The current dislocation of the mortgage insurance-linked securities market due to the COVID-19 pandemic is likely to cause mortgage reinsurance rates to rise.
A.M. Best believes that traditional reinsurance will remain available, but at a price.
Access to the capital markets has been a key lever for private mortgage insurers to grow their books.
The current dislocation of the mortgage insurance-linked securities (ILS) market due to the COVID-19 pandemic is likely to cause mortgage reinsurance rates to rise, impacting the originate to distribute model of many mortgage insurers.
Over the last few years, issuance of mortgage insurance-linked securities, or mortgage insurance linked notes (ILN), has become a significant source of capital markets backed mortgage reinsurance for the biggest U.S. mortgage underwriters.
Structured like a catastrophe bond, or 144a insurance-linked security, these mortgage ILS deals have become a key source of excess-of-loss reinsurance for the mortgage insurance market, enabling them to grow their underwriting on the front-end, safe in the knowledge that the reinsurance capacity is available from the deepest and most liquid source possible, the capital markets.
But, after the COVID-19 pandemic drove dislocation through financial and capital markets, it has resulted in the issuance of mortgage ILS grinding to a halt.
Rating agency A.M. Best highlights this in a recent report and says that while access to mortgage ILS reinsurance caapcity is less readily available, the growing "originate, manage, and distribute" business model of private mortgage insurers has become less simple and almost certainly more expensive.
This business model drove demand for mortgage reinsurance higher, pushing insurers to tap the capital markets and look to the ILS structure to do so.
Now, mortgage ILS capacity is unavailable for the moment.
While the ILS market for catastrophe bonds bounced back quickly after a short hiatus caused by the coronavirus, the pandemic threatens elevated levels of mortgage loan delinquencies and so is a direct threat to in-force mortgage ILS, making issuance of fresh ones very difficult at this time, perhaps impossible as it could prove too costly.
However, A.M. Best believes that traditional reinsurance will remain available, but at a price.
"AM Best believes that reinsurance of private mortgage insurers will continue albeit with different terms and conditions and higher rates," the rating agency said.
Continuing, "At the very least, some private mortgage insurers need to continue buying reinsurance for purposes of reducing their PMIERs-related Minimum Required Assets (and mitigating the effect of the anticipated rise in claims) because the PMIERS sufficiency ratios of these insurers currently range from a low of 117% to a high of 200%. Therefore, AM Best believes traditional reinsurance will still be a necessary risk management tool for these insurers, particularly those currently on the lower rung of the PMIERs sufficiency ratio range. However, because net insurance written by the private mortgage insurers is projected to decline, the amount of risk in force they will cede to the traditional reinsurers may decline on the aggregate as well."
But that won't be from the capital markets for the moment, the rating agency believes, as the mortgage ILS market remains dislocated for now.
Access to the capital markets has been a key lever for private mortgage insurers to grow their books, so with that route to efficient risk capital now closed for a time they may slow their assumption of new policies a little, to avoid paying overly high rates for traditional reinsurance cover.
It seems likely that once the scale of delinquencies becomes clearer, the capital markets will likely open up again and mortgage ILS issuance will return.
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