More players are drawn to mortgage reinsurance by its growth, innovation, returns

The mortgage reinsurance markets have continued to develop and mature to the extent this product now represents a mainstream line of business for the growing number of reinsurers operating in the space, Joe Monaghan, leader of Aon Benfield’s US credit & guaranty, and government practice, told PCI Today.

“In the past 12 months five more reinsurers have started writing this type of business, meaning around 42 re/insurers are now operating in this space,” Monaghan said.

“While it’s a very stable market, there are areas where innovation is occurring and the potential for growth is great, especially if market share can be taken from the bond markets, which also take on this risk.”

Mortgage reinsurance, which has opened its doors only in the past four years to re/insurers, has become a lucrative new market providing much-needed growth and diversification for those willing to take the plunge.

The US mortgage credit business has a very different risk profile compared with what re/insurers are used to writing. The reasons for its opening up are unique and present a compelling proposition for re/insurers, according to Monaghan.

Mortgage reinsurance business is mainly generated in the US by Fannie Mae and Freddie Mac, the two US government-sponsored enterprises that provide liquidity to the US mortgage markets by buying mortgages from lenders.

Since the 2008 financial crash and over the last four years in particular, they have been encouraged by government to transfer more risk into the private sector. They do this in two ways: around 75 percent of risks are transferred into the bond markets and about 25 percent into the re/insurance sector.

Monaghan said there is a pipeline of new entrants preparing to enter the market.

“All deals are oversubscribed and rates are down, but they still present an attractive return profile for reinsurers,” he said.

He estimated that some $70 billion of risk exposure has been transferred into the private sector so far—roughly 20 percent of that into the re/insurance sector.

Innovation is taking place: Freddie Mac has tweaked its reinsurance structure in the last 12 months, which means the amount it is buying is slightly down on previous years, and Fannie and Freddie Mac have both succeeded in buying a new form of coverage.

“Traditionally, a block of business has been originated and the coverage kicks in around six or nine months later. This new coverage puts protection in place for mortgages originated, within preset criteria, in advance. Policymakers like this because it removes that window of around six months when protection is not in place,” Monaghan said.

“These are forward contracts: coverage is in place from the moment the mortgages are acquired by Fannie or Freddie. We also expect to see reinsurance opportunities from mortgage insurance (MI) companies, which represents further innovation for this market.”

Although there will be no ceded losses to mortgage reinsurers from the recent hurricanes, he believes the wider response of reinsurers to the losses will help reassure policymakers in terms of the financial robustness of reinsurers and their willingness to pay claims.

“These losses will also illustrate that this line of business is truly uncorrelated from the other parts of re/insurers’ portfolios. This market has shown itself able to deliver returns in the high-teens—and that is through the entire cycle, including 2007 and 2008 when the market would have borne losses,” he said.

While MI companies will deliver some growth, Monaghan said a potentially larger opportunity will come if reinsurers can take a share from the bond markets.

“The bond markets are fully collateralised and spreads have come in, but even if reinsurers were to achieve modest market share growth from 25 to 30 percent that would represent significant growth of reinsurance limit placed year on year,” he explained.

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