Old Republic (NYSE:ORI)
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5 Years : From Apr 2012 to Apr 2017
Taking the bad with the good long has been a fact of life for U.S. mortgage insurers. But now, as the industry struggles through the toughest patch of its five-decade history, one long-time executive is shopping a proposal that would help mortgage insurers the next time the housing market implodes.
The only problem: Easing mortgage insurers through the bad times would require them to sacrifice some of the outsized profits they enjoy when the housing market is healthy.
The plan, put forward by Aldo Zucaro, chief executive of Old Republic International Corp. (ORI), calls for mortgage insurers to create a mutual reinsurance company. The reinsurer would collect premiums from each of the rival mortgage insurers, and then cover their losses when a housing crisis hits.
"There's bound to be another catastrophic period," Zucaro said. "In this industry, you get some very good years and then--whamo--you get hit and you better have the money to weather the storm."
Zucaro is putting forward the plan as Congress and the Obama administration consider ways to reform the mortgage-finance market and wind down government-controlled mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC), whose government takeover has cost taxpayers about $138 billion so far. The mortgage-insurance industry, which insures loans sold to Fannie and Freddie, has paid $22 billion to the two companies since 2007, according to an industry trade group.
Whether other mortgage insurers will agree to Zucaro's plan is an open question. Spokespeople for some of the leading mortgage insurers, including MGIC Investment Corp. (MTG), PMI Group Inc. (PMI) and Genworth Financial Inc. (GNW), had no comments on Zucaro's proposal, though a few said they were reviewing it.
"We are going to have some further discussions with the key players in the industry," Zucaro said.
Mortgage insurers sell protection on home loans where a borrower has put down less than the standard 20% down payment. The insurance is typically paid for by the homeowner, but claims are paid to the lender if the borrower defaults.
The promise to reimburse lenders on defaults has proven to be a costly one in recent years. Mortgage insurers sold too much underpriced coverage as the housing bubble inflated, and the industry has lost more than $15 billion since 2007 as it made good on its policies.
At the same time, the industry has ceded much of its market share to the government's Federal Housing Administration. So even though mortgage insurers have tightened underwriting standards and raised prices, profits from new policies so far haven't been enough to offset losses from the older ones. Many who track mortgage insurers don't expect the industry to report a profitable year until 2013.
By then, Zucaro estimates mortgage insurers will have paid nearly twice as much in claims as they collected in premiums over the six-year length of the crisis.
The smallest publicly traded mortgage insurer, Triad Guaranty Inc. (TGIC), was forced to stop selling new policies in 2008 when its capital ran short. Many of the others have been forced to get waivers from state insurance regulators to continue selling new coverage, and drastically have diluted long-time shareholders when they issued new stock while the shares were near historic lows.
Zucaro said a mutual reinsurer would help companies avoid such pitfalls. As outlined in a white paper Old Republic has distributed across the industry, the mutual would begin paying struggling mortgage insurers in the next housing crisis when the industry, on average, is paying out more than it's collecting in premiums. In the interim, the mutual would build reserves by charging mortgage insurers based on how much they insure and how risky their policies are judged to be.
In the 55 years since MGIC founded the first modern-day mortgage insurer, the industry has gone through one other period of paying out more in claims than it's collected in premiums. From 1985 to 1989, mortgage insurers paid out roughly 30% more than they earned. Old Republic posits the mutual reinsurer would have almost 20 years to build up billion of dollars in reserves before another housing calamity strikes.
Collecting the reserves would require the mortgage insurers to pay roughly 20% of their premiums to the reinsurers, cutting into insurers' profits. But Old Republic calculates that would be about what's needed to build a large-enough reserve fund over nearly two decades to reimburse mortgage insurers if the next crisis is as large as the current one.
Had the plan been in place since the last housing crisis ended, "we would obviously have had much lower earnings in the good years because you would have eliminated those times when we had 18% and 20% or more returns on equity," Zucaro said. "But we still would have produced an 11% or 12% return on equity, which in the property-casualty business is a very decent result."
State insurance regulators would have to sign off on the plan. Representatives for the insurance regulatory offices in the key mortgage-insurance states of North Carolina, Pennsylvania and Wisconsin also declined to comment or didn't respond to requests for comment.
Freddie and Fannie would also need to agree.
"We believe that the regulators like the concept," Zucaro said, "but in both cases they would prefer to see the industry come together and agree to the concept."
-By Erik Holm, Dow Jones Newswires; 212-416-2892; email@example.com