Reinsurers writing US mortgage business tipped to double

Reinsurance companies are becoming increasingly familiar with the concepts—and the attractions—of working with mortgage organisations such as Freddie Mac and Fannie Mae in the credit risk transfer market, and many are enjoying profitable growth on the back of this.

Gina Subramonian Healy, vice president of credit risk transfer at Freddie Mac, said that since the first transactions were done with reinsurers back in 2013, and thanks to brokers such as Aon Benfield facilitating, the size of the market has grown substantially.

“Since 2013, Freddie Mac’s reinsurance risk transfer programme has increased in size of achieve a cumulative risk transfer of just over $5.5 billion across 20 transactions,” said Subramonian Healy. “The panel of reinsurance participants has also increased from an initial four markets, to approximately 25 active markets today.”

She believes more growth is to come. “The goal is to get to 50,” she said. “On an annual basis we plan to transfer approximately $2.5 billion of risk to the reinsurance market and continue to offer a sustainable programme.”

She explained that Freddie Mac’s portfolio has approximately $2 trillion worth of underlying residential single family mortgages, and it plans to use this method of risk transfer more.

Fannie Mae and Freddie Mac are two US government-backed financial institutions that provide liquidity to the US mortgage markets by buying mortgages from lenders. Traditionally Fannie and Freddie held these assets on their own balance sheets, but the 2008 financial crisis—which was triggered by a sudden rise in defaults in the US residential mortgage market—meant they suffered big losses and needed to be bailed out by the US government.

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

“Following the financial crisis, a core part of our strategy is to distribute credit risk and attract new sources of private capital while retaining sufficient skin in the game to ensure alignment of interest,” said Subramonian Healy.

“Mortgage credit risk is an attractive product for the reinsurance market.” as it represents uncorrelated risk with attractive returns.”

The quality of the business is also very high. The process of mortgage approval has been tightened since the financial crisis, meaning high underwriting standards and detailed documentation. The quality of the business and the availability of data are exceptional and that means it can be very profitable business for re/insurers.

Subramonian Healy said Freddie Mac, as the credit risk manager, applies strict underwriting guidelines as well as leveraging automated tools to ensure that loans meet the guidelines. These efforts combined with stricter regulation have significantly improved the quality of the mortgages underwritten post the financial crisis.

“We are focused on growing the credit risk transfer through multiple programmatic offerings and diversifying products and investors,” added Subramonian Healy. “The reinsurance transactions are now a core part of Freddie Mac’s portfolio management strategy.”

Joe Monaghan, executive managing director at Aon Benfield, the dominant broker in this market responsible for placing over 90 percent of the risks, added that reinsurers were becoming increasingly aware of this part of the market.

According to Aon Benfield, reinsurers are able to choose a level of risk and engagement that they find comfortable. The more they know about it, the more they are willing to become involved with it, with many reacting favourably to it.

“We see a lot of room for growth,” Monaghan said. “We are working as an advocate of this market and we expect solid growth for the next few years as more mortgage business is transferred in this way and more re/insurers want to participate.”