Residential Mortgage Insurance Underwriting Practices and Procedures – Guideline (2019)
I. Purpose and Scope of the Guideline
Mortgage (default) insurance is a financial product offered by a mortgage insurer that protects a lender against losses caused by a borrower’s default on a mortgage loan. Given the exposure to potential losses, a mortgage insurer’s safety and soundness is strongly influenced by its mortgage insurance underwriting policies, practices, and risk management.
This Guideline sets out the Office of the Superintendent of Financial Institutions’ (OSFI’s) expectations for prudent residential mortgage insurance underwriting and related activities. This Guideline is applicable to all federally-regulated mortgage insurers (FRMIs) to which the Insurance Companies Act applies and that provide mortgage insurance for residential mortgage loans in Canada, and/or reinsurance for such insured loans.
This Guideline complements OSFI’s Supervisory Framework and Assessment Criteria and other Guidelines (see Section IV), as well as the Government of Canada’s mortgage insurance guarantee framework.
Section II of this Guideline articulates six fundamental principles for sound residential mortgage insurance underwriting:
Principle 1 relates to a FRMI’s governance and the development of business objectives, strategies and oversight mechanisms in respect of residential mortgage insurance underwriting.
Principles 2 to 4 focus on a FRMI’s interaction with lenders as part of the mortgage insurance underwriting process. This includes:
Principles 5 and 6 relate to a FRMI’s internal underwriting operations and risk management. This includes:
The final section of the Guideline outlines disclosure and supervisory requirements.
OSFI expects FRMIs to verify that their residential mortgage insurance operations are well supported by prudent mortgage insurance underwriting practices, and have sound risk management and internal controls that are commensurate with these operations.
Principle 1: Residential Mortgage Insurance Underwriting Plan
A FRMI that is engaged in residential mortgage insurance underwriting should have a comprehensive Residential Mortgage Insurance Underwriting Plan (RMIUP). The FRMI’s insurance underwriting practices and procedures should comply with its established RMIUP.
Residential Mortgage Insurance Underwriting Plan (RMIUP)
The RMIUP is a document (or set of documents) that consolidates the FRMI’s key mortgage insurance underwriting policies. It includes a description of a FRMI’s business objectives, risk appetite, and risk management policies. The RMIUP also contains other key elements that relate to, or support, mortgage insurance underwriting.
The RMIUP should include the insurer’s complete set of mortgage insurance products (and baseline underwriting criteria for each product
The RMIUP should describe the FRMI’s delegated authorities for approving mortgage insurance applications, including its approach for approving any exceptions to the baseline underwriting criteria. Additionally, the RMIUP should outline the FRMI’s policies for detecting and addressing fraud.
FRMIs should revisit their RMIUP on a regular basis to ensure that there is strong alignment between their risk appetite statement and their actual mortgage insurance underwriting policies and practices.
Role of Senior Management – Development and Oversight of RMIUP
Senior Management should be responsible for oversight of the development and implementation of the RMIUP.
The FRMI’s Senior Management should review, discuss and approve the RMIUP or any changes to the RMIUP at least annually, or more frequently as circumstances require. Senior Management should consider how the decisions, plans, and policies they make with respect to residential mortgage insurance underwriting will potentially impact the FRMI. Senior Management should also ensure that the RMIUP is consistent with the overall business and risk strategy for the FRMI, and that the FRMI’s internal controls are sound and being implemented in an effective manner.
Please refer to OSFI’s Corporate Governance Guideline for OSFI’s expectations of FRMI Boards of Directors in regards to operational, business, risk and crisis management policies.
Internal Controls, Monitoring and Reporting
Effective controls, monitoring and reporting systems and procedures should be developed and maintained by FRMIs to ensure ongoing operational compliance with the RMIUP. This includes processes for monitoring and testing compliance with established mortgage insurance underwriting policies by the FRMI’s staff, mortgage lenders, and third parties (e.g., property appraisers).
A FRMI should identify, measure, monitor, and report to the Senior Management on all relevant risks (e.g., strategic, operational, and financial, including credit, market, and liquidity risks) in its residential mortgage insurance operations, on an ongoing basis. To support operational compliance, the FRMI’s residential mortgage insurance risk appetite, risk limit profile, and risk management policies should be understood at all relevant levels of the FRMI.
A FRMI should have adequate processes in place with respect to residential mortgage insurance to independently and objectively:
- Ensure that risks are appropriately controlled and mitigated, and provide assurances to Senior Management;
- Ensure that risk management policies, processes and limits are being adhered to, and provide assurances to Senior Management;
- Provide Senior Management with regular reporting that covers:
- Insurance underwriting exceptions, including the identification of any patterns, trends or systemic issues within the residential mortgage insurance portfolio that may impair insurance quality or risk mitigation factors;
- Quality assurance processes in relation to lenders’ practices and compliance with the FRMI’s mortgage insurance criteria and mortgage insurance coverage requirements;
- Claims settlement and claims exceptions, as well as operational preparedness for increased claims under stress events; and
- Effectiveness of underwriting systems and key underwriting-related models (e.g., property valuation).
Principle 2: Establishing Standards for the Initial Assessment and Qualification of Mortgage Lenders
A FRMI should establish sound standards for the purpose of initially assessing and qualifying mortgage lenders for mortgage insurance coverage.
A FRMI should ensure that a lender applying for mortgage insurance coverage is adequately qualified to offer and service mortgage loans and that it has adequate processes in place to comply with the FRMI’s mortgage insurance coverage requirements, before providing mortgage insurance coverage to that lender.
To carry out an initial assessment of a mortgage lender, a FRMI should establish sound qualification standards. Factors that should be considered include, but are not limited to:
Lenders should meet the FRMI’s established standards on an ongoing basis, and this should be periodically reviewed and verified by the FRMI. The nature of the assessment and designation should reflect the lender’s regulatory status,
Principle 3: Mortgage Insurance Criteria and Insurance Coverage Requirements for Lenders
A FRMI should establish prudent underwriting criteria, which specify the characteristics and parameters of insurable mortgage loans for lenders. In addition, for the purpose of controlling risk, a FRMI should promote sound mortgage underwriting and loan management practices by mortgage lenders by establishing prudent requirements in its insurance policies (e.g., Master Policy Agreements).
Important factors that influence the overall risk borne by a FRMI from its mortgage insurance business include, among others, the underlying risk of the mortgage loans it has insured, as well as the effectiveness of lenders’ mortgage underwriting practices and management of those loans.
To help manage credit risk and to promote prudent mortgage underwriting, proper loan management, and timely reporting of relevant information by lenders, a FRMI should outline the specific characteristics and parameters that define the types of mortgage loans the FRMI is normally willing to insure (i.e., “criteria for mortgage loans”). A FRMI should also establish requirements for lenders (usually contained in a Master Policy Agreement), as a condition for initial and continuing mortgage insurance coverage.
Criteria for Mortgage Loans
A FRMI’s criteria for mortgage loans
At minimum, the criteria for mortgage loans should cover the following components, for each mortgage insurance product and insurance type (i.e., transactional or portfolio insurance).
(i) Mortgage Loan Parameters:
(ii) Borrower’s Background and Willingness and Capacity to Service Debt:
As part of the insurance underwriting process, a FRMI should ensure that lenders have a process for undertaking a reasonable inquiry into a borrower’s background and demonstrated willingness and capacity to service debt. As part of its criteria for mortgage loans, a FRMI should establish and outline prudent underwriting criteria for the assessment of the borrower, which should include, but is not limited to:
(iii) Underlying Mortgage Property:
Conducting a thorough assessment of the underlying property, prior to mortgage insurance approval, helps to reduce risk in the residential mortgage insurance business. As part of the FRMI’s criteria for mortgage loans, a FRMI should outline clear and transparent policies in respect of the property acting as collateral, including:
(iv) Mortgage Insurance Premiums:
A FRMI should establish actuarially-sound premium rates for the risks it incurs, taking into consideration the overall risk of insuring mortgage loans and the potential that economic and market conditions and/or borrower characteristics can unexpectedly change. A FRMI should review its mortgage insurance premiums periodically, but at least annually.
Insurance Coverage – Conditions and Requirements for Lenders
To promote prudent mortgage loan underwriting and loan management consistent with the FRMI’s interests and to help control risk, a FRMI should outline (e.g., in a Master Policy Agreement or other insurance policy documents) requirements, conditions, and any other obligations to be adhered to, or carried out, by lenders for initial and continuing mortgage insurance coverage. The elements covered should include, but are not limited to, the following:
To achieve clarity and certainty in respect of mortgage insurance coverage, the insurance agreements between a FRMI and mortgage lenders should be clear, comprehensive and unambiguous. A FRMI should ensure that its insurance policy coverage requirements, obligations, and any other terms and conditions are binding and enforceable. Complete and final agreement of all components of the mortgage insurance contract should be executed between a FRMI and a lender prior to or upon the effective date of committing any mortgage insurance coverage.
In general, a FRMI’s maintenance of insurance coverage and payment of claims should be made conditional on the lender satisfying all policy coverage obligations and other requirements in the FRMI’s insurance agreements. Any claims exceptions should be defined in the FRMI’s RMIUP, tracked, and reported to Senior Management.
As part of a FRMI’s sound practice, the FRMI should review the requirements, conditions, and obligations established in its insurance coverage agreements, at least annually, or more frequently as needed. Such reviews ensure the agreements remain current and consistent with the decisions made by the FRMI’s Senior Management, as outlined in the FRMI’s RMIUP.
Principle 4: FRMI’s Periodic Assessments of Lenders’ Underwriting Practices
A FRMI should exercise reasonable due diligence regarding lenders’ underwriting practices, on a periodic basis, in order to assess consistency with the FRMI’s criteria for insuring mortgage loans and compliance with the requirements contained in the FRMI’s policy coverage documents. A FRMI should establish clear policies for identifying, escalating, and as needed, addressing weak or non-compliant lender practices.
As part of the mortgage insurance underwriting process, a FRMI typically obtains information from a lender’s initial assessment of a prospective borrower. The overall prudence and rigour employed by a mortgage lender in the loan underwriting process is a factor that can influence the risk being transferred to the FRMI.
Given that the underlying motivations for funding a mortgage loan can differ from those for insuring a mortgage loan, and that underwriting discipline among market participants can change over time, it is important that a FRMI assess and verify the degree to which its stated criteria and insurance policies are being followed by mortgage lenders (or other servicing companies), as a means to measure, track, and control risk. Assessing lenders’ practices can also help to identify changing trends or emerging industry practices that may require greater attention, remedial action, or changes to insurance underwriting criteria.
OSFI expects that a FRMI will undertake reasonable inquiries and reviews, on a risk-based and periodic basis, into lenders’ underwriting practices. This may include, but is not limited to, reviews for assessing accuracy of insured mortgage loan information in applications, reviews that are triggered and focused on specific events (e.g., review of insurance claims), in-depth lender-specific assessments (e.g., to assess a lender’s underwriting and control functions), and/or cross-sectional reviews of underwriting criteria across a group of lenders.
In general, a FRMI’s assessment of an individual lender’s practices, and the frequency of those assessments, should be commensurate with the FRMI’s level or concentration of risk to that lender (i.e., a risk-based approach). OSFI expects a FRMI to exercise a relatively higher level of examination and scrutiny in respect of underperforming lenders (e.g., those with proportionately higher levels of delinquencies and claims, on a risk-adjusted basis) or whose practices have been found unsatisfactory or inconsistent with the insurer’s criteria or conditions established in the mortgage insurance policies (e.g., poor loan documentation, inconsistent reporting, evidence of misrepresentation, forms of negligence, etc.).
The review process can include various methods, including automated reviews, desk-reviews, as well as on-site inspections involving a team of reviewers.
Lender reviews should be undertaken by an independent function within or outside the FRMI (either an internal or external group, or combination of both).
In general, the results of such reviews should be considered in the insurance underwriting decision-making process (i.e., part of the assessment of risk factors), including to help a FRMI determine whether to insure various mortgage loans by specific lenders or consider changes to underwriting standards. A FRMI should have a policy for determining the relative weight placed on its lender assessments and their contribution to the underwriting decision-making process.
OSFI expects that a FRMI will put in place clear policies to identify, escalate, and undertake remedial action, as part of its review and quality assurance processes, to address materially weak or inadequate underwriting practices or procedures by lenders. In cases where the FRMI identifies significant inadequacies, the FRMI should consider appropriate responsive actions (e.g., depending on the circumstances, corrective measures, applying more stringent underwriting standards, or where remedial action is ineffective to effect change, declining to insure mortgage loans by a specific lender, etc.).
Principle 5: Assessment and Validation of Underwriting Systems, Models, and Underwriters’ Processes
A FRMI that is engaged in residential mortgage insurance underwriting should periodically assess and validate its insurance underwriting systems, models, and underwriters’ processes, to ensure sound insurance underwriting outcomes and consistency with the FRMI’s RMIUP.
Mortgage insurers often rely upon proprietary automated underwriting systems and other models to provide timely and comprehensive information for decision-making into the mortgage insurance underwriting process. In the case of mortgage loans that do not meet standard underwriting characteristics or that are flagged for a closer review, mortgage insurers typically rely on individual underwriters to manually re-examine specific details of such loans before providing a recommendation as to whether to extend mortgage insurance.
Ensuring that such systems, models, and underwriters’ processes are robust and produce outcomes that are consistent with the objectives and risk appetite outlined in a FRMI’s RMIUP is central to sound mortgage insurance underwriting and risk mitigation.
Automated Underwriting Systems and Models
Automated underwriting systems and other models are commonly used to help an insurer efficiently assess the risk of insuring a mortgage loan (or a group of mortgage loans). Given the importance of underwriting systems and other models to mortgage insurance underwriting, a FRMI should establish an appropriate governance framework for models that outlines the standards and criteria related to the adoption and use of models, data inputs, initial and ongoing validation, and the treatment of model redevelopment and recalibration.
As part of that framework, a FRMI should have an independent validation process for models at initial implementation, and on a periodic basis, to ensure ongoing performance and suitability. As needed, mortgage insurers should recalibrate associated parameters with respect to their models, based on findings of file reviews (e.g., performance of comparable tools for property assessments).
For automated underwriting systems, a FRMI should maintain adequate mechanisms for detecting and preventing fraud or misrepresentation. A FRMI should also put in place programs to continuously monitor and audit the information received on mortgage loans to reduce the potential for inaccuracies and to help detect fraud or “gaming.” This includes the use of back-testing processes. A FRMI should take immediate remedial action to address identified weaknesses in its automated underwriting systems.
Mortgage Insurance Underwriters’ Processes
Mortgage insurers often depend on underwriters to assess the risks underlying mortgage loans that generally do not meet standard underwriting characteristics or which are otherwise flagged by automated systems. Underwriters are normally required to assess the degree to which such loans are deficient in meeting baseline characteristics and judge the value of compensating factors (e.g., risk mitigating factors, such as a borrower’s assets), prior to approving a mortgage loan for insurance.
A FRMI should ensure that its underwriting personnel have the appropriate skills, experience and training to carry out their function. To support consistency of outcomes with a FRMI’s RMIUP, a FRMI should document and maintain standard operating procedures for all personnel involved in the underwriting of mortgage insurance. Underwriters’ decisions should be well-documented and sufficient to facilitate third-party replication of the approval decision. A specific underwriting authority and escalation process should be established and applied according to the level of underwriting risk, as well as for review and approval of policy exceptions.
A FRMI should have in place processes, conducted by an independent oversight function, for regularly monitoring and evaluating the overall quality of underwriters’ practices and for assessing the performance of individual underwriters and compliance with established procedures. This includes internal underwriting audits as a means to assess compliance and consistency in decision-making.
Principle 6: Effective Portfolio Risk Management and other Risk Mitigation
FRMIs should have effective portfolio risk management practices, including the use of stress testing and, as appropriate, the use of reinsurance. Given the objectives and risk appetite established in the RMIUP, a FRMI should consider the outcome of stress-testing and risk mitigation in appropriately setting or adjusting its mortgage insurance underwriting criteria.
Portfolio Risk Management and Stress Testing
A mortgage insurer commonly holds a portfolio of invested insurance premiums on the asset-side of its balance sheet. It also holds insured mortgage loan liabilities (i.e., the “insurance in-force” portfolio). Variability in the returns on its invested assets, as well as uncertainty in the number and value of insurance claims pose risk to a mortgage insurer in achieving its business objectives, and may necessitate changes to underwriting criteria.
To support an assessment of risk, a FRMI should have in place a stress-testing regime that considers “exceptional, but plausible” events and scenarios and their impact on the asset- and liability-side portfolios.
To support portfolio risk management, stress testing activities, and overall assessment of risks, a FRMI should rely on accurate, updated information on its insured mortgage loans (e.g., current outstanding insured mortgage loan balances and other current, relevant information judged necessary by the FRMI).
Reinsurance is often used as a risk mitigation strategy by insurers. However, reinsurance by a mortgage insurer (i.e., ceding risk to a reinsurer) should not be used as a substitute for sound mortgage insurance underwriting and for conducting adequate, ongoing due diligence on lenders and borrowers. A FRMI that seeks to reinsure the risks under its mortgage insurance policies should ensure compliance and consistency with applicable laws, regulations and relevant guidelines.
Higher-Risk Insured Mortgage Loans
FRMIs have the flexibility to insure a wide range of residential mortgage loans with varying risk profiles. However, for a FRMI’s insured residential mortgage loan portfolios that constitute greater risks (as defined by the FRMI), OSFI expects a FRMI to exercise heightened prudence through:
III. Guideline Administration
Increased disclosure leads to greater transparency, clarity and public confidence in FRMIs’ residential mortgage insurance underwriting practices. As a matter of principle, FRMIs should publicly disclose sufficient information related to their residential mortgage insurance portfolios for market participants to be able to conduct an adequate evaluation of the soundness and condition of their residential mortgage insurance operations.
FRMIs are expected to make public disclosures related to residential mortgage insurance. Such disclosures should be carried out on a quarterly basis, in a readily understandable format, and in a location generally available to the public.
The disclosures should include, but are not limited to, a breakdown of information for residential mortgage loans insured during the quarter
FRMIs should also provide a discussion of the potential impact an economic downturn may have on insured residential mortgage loans.
Supervision of FRMIs
Information for Supervisory Purposes
Enhanced transparency and sound documentation will allow OSFI to better understand the FRMI’s financial position and economic impacts and risks associated with a FRMI’s residential mortgage insurance underwriting practices and procedures. A FRMI should maintain and provide to OSFI, upon request, its RMIUP and associated management reports. A FRMI should promptly inform OSFI if it becomes aware of any mortgage insurance underwriting issues that could materially impact its financial condition.
Non-compliance with the Guideline
OSFI supervises FRMIs in order to determine whether they are in sound financial condition and to promptly advise the FRMI Board and Senior Management in the event that the institution is judged not to be in sound financial condition or is not complying with supervisory requirements. OSFI is required to take, or will require the Board and/or Senior Management to take, necessary corrective measures to deal with prudential soundness issues in an expeditious manner and to promote the adoption of policies and procedures designed to control and manage risk by Senior Management and Boards.
Where a FRMI fails to adequately account and control for the risks of underwriting insurance for residential mortgage loans, on a case-by-case basis, OSFI can take, or require the FRMI to take, corrective measures. OSFI’s actions can include heightened supervisory activity and/or discretionary authority to require the FRMI to adjust its capital, commensurate with the risks being undertaken by the FRMI.
IV. Other Guidance
This Guideline is complementary to, and should be read in conjunction with, other relevant OSFI guidance and the Government of Canada’s mortgage insurance guarantee framework, including but not limited to: