Editor: David Reiss
Brooklyn Law School

February 14, 2014

Federalizing Monoline Mortgage Insurance

By David Reiss

The Federal Insurance Office of the Department of Treasury issued a report required pursuant to Dodd-Frank, How To Modernize And Improve The System Of Insurance Regulation In The United States, which addresses among other things the state of the monoline mortgage insurance industry:

Recommendation: Federal standards and oversight for mortgage insurers should be developed and implemented.

Like financial guarantors, private mortgage insurers are monoline companies that experienced devastating losses during the financial crisis. A business predominantly focused on providing credit enhancement to mortgages guaranteed by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, mortgage insurers migrated from the core business of insuring conventional, well-underwritten mortgage loans to providing insurance on pools of Alt-A and subprime mortgages in the years leading up to the financial crisis. The dramatic decline in housing prices and the impact of the change in underwriting practices required mortgage insurers to draw down capital and reserves to pay claims resulting in the failure of three out of the eight mortgage insurers in the United States. Historically high levels of claim denials, including policy rescissions, helped put taxpayers at risk.

Regulatory oversight of mortgage insurance varies state by state. Though mortgage insurance coverage is provided nationally, only 16 states impose specific requirements on private mortgage insurers. Of these requirements, two govern the solvency regime and, therefore, are of particular significance: (1) a limit on total liability, net of reinsurance, for all policies of 25 times the sum of capital, surplus, and contingency reserves, (known as a 25:1 risk-to-capital ratio); and (2) a requirement of annual contributions to a contingency reserve equal to 50 percent of the mortgage insurer’s earned premium. In addition to the states, the GSEs (and through conservatorship, the Federal Housing Finance Agency) establish uniform standards and eligibility requirements that in some cases are more stringent than those required by state regulators. As the financial crisis unfolded, mortgage insurers no longer met state or contractual capital requirements. State regulators granted waivers in order to allow mortgage insurers to continue to write new business while the GSEs loosened other standards that were applicable to mortgage insurers.

The private mortgage insurance sector is interconnected with other aspects of the federal housing finance system and, therefore, is an issue of significant national interest. As the United States continues to recover from the financial crisis and works to reform aspects of the housing finance system, private mortgage insurance may be an important component of any reform package as an alternative way to place private capital in front of any government or taxpayer risk. Robust national solvency and business practice standards, with uniform implementation, for mortgage insurers would help foster greater confidence in the solvency and performance of housing finance. To achieve this objective, it is necessary to establish federal oversight of federally developed standards applicable to mortgage insurance. (31-32)

This critique of the monoline insurance industry seems accurate to me. The industry has a tendency to fail when it is needed most — during major financial crises. Having multiple states regulate monoline insurers allows this nationally (and globally) significant industry to engage in regulatory arbitrage — that is, finding the most pliable regulatory environment in which to operate. National regulation would solve that problem. As always, a single federal regulator is more prone to capture by the industry it regulates than a bunch of state regulators. We have, however, tried the alternative and it has not worked so well. I think a federal approach is worth a try.

| Permalink