Loss Reserving Approaches for Mortgage Guaranty Insurance

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Loss Reserving Approaches for Mortgage Guaranty
Insurance
2003 CAS Annual Meeting New Orleans
Marriott John F. Gibson, FCAS,
MAAA Principal PricewaterhouseCoopers, LLP
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Outline of Presentation

• Loss Reserving Distinctives
• Factors that Influence Ultimate Losses
• Data to Analyze
• Contingency Reserves
• Industry Loss Reserving Approach
• Problems with Traditional Loss Development
  Methods
• Loss Reserving Approaches
• Current and Future Trends

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Loss Reserving Distinctives

• Claim Loan that has defaulted as of the
  statement date
• Not a reserve for the life of the loan
• Type and amount of coverage
• Amounts paid can exceed theoretical coverage

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Factors that Influence Ultimate Losses

• Housing Values
• Unemployment
• Interest Rates
• Claim Settlement Practices

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Annual Average 30-Year Fixed Rate
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Data to Analyze

• Analysis by region or state
• Analysis by type of loan LTV
• Analysis by size of loan
• Analysis by age of loan
• Analysis of Pool Insurance and other higher risk
  segments

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Contingency Reserves Need

• Premiums and losses have mismatched timing
• Losses realized when loans become delinquent
• But economic catastrophes can drive 100 loss
  ratios for a number of consecutive years
• Mortgage insurers are monoline

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Contingency Reserves - Determination
50 of premium each year is set aside into a
contingency reserve and held for 10 years Losses
in excess of a 35 loss ratio in a calendar year
can be removed on a FIFO basis After 10 years,
remaining funds, if any, can be moved to free
surplus
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Industry Loss Reserving Approach

• Identification of claims by status for example
• Delinquent
• Pending Foreclosure
• Foreclosure
• Claim Filed
• Severity Factor Percentage of exposure to be
  paid greater than 100 for filed claim

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Industry Loss Reserving Approach

• IBNR Provision of reported
• Regional analysis
• Pool business analysis
• Recent runoff history very favorable

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Recent Runoff History(in millions)
Year Original Loss Reserve Developed Reserves Thru 02 Developed to Original
1997 1,152 621 (46)
1998 1,260 504 (60)
1999 1,307 530 (60)
2000 1,337 642 (52)
2001 1,477 1,098 (26)
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Problems with Traditional Loss Development Methods

• Leverage effect of economic cycle on number of
  defaults, cure rates and amounts paid can produce
  significant volatility
• Economic cycle operates on a calendar year, not
  an accident year

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Loss Reserving ApproachProjection of Ultimate
Reported Delinquencies

• Delinquencies are reported quickly 85 at 12
  months, more that 99 at 24 months
• Eliminates need for separate IBNR provision

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Loss Reserving ApproachDelinquency Rate
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Loss Reserving ApproachProjections of Ultimate
Claims Paid - Approaches

• Project directly very volatile
• Project Closed Without Payment (Cured) claims and
  subtract from ultimate reported
• Bornhuetter Ferguson method using a priori
  ratio of closed with payment (CWP) to loan
  balances

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Loss Reserving ApproachDetermining Paid Claims
by Payment Year

• Subtract cumulative CWP claims from ultimate CWP
  claim to derive remaining CWP claims by accident
  year
• Using CWP pattern, determine distribution of
  remaining CWP claim for each accident year to
  each payment year
• Sum for each payment year

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Loss Reserving ApproachCure Rate
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Loss Reserving ApproachDetermination of Severity

• Review calendar year severity has been
  declining since 1996
• Determine selected average loss payment for
  future calendar years
• Trend of prior years
• Relate to average coverage amounts
• Balance recent favorable results with leveraged
  effect of economic change

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Loss Reserving ApproachAverage Paid Severity by
Calendar Year
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Loss Reserving ApproachReserve Estimates

• Loss reserve by payment year is projected claims
  to be closed by payment year times projected loss
  payment by payment year
• Supplement with traditional loss development
  methods

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Loss Reserving ApproachDetermination of Reserve
Range

• Based on conservative and optimistic assumptions
  for defaults, cure rates and severity
• Reserve range is much wider than most PC lines
  of business

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Current Future Trends

• Impact of the Economic Cycle
• Refinance Cycle
• House Price Appreciation
• Deterioration of Credit Quality