Mortgage Insurance: Market Structure, Underwriting Cycle, and Policy Implications

The events of the last few years, particularly those in the global financial crisis that began in 2007, indicate that mortgage insurance (MI) is subject to significant stress in the worst tail events. This report examines the interaction of mortgage insurers with mortgage originators and underwriters and makes a set of recommendations directed at policymakers and supervisors which aim at reducing the likelihood of MI stress and failure in such tail events.

Mortgage insurance is used to protect mortgage lenders (ie originators and/or underwriters) by transferring mortgage risk, and notably tail risk, from lenders to insurers. Insurers by their nature provide services for events in the tail of distributions, whereas the banking sector tends to provide services closer to the mean of distributions.

The events of the last few years, particularly those in the global financial crisis that began in 2007, indicate that MI is subject to significant stress in the worst tail events. In the worst cases, failure of a mortgage insurer may occur leading to resolution of the insurer, whereby some of the most extreme tail risk may revert to the lender at the very time that the insurance would be most needed, potentially creating systemic risk.

At its most fundamental level, this report examines the interaction of mortgage insurers with mortgage originators and underwriters and makes a set of recommendations directed at policymakers and supervisors that aim at reducing the likelihood of MI stress and failure in such tail events.

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