BIS: Joint Forum releases consultative paper - Mortgage insurance (MI): market structure, underwriting cycle and policy implications

11 February 2013

This report examines the interaction of MI with mortgage originators and underwriters, and makes a set of recommendations directed at policymakers and supervisors, aimed at reducing the likelihood of mortgage insurance stress and failure in such tail events. Comments are requested by 30 April, 2013.

Mortgage insurance is used to protect mortgage lenders (i.e. 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 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. A summary of these recommendations follow:

• Policymakers should consider requiring that mortgage originators and mortgage insurers align their interests;
• Supervisors should ensure that mortgage insurers and mortgage originators maintain strong underwriting standards;
• Supervisors should be alert to - and correct for - deterioration in underwriting standards stemming from behavioural incentives influencing mortgage originators and mortgage insurers;
• Supervisors should require mortgage insurers to build long-term capital buffers and reserves during the valleys of the underwriting cycle to cover claims during its peaks;
• Supervisors should be aware of and mitigate cross-sectoral arbitrage which could arise from differences in the accounting between insurers' technical reserves and banks' loan loss provisions, and from differences in the capital requirements for credit risk between banks and insurers; and
• Supervisors should apply the FSB Principles for Sound Residential Mortgage Underwriting Practices ("FSB Principles") to mortgage insurers noting that proper supervisory implementation necessitates both insurance and banking expertise.

Mr Thomas Schmitz-Lippert, Chairman of the Joint Forum, stated: "We looked through the underwriting cycle when developing the report's recommendations. It is paramount to implement these recommendations in order to strengthen and reinforce oversight of mortgage insurers and thereby increase their resilience over the longer term."

Comments on this consultative report should be submitted by 30 April, 2013

Press release

Full report

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