Fannie, Freddie and Climate Change

NOAA / National Climatic Data Center

The Housing Finance Policy Center at the Urban Institute issued its September 2017 Housing Finance At A Glance Chartbook. The introduction asks what the recent hurricanes tell us about GSE credit risk transfer. But it also has broader implications regarding the impact of climate-change related natural disasters on the mortgage market:

The GSEs’ capital markets risk transfer programs that began in 2013 have proven to be very successful in bringing in private capital, reducing the government’s role in the mortgage market and reducing taxpayer risk. Investor demand for Fannie Mae’s CAS and Freddie Mac’s STACR securities overall has been robust, in large part because of an improving economy and extremely low delinquency rates for loans underlying these securities.

Enter hurricanes Harvey, Irma and Maria. These three storms have inflicted substantial damage to homes in the affected areas. Many of these homes have mortgages backed by Fannie Mae and Freddie Mac, and many of these mortgages in turn are in the reference pools of mortgages underlying CAS and STACR securities. It is too early to know what the eventual losses might look like – that will depend on the extent of the damage, insurance coverage (including flood insurance), and the degree to which loss mitigation will succeed in minimizing borrower defaults and foreclosures.

Depending on how all of these factors eventually play out, investors in the riskiest tranches of CAS and STACR securities could witness marginally higher than expected losses. Up until Harvey, CRT markets had not experienced a real shock that threatened to affect the credit performance of underlying mortgages (except after Brexit, whose impact on the US mortgage market proved to be minimal). The arrival of these storms therefore in some ways is the first real test of the resiliency of credit risk transfer market.

It is also the first test for the GSEs in balancing the needs of borrowers with those of CRT investors. In some of the earlier fixed severity deals, investor losses were triggered when a loan went 180 days delinquent (i.e. experienced a credit event). Hence, forbearance of more than six months could trigger a credit event. Fannie Mae put out a press release that it would wait 20 months from the point at which disaster relief was granted before evaluating whether a loan in a CAS deal experienced a credit event. While most of Freddie’s STACR deals had language that dealt with this issue, a few of the very early deals did not; no changes were made to these deals. Both Freddie Mac and Fannie Mae have provided investors with an exposure assessment of the volume of affected loans in order to allow them to better estimate their risk exposure.

So how has the market responded so far? In the immediate aftermath of the first storm, spreads on CRT bonds generally widened by about 40 basis points, meaning investors demanded a higher rate of return. But thereafter, spreads have tightened by about 20 basis points, suggesting that many investors saw this as a good buying opportunity. This is precisely how capital markets are intended to work. If spreads had continued to widen substantially, that would have signaled a breakdown in investor confidence in future performance of these securities. The fact that that did not happen is an encouraging sign for the continued evolution of the credit risk transfer market.

To be clear, it is still very early to reasonably estimate what eventual investor losses will look like. As the process of damage assessment continues and more robust loss estimates come in, one can expect CAS/STACR pricing to fluctuate. But early pricing strongly indicates that investors’ underlying belief in these securities is largely intact. This matters because it tells the GSEs that the CRT market is resilient enough to withstand shocks and gives them confidence to further expand these offerings.

Deductible Up, Premium Down

 

photo by Stewart Black

InsuranceQuotes.com quoted me in Homeowners Insurance: Higher Deductibles Lower Premiums, But Can You Afford to Take the Risk? It opens,

Raising the deductible on your home insurance policy is one proven way to save money on your premiums, but it’s not the best financial decision for every homeowner.

Before you reach for the phone to bump up your deductible there are two important factors to consider: Do you have enough money saved to cover higher out-of-pocket claim costs, and have you discussed potential savings and ramifications with an insurance agent?

“The bottom line is that you want to make sure you are comfortable with the deductible amount you’ve selected,” says Stacy Molinari, personal lines and claims manager of Insurance Marketing Agencies, Inc. “And that means you need to make sure you have enough of a financial cushion to cover the deductible. Otherwise it could cost you more in the long run.”

So, just how much savings are out there when switching to a higher deductible? Let’s break it down by looking at a report commissioned by insuranceQuotes.com.

The 2016 Quadrant Information Services study examined the average economic impact of increasing a home insurance deductible (i.e. how much you pay out of pocket for a claim before your insurance coverage kicks in). Using a hypothetical two-story, single-family home covered for $140,000, the study looked at how much an annual U.S. home insurance premium can decrease after increasing the deductible.

According to the National Association of Insurance Commissioners (NAIC), the average home insurance premiums is $1,034, and the study examined three different percentage increases and their respective premium savings:

  • Increase from $500 to $1,000: 7 percent savings.
  • Increase from $500 to $2,000: 16 percent savings.
  • Increase from $500 to $5,000: 28 percent savings.

What makes home insurance deductibles so significant?

In short, a home insurance deducible is one of many gauges an insurance company uses to determine how much risk the consumer is willing to accept. A higher deductible means more risk being taken on by the homeowner, and that additional risk makes it cheaper to insure the policyholder.

“A higher deductible is a signal to the insurance company that the homeowner is less likely to file claims because they are agreeing to a higher threshold for doing so,” says David Reiss, law professor and research director at Brooklyn Law School’s Center for Urban Business Entrepreneurship. “And the less likely you are to make a claim, the lower your premium is going to be.”