Trends, truth and trajectory of mortgage reinsurance

Capsicum Re’s* Steven Rance explains how the ‘threat’ of recession could actually be the perfect time to put new structures together for mortgage reinsurance.

With daily headlines continuing to serve up hard, cold facts about the enormity of the economic and employment ramifications being wrought by Covid-19 around the world – and with the last global financial crisis still fresh in the collective memory – mortgage reinsurance might seem like a natural, even likely, contender for next ‘casualty’ of the current global crisis.

But the reality is very different. Not only does the mortgage reinsurance market remain fully open for business, reinsurers are actively looking to work with clients and specialist brokers in a constructive and collaborative manner on new transactions and alternative structures.

Over the past six months, a number of transactions have been successfully executed, providing positive evidence of the market remaining operational and active throughout the cycle.

These successful transactions also illustrate how reinsurance capacity can be relied upon for long-term risk transfer partners. By way of example, we have placed four mortgage reinsurance transactions since March across seven carriers, with our latest deal on 31 August at only a small material price increase to pre-Covid levels.

This includes two high loan-to-value US transactions – that relied solely on reinsurance capacity – which were successfully placed in April and August for significantly over $1bn of future mortgage originations each. So the mortgage reinsurance market is proving itself resilient and stable with deals consistently being executed at reasonable pricing levels.

Our experience over the past few months has also shown us that the capacity in the market is not just open to new transactions, but willing and wanting to take a genuine partnership approach with clients on their risk transfer needs.

We have seen first-hand how this combined approach is allowing clients to seek innovative structures at accurate premium levels given the position of the cycle.

Recession: risk or opportunity?

The threat of deepening or prolonged recessions around the globe coupled with their historic link to mortgage defaults is, however, likely to prompt many to still ponder the longer term knock-on effects on this specialist area of reinsurance.

Such concern is arguably unfounded. Mortgage is and always has been a ‘through the cycle’ proposition. For those of us that have been involved in the mortgage space for several decades, experience tells us that a market downturn can create as many, if not more, opportunities than a buoyant market.

For example, most European countries have 10 percent or more of their mortgage holders on repayment holidays.

The longer these holidays extend then the higher the repayments will be on resumption. No one yet entirely understands the correlation between mortgage holidays and furloughs or what will happen when both end. But our focus remains resolutely on creating client solutions, so we have been placing portfolio reinsurance with significant retentions to protect lenders against a worst case scenario.

In fact, as specialist brokers and reinsurers we should be encouraging all stakeholders to build long-term solutions which will weather market conditions – good and bad.

For mortgage reinsurers, the good years balance the tougher ones. Every single year will see mortgage defaults, but this can be minimal and are usually down to personal circumstances, or localised where a specific economy suffers. Even in a macro-economic scenario, the impact differs globally, in terms of severity and timing. Reinsurers should build a portfolio of transactions and programmes which blend geography, risk profiles and the client base.

At the heart of it all is a huge amount of available, regulated and uniformed data. This has allowed for accurate modelling of the risk and for crisis-replay RDS (realistic disaster scenarios) so that reinsurers can manage their exposures in all economic scenarios. A variety of structures and drivers will also lead to varied performance metrics – for example, a capital relief structure on a portfolio of seasoned low loan-to-value loans will respond in a different way to a first time buyer excess-of-loss programme.

And it is this data-rich status that is the key to why mortgage reinsurance is not only a growth market, but how and why it holds an advantage over other growth lines. Take cyber – undoubtedly a growth area for reinsurers, but one that has to contend with far fewer data points. So the wealth of data surrounding mortgage performance and house prices going back over decades, is the fundamental difference between these two growth classes. All insurers love the ability to model risk and, for mortgage, there are millions of depersonalised records available for analysis, evidencing performance data going back years and over several cycles. That means reinsurers are able to model specific mortgage types and performance over a range of economic scenarios.

“For mortgage reinsurers, the good years balance the tougher ones”

Growth: current and future potential

Moving from risk evaluation and appetite to performance and growth, returns on mortgage reinsurance have been highly attractive over recent years, with good margins and low loss ratios.

The market has essentially enjoyed rapid expansion since 2013, with now over 50 reinsurers working within the space and continues on a strong growth trajectory.

In fact, in the nearly three decades I’ve been working in and around the field of mortgages, I’ve not seen such a profusion of mortgage risk transfer transactions or reinsurers prepared to provide capacity, with many building specific expertise in the mortgage arena.

This growth has largely been driven by the US government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.

Since 2014, they have been issuing mortgage reinsurance transactions on a regular basis putting billions of dollars into reinsurers and driving a market that now includes reinsurers from across the globe.

It remains true, however, that the global market for mortgage insurance can be divided into the US and the rest of the world. Regulated markets and the GSEs in the US have succeeded incredibly well in developing the reinsurance market. The regulator and MIs have added to this by changing the MI capital regime and so encouraging the monolines to seek reinsurance. So, in terms of growth specifics, the reinsurer role in the mortgage space has expanded exponentially in the US but there is still far more opportunity and demand to be met elsewhere in the world. Outside of the US, the fact remains that the use of mortgage insurance is less well-established, which naturally necessitates a process of introduction, adaption and education on the risks and opportunities with both clients and reinsurance markets.

Broker role: deeper, diversified, driver of change

Consequently, the broker’s role now involves a great deal more than just putting two parties together and facilitating the transaction. It is far more analytical, consultative and often regulatory driven – typically leading to long-term programmes which require constant support.

Specialist mortgage reinsurance brokers will be daily dealing with lenders, house builders, regulators and governments around the globe. And, having helped to establish a strong base of reinsurance capacity, the focus is now on utilising this to address client issues in a range of areas, including capital relief, risk transfer and new product development.

What we are seeing now is a combination of factors and solutions involving mortgage insurers, captive structures, retained layers and, of course, reinsurers. All these elements are combining to offer our clients choice, but they also need guidance. Which is why our role today is as much consultant as it is broker – pulling together the various elements and options to create an optimal solution. Being able to blend through-the-cycle experience with a dedicated focus on this niche area ultimately enables a specialist broker to deliver where others may fail.

Contrary to superficial expectation, therefore, the mortgage market is more upbeat than many may expect. This is the first time that reinsurance capacity has been tested since its development in the mortgage indemnity business and all the signs are that capacity is here to stay. It can be relied upon and is fundamental to any risk transfer program sought by clients worldwide. Experience is revealing that, thanks to the benefit reinsurers derive from their diversified portfolios of risk, even in times of stress they are willing and able to step up and continue to meet commitments.

So, one could argue that the ‘threat’ of recession is actually the perfect time to be putting new structures together. Our clients are more motivated to seek protection and more flexible on structures and retentions. Now is the time, for us as specialist brokers and advisors, to educate and support our clients by producing programmes that will ‘stick’ long past any single event – provided they continue to deliver for all stakeholders.

*Capsicum Re will rebrand to Gallagher Re on 1 October 2020.