Opportunities remain for reinsurers in the U.S mortgage market, although companies must exercise strong discipline as the underwriting cycle is now past its peak, with credit risk and pricing pressure likely to increase as capacity expands, according to a report by S&P Global Ratings.
The U.S housing and mortgage market has had a strong run of growth since the government-sponsored entities (Freddie Mac and Fannie Mae) moved to tap private capital in 2013, and has proved rewarding for re/insurers that were early to recognise its opportunities and take advantage of the strong underwriting cycle.
The number of players is also currently keeping pace with the rising demands from the GSEs and private mortgage insurers (PMIs) despite the increasing risk profile and lower pricing, and S&P expects that earnings will remain robust over the next few years.
Nevertheless, re/insurers need to remain disciplined with their approach to mortgage business – particularly those entering at this stage in the cycle – as the long-tail nature of mortgage risk may prove difficult to remove from the books if the market were to turn, S&P warned.
Accordingly, the report recommended that re/insurers should have a good understanding of the risk and its correlation, align limits with their risk appetite, and strengthen risk controls to manage exposure, in addition to having the means to analyse the risk-reward profile.
S&P also noted that demand for mortgage reinsurance is expected to continue to grow due to underlying macro-economic and housing fundamentals, notwithstanding the anticipated lower level of origination activity due to declining affordability caused by higher interest rates, housing supply constraints, and house price increases.
Considering new business and accumulation of exposure, S&P therefore believes that additional capacity is necessary to absorb the risk and sustain a certain level of demand for the reinsurance of these risks.
Furthermore, the GSEs continue to offload risk in order to reduce taxpayer exposure, while U.S PMIs are also increasingly relying on reinsurance capacity, with reinsurance utilisation growing to 34% in 2017 from 16% in 2013.
Meanwhile, tightened underwriting standards in the aftermath of the financial crisis have ensured that the mortgage performance of post-crisis vintages has exceeded expectations.
Despite the downward trend in risk-adjusted pricing, mortgage reinsurance remains attractive with generally low double-digit return on capital, and S&P noted that it is thus unsurprising that overall capacity has increased in terms of both the appetite of existing players and the entry of new players.
Additionally, while re/insurers are generally exercising due caution in the sector, with strong pricing discipline and reduced participation rates, S&P said that it expects to see greater sophistication in terms of establishing limits, analytics and risk monitoring as exposures increase.
S&P added that its view of a company’s financial strength will weaken if the company has oversized risk tolerances, doesn’t have the means to manage risk to within its defined limits, or fails to maintain adequate capitalisation.
