The Walnut Creek, Calif., mortgage insurer PMI Group Inc. is rising to the defense of deep-cede captive reinsurance.
For several years these deals, which mortgage insurers strike with lenders in return for a steady flow of business, have generated concerns among analysts, who say the insurers have been giving up too much.
A crackdown this year on the title insurance industry's reinsurance arrangements is now leading to scrutiny of mortgage insurers' deals. Last week the New York Insurance Department requested information from mortgage insurers doing business in the state. Meanwhile, the American International Group Inc. scandal has brought new scrutiny to accounting for reinsurance.
On Monday, PMI released a study that concluded its deals make economic sense and comply with the law.
The study had been in the works since long before the regulatory and accounting issues came up. Analysts said PMI promised to produce such a report in late 2003, in response to the assertion that deep-cede structures left the primary insurer with a return of less than 10%.
During a conference call Monday to discuss the study, a few analysts sounded unconvinced that the historical data used in the study reflect how the deals will turn out in the future.
Nevertheless, executives said the 24-year period covered by the study included enough environments to prove that the deals are both sound and legal.
"We think the study … really captured the different scenarios that should have been modeled," said Steve Smith, the president and chief operating officer of PMI.
In recent years MGIC Investment Corp., Genworth Financial Inc., and AIG's United Guaranty Corp. have made a point of saying publicly that they are trying to move away from deals that provide the most benefits to lenders.
Insurance regulators in California, Colorado, and North Carolina have also warned that they might look into mortgage reinsurance, though indications are that their title probes will come first.
According to the study, conducted by the actuarial and consulting firm Milliman Inc., PMI's standard reinsurance deals lower its mean expected returns by only 2.7 percentage points, to 16.1%, while noticeably cutting the volatility of those returns. The reinsurance cut the standard deviation in the returns from 15.6% to 11.1%.
Milliman analyzed both standard PMI deals, where it ceded 38.2% of premiums, in return for coverage after 3.7% of losses, up to 9.1% of the risk insured; and common industrywide deep-cede deals, where 40% of premiums were ceded in return for coverage after 4% of losses, up to 10% of the risk.
Only the findings for standard PMI deals were released, but PMI said the results for the industry deep-cede deals were similar.
Simulations using default and prepayment data from 1980 through 2003 showed a "more than remote" possibility that the reinsurer will take losses in such deals, PMI said.
The generally accepted standard for moving reinsured exposures off balance sheet under Financial Accounting Standard 113 is a 110% present value loss ratio in at least 10% of scenarios, PMI said.
In the mean case, deep-cede captives are insuring not just catastrophic losses but also expected losses, the study said; the mean loss level from the underlying insurance is 5.6%. The median loss rate of 4.1% suggests that in over half the scenarios, the captive will take a loss, it said.
The study also suggests that the average underwriting results for mortgage reinsurers are reasonable in relation to those of primary mortgage insurers.
There is a 20% chance the reinsurer will be paying out at least 95% of the premiums it collects, the study said. The reinsurer's worst 30% of scenarios generated higher loss ratios than the primary insurer's.
Before the call, Geoffrey Dunn, an analyst at Keefe, Bruyette & Woods Inc., said any regulatory heat would hinge on the cost of the reinsurance relative to the risk laid off. "If you look back historically you can find periods" where captive reinsurers have taken losses - one test of whether such deals are compliant with the Real Estate Settlement Procedures Act.
Not everyone was convinced that PMI proved its point about the profitability of the deals.
Ed Groshans, an analyst with Fox-Pitt, Kelton Inc., said he thought looking backwards would underestimate the effects of a changing mortgage market, particularly the shorter loan lives associated with a flurry of ARMs.
"I would think that the persistency rate over that period [in the study] was higher than the persistency rates of the period we're going to see," he said.
Mortgage insurers said Monday that the formal regulatory scrutiny of captive reinsurance has been limited to New York so far.
PMI said it has gone "proactively" to Arizona and California regulators to state its case.
Richard L. Gray, United Guaranty's general counsel, said the Greensboro, N.C. insurer went to North Carolina's insurance regulator in anticipation of questions. United Guaranty expected states to scrutinize the deals, because the title insurers have repeatedly used guidance from the Department of Housing and Urban Development on mortgage reinsurance deals in defending their arrangements, he said.
