An Introduction to Private Mortgage Guaranty Insurance

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

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

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

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

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

6. Distribution by Dollar Volumeof Insured Mortgages

7. 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).

8. Industry Overview

9. 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.

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

11. 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.

12. MI Industry Loss Ratios

13. Industry Income Statement – 2002($ Millions) • Net Premiums Earned $3,836 • Losses 832 • Expenses 899 • U/W Income 2,104 • Operating Income 2,913

14. Industry Balance Sheet (as of 12/31/02 - $ Millions) • Admitted Assets $19,761 • UEPR 451 • Loss Reserves 2,025 • Contingency Reserves 12,789 • Policyholders Surplus 3,273 • Risk-to-Capital Ratio 11.03:1

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

16. Importance ofSecondary 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.

17. 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.

18. 20% down 80% LTV $80,000 loan amount Loan-to-Value Ratio (LTV) 5% down • 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. 95% LTV $95,000 loan amount $100,000 value

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

20. 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.

21. CoverageHow 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

22. 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.

23. 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.

24. Understanding Claims

25. 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.

26. Questions?