SD13 - Private Mortgage Guaranty Insurance


Executive Summary:
Purpose of Study

The State Corporation Commission's Bureau of Insurance (Bureau) was requested by the 1994 General Assembly, pursuant to Senate Joint Resolution No. 177, to study (i) whether competition effectively regulates premiums charged by private mortgage guaranty insurers and (ii) whether minimum loss ratio standards should be imposed on companies writing private mortgage insurance in the Commonwealth. This study was requested because questions exist regarding the reasonableness of premiums charged by mortgage guaranty insurers. Also, as stated in the resolution, mortgage guaranty insurance protects the lender against default on the mortgage, and the insurer is selected by the lender while the borrower pays the premium.

Findings

The Bureau surveyed all of the state insurance departments to determine how other states regulate the rates charged by mortgage guaranty insurers. None of the states that responded to the Bureau's survey impose minimum loss ratio standards for mortgage guaranty insurance. Out of a total of 27 responses received, 12 states indicated that mortgage guaranty insurance rates are subject to "prior approval" rating laws (which means that rates must be approved by the insurance department before they are used); 13 states indicated that mortgage guaranty insurance rates are subject to "file and use" or "use and file" rating laws (meaning that rates must be filed with the insurance department, but prior approval is not required); and two insurance departments indicated on the survey that mortgage guaranty insurance rates are not regulated in their state. The Mortgage Guaranty Insurance Model Act, adopted by the National Association of Insurance Commissioners, calls for "file and use" rate regulation for mortgage guaranty insurance rates (meaning that rates do not have to be approved before being used). This is the method of rate regulation currently in effect for mortgage guaranty insurance in Virginia.

The Bureau considered whether there had been many consumer complaints received by its Property and Casualty Consumer Services Section pertaining to mortgage guaranty insurance. The Property and Casualty Consumer Services' records indicate that they received four complaints on mortgage guaranty insurance from January 1, 1991 to October 1, 1994.

In determining whether competition effectively regulates the premiums charged for mortgage guaranty insurance, the Bureau considered a number of factors similar to those used when it conducts its statutory biennial study of the rates charged for commercial liability insurance. The Bureau's findings are summarized below:

(1) Market Share and the Number of Insurers Actually Writing the Coverage. In 1993, there were 17 companies with direct written premiums in Virginia; the top three companies accounted for 74% of the market.

(2) Ease of Entry. While there are no operational or regulatory barriers, Virginia does have a contingency reserve requirement which mandates that 50% of each mortgage guaranty insurer's earned premiums be maintained for 10 years to protect against the effects of adverse economic cycles.

(3) Reliance on Rate Service Organizations. In many lines of insurance, rate service organizations compile statistical data and file rates or loss costs on behalf of their member companies. Unlike other lines of insurance, however, there are no rate service organizations for mortgage guaranty insurance. Therefore, mortgage guaranty insurers independently develop and file their own rates and there is no reliance on rate service organizations to develop and file rates on behalf of the companies.

(4) Rate Differentials. There are moderate rate differentials among a few of the companies writing this line of insurance in Virginia. There are more significant differences, however, between the prices charged by private mortgage insurers for conventional loans and those charged by the Federal Housing Administration for FHA loans. Premiums charged by private mortgage guaranty insurers are generally lower than those charged by the FHA since the FHA provides coverage for 100% of the loan while private mortgage insurers usually provide coverage for 25-30% of the loan. (The lender retains the exposure on the portion of the risk not insured by the private mortgage guaranty insurer.) Although price differentials among insurers are not significant, borrowers arc able to shop for the best "package" from lenders. This total package includes the premiums they will pay for mortgage guaranty insurance as well as interest rates, points, and other closing costs.

(5) Level of Profitability. In addition to reviewing countrywide data, the Bureau estimated the recent levels of profitability in Virginia for the seven largest writers of mortgage guaranty insurance in the Commonwealth. Based on 1992 and 1993 data, the two-year weighted average return on surplus was 12.9%, and the two-year aggregate average was 10.7%. Although a two-year profitability history will not reflect normal and expected variations within the business cycle, these figures indicate that Virginia's overall profitability has not been excessive. Similar conclusions can be drawn from countrywide data over the past five years. (According to the 1993 Best's Insurance Reports, the normal range for return on policyholders' surplus is currently from 5% to 15%.)

(6) Competition from Alternative Markets. Competition in this market must be viewed not only in terms of the number of private mortgage insurers competing for business but also in terms of any other competitors. The federal government, through the FHA and the VA, competes with the private sector for business that qualifies for these loans, and a significant share of the market is written through the federal programs.

Despite the level of market concentration in this line of insurance, there is ease of entry, moderate rate differentials, no reliance on rate service organizations, non-excessive rates of return during recent years, and competition from the federal programs. Based on these factors, it would appear that competition effectively regulates the premiums charged for mortgage guaranty insurance.

Finally, the Bureau reviewed the loss ratios of mortgage guaranty insurers transacting business in Virginia and considered the advantages and disadvantages of establishing Joss ratio standards for this line of insurance. The Bureau found that mortgage guaranty insurers' loss ratios in Virginia were as high as 162% in 1987 and as low as 38% in 1989. The seven-year average loss ratio for years 1987 through 1993 was 78%. (Loss ratios represent only a portion of a company's cost of doing business in relation to its income. Loss ratios do not take into account a company's other expenses such as acquisition costs, general administrative expenses, taxes, licenses, and fees.)

It would appear that minimum loss ratio standards would not be appropriate for mortgage guaranty insurance for the following reasons:

(1) If the Commission established a minimum loss ratio for mortgage guaranty insurance, any rates set according to that loss ratio would have no effect on policies already in force since rates for mortgage guaranty insurance are established at the inception of the loan and are not adjusted during the term of the loan.

(2) The business cycle in mortgage guaranty insurance tends to run about every 10-15 years, and loss ratios are subject to large fluctuations due to the exposure to catastrophic losses which may result from widespread economic downturns. Mortgage guaranty insurers take this volatility into consideration when setting their rates. Consequently, loss ratios may be either very high or very low, depending on the economic conditions of the region or the country at any given time. Trying to establish an appropriate minimum loss ratio would be difficult for this line of insurance.

Conclusion

Based on the findings contained in this report, the State Corporation Commission's Bureau of Insurance concludes that minimum loss ratio standards should not be established for mortgage guaranty insurance and that sufficient competition exists in this line of insurance to continue regulating mortgage guaranty insurance under Virginia's "file and use" rating laws.