The Board, with the approval of Governor-in-Council appoints three senior Vice-Presidents for seven year terms.

The responsibility of the Board of Directors is to “… manage the affairs of the Corporation and may for such purposes exercise all the powers of the Corporation.” In practice, this means that the Board reviews and approves major new initiatives, major projects and plans and budgets including the Corporate Plan that is submitted to the Treasury Board and the borrowing plan that is submitted to the Minister of Finance. Both the Corporate Plan and the Borrowing Plan must also be approved by the Minister Responsible for Housing before submission to the Treasury Board and the Minister of Finance respectively.

An important distinction to make is that, compared to the private sector, the President is not appointed by the Board of Directors so there is not a clear line of accountability to the Board of Directors. In addition, the Governor-in-Council, not the Board, has final say in approving CMHC Corporate Plan. Consequently, both the Corporation and its President must focus much more on meeting the government’s objectives for CMHC rather than on operating the mortgage insurance fund purely on business terms.


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mandate Reviews of other Crown Corporations

CMHC has not had a mandate review for over 20 years. Legislation requires that the mandates of both Export Development Canada (EDC) and Business Development Bank of Canada (BDC), two other agent Crown corporations providing financial services, be re-viewed every 10 years. One of the key questions addressed during those reviews is what role the private sector should play in addressing the financial services currently being provided by those Crown corporations.

export Development Canada

Export Development Canada (EDC) is Canada’s export credit agency. It offers innovative financing, insurance and risk management solutions to help Canadian exporters and investors expand their international business. EDC is a Crown corporation wholly owned by the Government of Canada.

Under the terms of the Export Development Act, the Government of Canada, through the Department of Foreign Affairs and Inter-national Trade, initiates a periodic independent review of EDC’s mandate and operational effectiveness. These reviews are conducted every 10 years, with the next mandate review scheduled to begin in 2008. The review will examine Canada’s challenges in global com-merce, the needs of Canadian exporters and investors, and the role that the private sector and public sector, including EDC, can play in helping the Government address those needs.

The review will include a public review of important issues relating to EDC and its mandate, and consultation with stakeholders and interested parties across the country. Within one year of the review being undertaken, the Minister of International Trade is required to report the findings of the review to Parliament, where findings are reviewed in committee.

business Development bank of Canada

The Business Development Bank of Canada (BDC) is a financial institution wholly owned by the Government of Canada. BDC plays a leadership role in delivering financial, investment and consulting services to Canadian small and medium-sized enterprises (SME). These services complement those of private sector financial institutions.

Much like EDC, BDC is required by legislation (the BDC Act) to undertake a review of its operations every ten years. The review is ar-ranged and conducted by Industry Canada, the federal government department responsible for BDC. The last report was tabled in 2001 and the next one will be done in 2011.

The 2001 review looked at the provision and operation of the BDC Act between fiscal years 1994–95 and 1999–2000. It presented the principal features of the BDC Act and its mandate, discussed how BDC responded to changes in the business environment and the demands of its SME customers, and summarized the results of the recent special examination of the Bank.

benefits to Canadians of a Change in CmHC’s Status

Canadians and Canada would benefit from greater competition in the mortgage insurance market in several ways:

1. Reduced contingent liability of the government, now approaching $500 billion, with authorization up to $550 billion3.

2. More focused, transparent and successful policy making on housing.

3. Expanded mortgage backed bond programs.

4. More choice and better terms for mortgage lenders and ultimately consumers.

To fully gain these benefits from a competitive market, the government would need to carefully manage a transition from the current environment with a controlling government entity in the market to one where several private sector companies compete vigorously and prudently for the existing business.

3 Contingent liability is based on outstanding insurance in force of CMHC as reported as $291 billion in the 2006 CMHC Annual Report and $172 billion as reported by Genworth Financial at September 30, 2007. Authorization reflects CMHC at $350 billion and the private insurance industry at $200 billion.


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Government action to increase Competition in the mortgage insurance marketThe discussion above clearly indicates that the government can address competition issues by either providing private mortgage insur-ers with the same advantages that CMHC currently enjoys or by removing those advantages and ensuring that CMHC has no special advantage over private insurers.

provide the same level of guarantee to private insurers as CmHC

One change that would have an important impact in better balancing the competitive environment would be to ensure that both CMHC’s mortgage insurance operations and those of private insurers are eligible for the same level of government guarantee. This could be done by either raising the level of government guarantee for private insurers to 100% or setting up CMHC’s mortgage insur-ance business in a separate Crown corporation and explicitly providing that the government will provide no backing to the corporation should it face bankruptcy. As discussed later, this may only be partially successful in levelling the playing field since financial institu-tions may assume that even without a guarantee the government would still provide financial support to this separate Crown corpora-tion if it were in difficulty.

Create a Separate Crown Corporation for the mortgage insurance business

The government could remove the Mortgage Insurance Fund and other related businesses (e.g., emili®, CMHC’s online risk assessment and processing platform also other CMHC activities such as data, valuation, MBS, etc. could be separated) from CMHC and have them managed by separate Boards of Directors and management.

There are clear precedents to this approach. Canadian National Railway and Air Canada, before their privatization, were both Crown corporations whose obligations were not guaranteed by the government. As a result, when the corporations were privatized, there was no need for the government to restructure their debt because it did not carry an explicit government guarantee.

Competition questions would, however, still need to be addressed even if the MIF were moved to a separate Crown corporation. These include:

• would the company be regulated by OSFI;

• what would be done to ensure the corporation makes a return on equity comparable to that of its competitors;

• what measures would be needed to ensure the corporation does not abuse its dominant market position; and,

• what alternative approval process would be used to approve new mortgage insurers for the MBS and CMB programs

privatize CmHC’s mortgage insurance business

The Government of Canada could follow the Australian example and decide that the public sector no longer needed to be in the mortgage insurance business because the private sector could provide this function. Canada has privatized other businesses when it determined that there was no longer a strong public policy rationale for the government to continue in those businesses. The current Conservative government has stated that part of its economic development policy is to, “privatize crown corporations that compete directly with comparable services from existing private sector institutions”.

In a major study entitled The Economics of Privatization4, Professor Don McFetridge, Professor and Chair of the Department of Economics at Carleton University found that,

“The weight of the evidence is that, taken as a whole, this process (privatization) has been efficiency enhancing.”

4 C.D. Howe Institute Benefactors Lecture, 1997, The Economics of Privatization, D.G. McFetridge, October 22, 1997.




Further, he notes,

“With respect to the entire process of commercialization, regulatory reform, and the sale of state-owned enterprises to the private sector, the weight of the evidence to date is that it has been beneficial…Whether or not privatization is a necessary part of the process, once commercial objectives have been adopted and regulatory reform has allowed competition or potential competition to exert its disciplining force, there is little, if anything, to be gained from continued state ownership — provided that the govern-ment sells its interest at a price equal to the present value of the income it might expect to derive from continued ownership.”

This analysis would suggest that for the mortgage insurance market, where CMHC was given commercial objectives in 1996 and the government is now making changes to try to encourage greater competition in the Canadian market by encouraging the entry of large international mortgage insurers, Canada has little to gain by continuing to provide this service through a government entity.

It should be noted that several of the Crown corporations that have been privatized have become internationally competitive. CN is a major competitor in the North American transportation market, Air Canada actively competes with other major international airlines and Petro-Canada has significant offshore interests. Privatization may create an opportunity for the government to create a Canadian-based mortgage insurer that would be able to expand beyond Canada’s borders and compete against other international insurers in other markets.

mandate Review of CmHC

It has been over 20 years since the government has held a comprehensive mandate review of CMHC. It is clear that much has changed in the housing and mortgage insurance markets since then. In addition, the mandates of other major financial Crown corporations, EDC and BDC, are subject to reviews conducted by independent third parties every ten years. Those reviews provide an opportunity to exam-ine the capacity of the private sector to provide the services currently provided by the Crown corporation and to assess whether there is an on-going need for a government role or whether a competitive private sector could provide the service without government intervention.

answering the panel’s QuestionsAlthough the competition issues identified in Canada’s mortgage insurance markets do not apply to all the questions the Panel posed in its consultation paper, we have provided our views on how they relate to several of the questions in the following sections.

Canada in a Global Context

Levelling the competitive playing field would open new opportunities for global insurers to enter the Canadian market and increase profit motive to invest in Canada. This would increase employment in Canada and equally important, bring new mortgage insurance products and expertise to Canadian homeowners. With the current special advantages that CMHC enjoys over global insurers entering Canada, the market cannot reach its potential to maximize benefits to borrowers and lenders, particularly because new entrants are additionally hampered by regulatory and start-up costs.

Sectoral investment Regimes

As the consultation paper notes, there are a number of ownership restrictions affecting large insurance companies and Canadian banks in Canada. We think it is important to add the advantages provided to CMHC in the mortgage insurance market as another area where government action restricts the ability of private sector mortgage insurers to enter that market, whether they are foreign or domestic.

The Canadian market is unique in having the government play such a large role in the mortgage insurance market. While there may have been historical reasons for the government playing a role when mortgage insurance was in its infancy and there were no private sec-tor mortgage insurers, that situation has clearly changed. Consequently, the government should look very seriously at whether it needs to continue to play such a dominant role in this market, or whether, as Mexico has decided at the outset, it should make every effort to encourage competing private mortgage insurers to meet the mortgage insurance needs of Canadian mortgage providers and homeowners.

Given the advantages that CMHC enjoys, there is no assurance that it is providing mortgage insurance services in the most productive way. If those services were provided through a fully competitive market, the competition would force all competitors to provide their services at the lowest cost possible, driving all companies involved in the Canadian mortgage insurance market to provide their services in the most productive manner.




Competition policy and law

The Competition Bureau should look more seriously at competition issues that CMHC’s involvement in the mortgage insurance market creates. Given CMHC’s dominant position in the Canadian mortgage insurance market, there would be good reasons for both the Bureau and those developing competition policy to address questions of what role the Corporation should be playing in a market where real competition with the private sector could bring benefits to consumers. Clearly, making the Canadian market more competitive will both attract new companies to the market and encourage those that have already entered the market to introduce creative products and services and to increase their investment in Canadian operations.

In the specific case of the mortgage insurance market, the fact that CMHC is a Crown corporation limits the extent to which it could be internationally competitive in mortgage insurance markets outside Canada. Therefore, there really is no tradeoff in this case between having internationally competitive Canadian companies and allowing foreign mortgage to expand in Canada. By increasing competition in the Canadian market by removing government from the Canadian market, Canada could actually increase the potential of having an internationally competitive Canadian company and improve competition and choice in the Canadian market.

becoming a Destination for talent, Capital and innovation

As a general rule, Canada’s financial markets are open to active competition. PMI believes that a similar policy should apply to the mortgage insurance market. By carefully examining the competition issues in that market and taking the measures needed to move to an active competitive market, Canada would be a more welcome destination for talent, capital and innovation for both mortgage insurance suppliers and in other services that support Canadians’ becoming homeowners.

Conclusion and RecommendationsThis submission has examined the issue of Canada’s mortgage insurance market and CMHC’s role in it from several different perspec-tives. It provides the key historical developments in Canada’s mortgage insurance market. It compares the current Canadian market to other countries with developed mortgage insurance markets (U.S. and Australia) and to a country (Mexico) that is actively trying to develop a mortgage insurance market by encouraging the private sector to assume as large a role as possible.

We have noted that in the case of other major financial Crown corporations – EDC and BDC – public mandate reviews are required every ten years. By contrast, no independent mandate review of CMHC has been conducted for over twenty years. Given that the Government of Canada has made a decision to encourage the entry of new competition into the Canadian market by agreeing to pro-vide guarantees to new entrants, it is clearly time for the government to assess the mortgage insurance market and CMHC’s role in it. This should include evaluating whether CMHC’s role in the market should be changed, either by creating a separate commercial Crown corporation or by privatizing CMHC’s mortgage insurance business entirely.

Finally, we have identified several changes that could be made that would help foster a more competitive and vigorous mortgage insur-ance market. We strongly urge the government to move immediately to provide a 100% guarantee to private insurers so they can compete more effectively with CMHC. At the same time, the government should examine whether other options including creating a separate corporation solely to provide mortgage insurance, privatizing CMHC or opening access to emili® and default data might be more effective in ensuring Canadians have access to the mortgage insurance services they need.

We recommend, therefore, that the Competition Policy Review Panel call on the government to initiate a public mandate review of Canada Mortgage and Housing Corporation. Furthermore, that review should specifically examine how competition could be in-creased in the Canadian mortgage insurance market and how CMHC’s mortgage insurance and related business should be restructured to best ensure that an active, competitive mortgage insurance market is created.

How competition would enhance benefits to Canadian homeowners, how policies could be changed to encourage greater investment by foreign firms in Canada’s mortgage insurance market, and how Canadian expertise could be used to build Canada’s place in foreign markets should also be included in such a review.

Thank you very much for giving PMI Canada an opportunity to address these important issues of competition in the mortgage insur-ance market. PMI would be pleased to offer further assistance or information as requested by the Panel.

Documents

SubmiSSion to Competition poliCy Review panel€¦ · SubmiSSion to Competition poliCy Review panel JanuaRy 11, 2008 Page of 15 one first Canadian PlaCe • P.o. Box 456 • 100 King