Advisory - Capital Requirements for Federally Regulated Mortgage Insurers

Document Properties

  • Type of Publication: Guidance Impact Analysis Statement
  • Date: December 2016

I. Background

OSFI’s Advisory, Interim Capital Requirements for Mortgage Insurance Companies (Interim Requirements), along with other OSFI guidelines, including Guideline A, Minimum Capital Test (MCT), provide the current framework within which OSFI assesses whether a mortgage insurance company maintains adequate capital.

II. Problem Identification

The current capital requirements for mortgage insurance risk were originally developed in the early 1990s and were last updated almost 15 years ago.  Developments since then, along with an increased emphasis on risk sensitivity, led OSFI to review its capital requirements for mortgage insurance risk.

The mortgage loan default insurance market and the characteristics of the products sold have evolved in recent years.  Since the current capital requirements were introduced, regulators’ understanding of credit risk and related modeling methodologies have also evolved.  These developments, along with the ongoing evolution of international financial reporting standards (IFRS), and economic and financial practice, point to the need for a comprehensive review of the capital requirements for mortgage insurance risk.

III. Objectives

OSFI’s objective is to introduce a new standard approach that updates the capital requirements for mortgage insurance risk and increases the probability that mortgage insurance companies can absorb severe but plausible losses.  In particular, the new framework should be based on an approach that:

  • Creates the right risk management incentives for mortgage insurance companies;
  • Determines requirements for each insured mortgage using direct observable risk proxies and a combination of valuation date and origination date information to ensure a level of conservatism in the protection provided to policyholders and unsecured creditors; and
  • Adapts easily to future changes in accounting or actuarial standards and regulation.

IV. Consultations

A new Advisory: Capital Requirements for Federally Regulated Mortgage Insurers (the “Advisory”) was developed with feedback from several rounds of directed stakeholder consultations and numerous impact analyses focused on specific aspects of the capital requirements for mortgage insurance risk.

On September 23, 2016, OSFI issued a draft Advisory for public consultation.  The comment period ended on October 21, 2016.  Consideration was given to all comments received and the Advisory was amended, as appropriate.  A summary of the comments and OSFI responses is included with the cover letter to the Advisory.

V. Recommendation

The recommended Advisory addresses some of the key issues with the current requirements.

The new insurance risk capital requirements consist of:

  1. A base capital requirement that applies to all mortgages at all times; and
  2. A supplementary capital requirement that only applies to mortgages originated during periods when the housing market for the region that corresponds to the mortgage has a house price-to-income ratio that exceeds a specified threshold.

Some of the important consequences of these new requirements are:

  • By using outstanding loan balance on the valuation date as the exposure measure, a mortgage’s actual pay down rate is captured and capital is only held against mortgages that are still in force.
  • By using a modified loan-to-value ratio, the borrower’s equity position in the property is better captured.
  • Differentiating requirements by borrower credit score ensures that more capital is held for borrowers who have a greater risk of default.
  • Differentiating requirements by remaining amortization on the valuation date recognizes the importance of the expected future pay-down rate and progression of the borrower’s equity position.
  • The base and supplementary capital requirements under the new framework will not depend on the premium that a mortgage insurer charges for underwriting a particular risk.
  • By using valuation date information rather than origination date information, mortgage insurers will have to maintain up-to-date information on their exposures, supporting better risk management.

Transition arrangements have been put in place for mortgages that are in-force as of year-end 2016 that have original amortization greater than 25 years or that were insured in bulk.  Transition arrangements have also been put in place with respect to borrower credit score updating and operational risk.

Capital requirements for commercial mortgages, unpaid claims and premium deficiencies are similar in approach to the current MCT.  Other items, including the diversification credit and a reference to the MCT for requirements other than those in the Advisory, remain unchanged.

It is recommended that the Advisory: Capital Requirements for Federally Regulated Mortgage Insurers be effective in 2017.

VI. Implementation

The Advisory for mortgage insurance companies would be effective on January 1, 2017. As per OSFI’s update process, OSFI will review the effectiveness of the Advisory and make amendments as required.