For any type of insurance company to be successful, it needs to properly price the risk it is taking on in the event it has to pay out a claim. At several of the private mortgage insurance companies, the notion of enhanced risk-based premiums has taken on new life, spurred by the events of the past few years.
At American International Group Inc.'s United Guaranty Corp., the risk-based pricing program is called Performance Premium.
Kim Garland, the unit's chief operating officer, said he has been in the mortgage insurance business for nearly two years. But in the 20 years before that, he was in personal-lines auto insurance.
Auto insurers are "fanatical about matching rate with risk," Garland said. "They will talk about how it is not about underwriting anymore, but it is about pricing."
Drivers run the gamut from very good to average, but they were being mispriced. So these companies became committed to trying to get the right price for each individual risk. But in the mortgage insurance business, the historical insurance rating algorithm seems to be lacking this concept,
Garland said. Instead, the business uses a subsidized pricing model, a mix of appropriately priced risk, underpriced risks and overpriced risks.
Therefore the underpriced risks and overpriced risks need to be in balance for that model to work. What happened in the time running up to the housing crisis, he said, is that mix got out of balance.
There are two solutions to this problem. One is to manage the mix of business better, and the other is to try to get every risk priced properly so the mix is less important.
Performance Premium is a pricing model that accomplishes that second option at United Guaranty. In the mortgage insurance business, Garland said, a credit score has been used as an underwriting variable, but not a pricing variable. In his example, borrowers with scores between 670 and 790 are treated the same. In reality, the loss experience between those scores varies.
Some of United Guaranty's competitors use some form of risk-based pricing, Garland said. But his company "pushed the pedal to the metal on introducing credit score into the rating model."
Debt-to-income ratio has been an underwriting variable that United Guaranty now uses as a pricing variable.
Traditionally, geography has been an underwriting variable, where insurers look for concentrations (and thus get more restrictive) in markets they are worried about. United Guaranty charges a price differential based on markets. Garland said United Guaranty charges more to insure a loan secured by a property in Las Vegas, compared with one in Topeka, Kan. It is simple enough for a company to merely raise its credit score standard, but not raise the pricing.
But with United Guaranty's model, it gets a loan where the borrower has a 760 credit score in each of those markets. It considers the Las Vegas loan more risky because of the differences in each locale because of the macroeconomic trends there versus Topeka.
The result of Performance Premium is a skew in the company's business in winning a higher percentage of business from better-quality borrowers, Garland said. "We believe this gives us both a mechanism to be more responsible risk managers and it is a growth accelerator. And hopefully, it is a more responsible way to do business," he said.
Jason Berkey, senior vice president, chief actuary at United Guaranty, said the company applied variables to loan premium pricing and analysis that others in the mortgage insurance business probably had not captured historically. Mike Zimmerman, senior vice president of investor relations at MGIC Investment Corp., said the concept is not entirely new. There had been what insiders called Smugs — special market underwriting guidelines. While the market has done away with the concept, the industry uses geographic tiers for pricing.
MGIC uses location and loan-to-value. In May 2010 it broke LTV down to three credit score buckets: 720 and higher, 680 to 719 and under 680.
When it made the decision to redefine its buckets (which included raising its credit score floor), there was uncertainty in the markets, Zimmerman said. This includes what changes, if any, the Federal Housing Administration makes to its pricing structure. Private mortgage insurers then and now are looking to recoup market share from the government program.
MGIC also wanted to reward borrowers with better credit with more affordable options. Performance Pricing might have made a difference in the tough years.
Garland said that when United Guaranty runs its historical book of business through this model, it found the rate it would have charged on some of the very worst stuff would have been five times higher than it actually charged. If it had charged that rate in the market back then, it likely would not have underwritten those loans.