Loss Reserving Approaches for Mortgage Guaranty Insurance

1. Loss Reserving Approaches for Mortgage Guaranty Insurance 2003 CAS Annual Meeting New Orleans Marriott John F. Gibson, FCAS, MAAA Principal PricewaterhouseCoopers, LLP

2. Outline of Presentation • Loss Reserving Distinctives • Factors that Influence Ultimate Losses • Data to Analyze • Contingency Reserves • Industry Loss Reserving Approach • Problems with Traditional Loss Development Methods • Loss Reserving Approaches • Current and Future Trends

3. Loss Reserving Distinctives • Claim = Loan that has defaulted as of the statement date • Not a reserve for the life of the loan • Type and amount of coverage • Amounts paid can exceed theoretical coverage

4. Factors that Influence Ultimate Losses • Housing Values • Unemployment • Interest Rates • Claim Settlement Practices

5. Annual Average 30-Year Fixed Rate

6. Data to Analyze • Analysis by region or state • Analysis by type of loan – LTV • Analysis by size of loan • Analysis by age of loan • Analysis of Pool Insurance and other higher risk segments

7. Contingency Reserves – Need • Premiums and losses have mismatched timing • Losses realized when loans become delinquent • But economic catastrophes can drive 100+% loss ratios for a number of consecutive years • Mortgage insurers are monoline

8. Contingency Reserves - Determination 50% of premium each year is set aside into a contingency reserve and held for 10 years Losses in excess of a 35% loss ratio in a calendar year can be removed on a FIFO basis After 10 years, remaining funds, if any, can be moved to free surplus

9. Industry Loss Reserving Approach • Identification of claims by status – for example: • Delinquent • Pending Foreclosure • Foreclosure • Claim Filed • Severity Factor – Percentage of exposure to be paid – greater than 100% for filed claim

10. Industry Loss Reserving Approach • IBNR Provision = % of reported • Regional analysis • Pool business analysis • Recent runoff history very favorable

11. Recent Runoff History(in $ millions)

12. Problems with Traditional Loss Development Methods • Leverage effect of economic cycle on number of defaults, cure rates and amounts paid can produce significant volatility • Economic cycle operates on a calendar year, not an accident year

13. Loss Reserving ApproachProjection of Ultimate Reported Delinquencies • Delinquencies are reported quickly – 85% at 12 months, more that 99% at 24 months • Eliminates need for separate IBNR provision

14. Loss Reserving ApproachDelinquency Rate

15. Loss Reserving ApproachProjections of Ultimate Claims Paid - Approaches • Project directly – very volatile • Project Closed Without Payment (Cured) claims and subtract from ultimate reported • Bornhuetter – Ferguson method using a priori ratio of closed with payment (CWP) to loan balances

16. Loss Reserving ApproachDetermining Paid Claims by Payment Year • Subtract cumulative CWP claims from ultimate CWP claim to derive remaining CWP claims by accident year • Using CWP pattern, determine distribution of remaining CWP claim for each accident year to each payment year • Sum for each payment year

17. Loss Reserving ApproachCure Rate

19. Loss Reserving ApproachDetermination of Severity • Review calendar year severity – has been declining since 1996 • Determine selected average loss payment for future calendar years • Trend of prior years • Relate to average coverage amounts • Balance recent favorable results with leveraged effect of economic change

20. Loss Reserving ApproachAverage Paid Severity by Calendar Year

21. Loss Reserving ApproachReserve Estimates • Loss reserve by payment year is projected claims to be closed by payment year times projected loss payment by payment year • Supplement with traditional loss development methods

22. Loss Reserving ApproachDetermination of Reserve Range • Based on conservative and optimistic assumptions for defaults, cure rates and severity • Reserve range is much wider than most P&C lines of business

23. Current & Future Trends • Impact of the Economic Cycle • Refinance Cycle • House Price Appreciation • Deterioration of Credit Quality