Many Americans are struggling with high out-of-pocket costs for health care.
The mortgage insurance subsidiary of AIG has been breaking new ground and grabbing market share with a new approach to pricing its coverage.
"What doesn't kill you makes you stronger" is an old saying revived by American pop singer Kelly Clarkson, who had a No. 1 hit by that name last year. * It could well be the anthem for United Guaranty Corporation, a Greensboro, North Carolina-based mortgage insurance subsidiary of the insurance giant American International Group (AIG), New York. * Like others in the mortgage insurance industry, United Guaranty has faced considerable headwinds since 2008. In spite of strong new books of business since 2009, the private mortgage insurance (MI) industry continues to be ravaged by claims from loans insured during the subprime lending era, with the agony being prolonged by a slow and uninspiring economic recovery. * Private MIs mostly insure mortgages purchased by Fannie Mae and Freddie Mac that have less than a 20 percent down payment. * Yet, since 2009, United Guaranty has surged in market share in a shrinking overall market for private MI with a new risk-pricing model for its insurance premiums and an emphasis on full-file or front-end underwriting of insured loans. The company, which ranked fifth three years ago, has moved up to become the second-largest underwriter of new private MI business after No. i-ranked Radian Guaranty Inc., Philadelphia. * The other top writers of new business during the second quarter of 2012 are third-ranked Mortgage Guaranty Insurance Corporation (MGIC), Milwaukee; and fourth-place Genworth Mortgage Insurance Co., Raleigh, North Carolina. These four companies combined wrote $34.75 billion or 87 percent of the $40.14 billion in new business written in the second quarter, according to Standard & Poor's (S&P), New York.
One reason for United Guaranty's success is its financial strength. United Guaranty Residential Insurance Co., a subsidiary of United Guaranty, is one of only two private MIs with an investment-grade rating. It has a BBB rating with a stable outlook from S&P and a Baai rating with a stable outlook from Moody's Investors Service, New York. (The only other MI rated investment-grade is San Francisco-based CMG Mortgage Insurance Co., which Moody's rated BBB-minus with a negative outlook. CMG provides private mortgage insurance to credit unions.)
Origins of the rebound
United Guaranty traces its rebound to a period of soul-searching following the financial crisis that broke out in September 2008.
In March 2009, United Guaranty parent company AIG brought in a new chief executive officer for United Guaranty, Eric Martinez, and a new chief operating officer, Kim Garland, who is now president and chief executive officer.
(In February 2012, Martinez transferred to Chartis, AIG's property and casualty group, where he serves as executive vice president of global claims, operations and systems. In May 2012, United Guaranty hired Donna DeMaio, formerly the head of MetLife Bank NA, as chief operating officer.)
Martinez, Garland and other senior executives began an internal review at United Guaranty aimed a deciding whether or not to stay in the business. The review stretched from March through December 2009.
During the review, Garland asked his senior managers if they could design from a blank sheet of paper a new mortgage insurance company "based on the crisis and everything we had experienced and everything we have learned," what kind of company would it be?
To answer that question, senior management tried to analyze what led to failures in underwriting and the pricing of risk.
"When we went back and tried to understand what happened, we looked in the mirror and said, 'We didn't necessarily act like an insurance company. We probably acted more like a mortgage finance company than an insurance company,'" says Garland.
As the review proceeded, Garland explains, senior managers came to the conclusion that to be a successful mortgage insurance company that could survive all parts of the business cycle, including severe downturns, United Guaranty should be governed by a set of four principles. The four tenets are:
* First, United Guaranty has to be able to adjust the pricing of premiums based on the risk of each loan.
* Second, the company should underwrite loans on the front end to limit the amount of risk the company is taking on and, thus, be able to reduce rescissions, denials and buybacks on the back end. Rescissions occur when an insurer rescinds coverage because the loans that were covered by insurance did not turn out to be what was claimed originally by the lender.
* Third, "We had to get a handle on loss management and claims," Garland says, "and to handle claims in a fair, consistent and efficient way."
* Fourth, United Guaranty had to possess financial strength and a strong credit rating. "That means you have an adequate loss reserve and resources to pay your obligations," says Garland.
Even as United Guaranty was discovering what it needed to do to survive and be a strong company, "in the second half of 2009, AIG was looking to sell United Guaranty. And we went through a process to do that," says Garland. "But all through that time, we kept understanding what happened, why it happened and what we would do."
During the review process, Robert Benmosche took the reins as chairman and chief executive officer at AIG. He quickly began "learning all the businesses" that make up the company, Garland says.
"And when he heard and understood what we were doing, he made the decision for AIG to keep United Guaranty and not to sell us," Garland adds.
"The four tenets on which we were going to run the company was (what] convinced Bob and the folks at AIG that this was a viable business if you ran it in the right way," Garland says.
"In December 2009, Bob and AIG made the decision to keep us - and that was one of the defining moments in our company's history," Garland says.
During the intervening three years, United Guaranty has worked to restructure and refocus United Guaranty, following the four tenets developed in the review process.
Boosting financial strength
United Guaranty's rebound likely could not have occurred without first moving decisively to deal with the financial strain of continuing claims from business written before 2009. To address this, AIG set up a subsidiary in mÌd-2009 to take on those exposures - MG Reinsurance Limited (MG Re), Burlington, Vermont. AIG placed $1.5 billion in trust assets and additional capital into the new entity, according to Garland.
In addition, the policy limits in MG Re went up to around $7 billion to $8 billion, Garland adds. "That was a commitment of enough real resources to make sure we have enough claims-paying capability and a commitment for more, if the need arose," Garland says. "It was a way to give us extra financial strength."
He adds, "The reinsurance structure was just a way for AIG to provide United Guaranty with more capital to help us get through a period of financial stress."
The reinsurance treaty between MG Re and United Guaranty essentially moved all continuing claims from the book of business from 2005 to 2008 to MG Re. This step is a key reason why United Guaranty Residential Mortgage Insurance Co. has both an investment-grade rating of BBB and a stable outlook, according to Ron Joas, credit analyst at Standard & Poor's. "They've turned that [investment-grade rating] into a competitive advantage," he says.
The reinsurance treaty between United Guaranty and AIG's affiliate MG Re has, in effect, "insulated" United Guaranty from continuing claims from 2008 and prior books of business. "So, a lot of the [financial] results you see today are driven by the new business that has been written since 2009," says Joas.
United Guaranty Residential Insurance Co. has in fact been profitable since 2010, when it earned $81 million, followed by $123 million in 2011 and $60 million in the first half of 2012, according to S&P.
Joas attributes "the good results so far" to the new policies implemented by the new management team hired in 2009.
United Guaranty has a net risk-to-capital ratio of 12.6 to 1 - "well below" the level of its peers, according to Joas. Under state insurance laws, private MIs are required to have a risk-to-capital ratio no higher than 25 to 1, which translates to a 4 percent capital ratio.
In 2008, United Guaranty's risk-to-capital ratio surged from 15.4 to 20.5, as delinquencies jumped and claims poured in and before liability for claims from its old book of business was transferred to MG Re. An expectation of continuing high claims in 2009 and afterward threatened the company's investment-grade rating.
United Guaranty wrote $15.01 billion in new insurance during the first six months of 2012, according to S&P. This compares with $18.4 billion for 2011 and $9.9 billion in 2010.
By contrast, the company wrote $42.9 billion in new business in 2007, at the height of the housing bubble, $23.1 billion in 2008 and $12.2 billion in 2009.
One of the reasons the private MI share of mortgage insurance has declined is the surge in government mortgage insurance from the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) that began in late 2007. In 2011, for example, the private MI share of new mortgage insurance was only 25 percent - half its historic average of more than 50 percent, according to S&P.
Even though private mortgage insurance is expected to reclaim a larger share of business in the future while FHA and VA are expected to take a smaller share, the overall volume of mortgage originations is expected to remain only half the level of the mid-2000s, when it was more than $2 trillion a year, Joas explains.
"Tight credit, the weak economy, high unemployment rates, low property values and private mortgage insurers' lower penetration rates relative to the FHA and VA's share all contribute to the industry's weakened business position," Joas says.
Performance premium pricing
In January 2010, after deciding to stay in the business, United Guaranty began to roll out "our initial version of the risk-based pricing model," Garland says. "It's not a foreign concept in insurance, but it was a foreign concept in mortgage insurance."
Under its new pricing model, United Guaranty began to charge a lower price for premiums to insure loans that were lower risks and to charge higher prices for premiums to insure loans that were higher risks, Garland explains. "The challenge was to introduce [the new pricing model] into an industry where that was not how they had done things before," he explains.
The sales team had to go out into the marketplace in 2010 and persuade lenders to try something new, according to Garland. "In the first week, we had four lenders adopt it," he recalls.
"As we implemented it, we learned to adjust it," Garland says. The refinements, in turn, helped sell the concept and today United Guaranty has sold variable pricing to more than 3,000 lenders, he adds. The pricing model went through its 11th iteration in November.
For the first nine months of 2012, 92 percent of all new insurance sold by United Guaranty was based on what the company calls "performance premium pricing," which is based on a number of categories of risk.
The ability to price risk sets United Guaranty apart from other insurers, according to Garland.
"That ability to evaluate risk at a loan level has been one of the differentiators and probably the biggest driver of how we've gone from being historically around an 11 [percent] to 13 percent market share company to today, when we're about a 30 percent market share company [in the third quarter of 2012]," Garland says.
Chris Clement, senior vice president for field production at United Guaranty, recalls the challenge the sales force faced with its new pricing strategy when it was first introduced. "Prior to that time - and I've been with United Guaranty 28 years - for all those years, people used a rate card," Clement says. "Rates were static."
To be sure, there was not just one single rate on the old rate card. United Guaranty previously charged different rates based on the loan-to-value (LTV) ratio, with lower LTVs getting lower price, as well as rates based on selected bands or ranges of credit scores.
"When Kim Garland and Eric Martinez came on board," Clement recalls, "they were traditional insurance guys, and after looking at how United Guaranty priced its premiums, [they] said, 'This makes no sense.'" The two worked with the company's actuaries to come up with performance premium pricing.
Clement says that United Guaranty put together a team of salespeople "to learn performance premium and how we might position it and message it." Once they had worked out an approach to selling it, a pilot sales effort was launched.
"It was tough at first because [the lenders] had not seen anything like it," Clement recalls. "We like it when you guys are all the same," was the response they got at first. "No one said, 'This is the stupidest thing 1 ever heard,'" he recalls.
"The operations people and the underwriters understood what we were trying to do," Clement says. "It makes complete sense and it's about time somebody thought about it," they told the United Guaranty salespeople, he recalls. "But it would be hard, and I don't know if I want to go through the hassle of trying to introduce it."
It was at this point that United Guaranty produced material that would show how much customers could save with performance premium pricing and how it could lower the cost for its borrowers. Further, Clement says, higher prices for riskier loans would allow the company "to expand the credit box," meaning it could offer more products and terms for its loans and be more flexible in selected markets. For example, higher pricing made it possible to offer mortgage insurance on loans for second homes, Clement explains.
"Our initial success was with small to midsized lenders that were more nimble and could make changes quicker," Clement says. Later, the larger lenders began to fall in line.
"In the beginning, there were less than 1,000 users who were willing to try performance premium with at least one loan. Now we're at 2,700 or 2,800 out of 3,000 lenders," he says. In the first nine months of 2012, 91.8 percent of insurance written by United Guaranty was done with performance premium pricing. In September 2012 alone, it was 97 percent of business.
Garland, too, is pleased with the results. "I could not be prouder of our salespeople," he says. "They took a concept that was different and they had to believe in it themselves first, and then they had to go out and sell it. They are part of the lore of our company. Without their success, we would not be where we are today."
How complex is the company's risk pricing for premiums? "We use 15 to 20 variables when we evaluate an individual loan and price it," Garland says. Some of the variables include debt-to-income (DTI) ratios and the risk for home-price declines. "There is a lot more segmentation than maybe the traditional mortgage insurance pricing model," says Garland.
United Guaranty's risk-pricing model has meant that the insurer is able to charge less than its competitors for lower-risk loans, but it charges more for insurance on higher-risk loans. As a result, "We've probably written a disproportional amount of lower-risk business than some of the other mortgage insurers" since introducing its new pricing model in early 2010, Garland says.
Move to front-end underwriting
Garland, who comes from an auto and personal lines insurance background, found the delegated underwriting approach for mortgage insurance to be unfamiliar. "So I was intrigued, surprised - whatever - about how the model of delegated underwriting evolved and why," he says. Delegated underwriter refers to the fact that the insurance company delegates the decision on the underwriting of the loan it is being asked to insure to the lender that makes the loan.
So, as the senior management team sought to understand why the industry relied on delegated underwriting, it decided "to look back at the entire history of the mortgage insurance industry to see what worked and what didn't work," Garland says.
The team looked all the way back at the huge losses in the 1930s, when the Great Depression wiped out the mortgage insurance industry.
"There were two common themes that created the poor economic results and failure of mortgage insurers, and that was relaxation and degradation of underwriting," Garland says. "The valuation of risk and pricing of that risk deteriorated, and the types of loans that were written were very high-risk."
He adds, "The other thing we see is that the historic model is built on delegated underwriting, and reps and warrants means that rescission was just part of the process." Failing to evaluate insured loans on the front end and instead evaluating them on the back end has some negative consequences, he explains.
"It creates friction between us and our customers. It creates lack of confidence in how solid our product is going to be," Garland says.
"It actually lets bad loans into the system, which is bad for us as an insurer; it's bad for the investors and it's bad for servicers," Garland adds.
"We decided that we at United Guaranty were better off and our industry was better off and all the stakeholders that surround our industry are better off if we actually spend the time and resources to underwrite loans on the front end rather than try to resolve it on the back end," he says.
In third-quarter 2008, 89 percent of United Guaranty's loans were done via delegated underwriting and 1 1 percent were full-file or front-end underwriting - the company's low point in full-file underwriting. By September 2012, 56 percent of loans insured were full-file or frontend underwriting while 45 percent were delegated underwriting, according to Garland.
As United Guaranty moved toward more front-end underwriting, it tripled the number of underwriters it employed - from 50 in early 2011 to 186 in September 2012, according to Jason Berkey, executive vice president and chief risk officer at United Guaranty.
The company is investing in new technology to speed the process of front-end underwriting from the point where the loan officer enters data into the loan underwriting system. The same data is immediately also made available electronically at United Guaranty, making it unnecessary to do a second data entry.
The service-level agreements with customers have established a goal of delivering a decision on coverage within 24 hours to avoid slowing down the loan approval and closing process. And because loan applications often come in late in the day, United Guaranty "is looking to open an office on the West Coast" to make sure the company can meet the 24-hour goal for customers in that Pacific time zone, Berkey says.
United Guaranty also invested tens of millions of dollars in new technology to support underwriting loans on the front end.
The insurer also developed a new product offering called CoverEdge"111 that is "a rescission-proof underwrite," Garland says.
"We looked at all the things that created a rescission or denial |of a claim] and tried to design something that solved for all those things," he explains.
"We believe that the industry and our customers will be better off and less exposed if we design an offering that moved us toward taking rescissions out of the process," he adds.
Outlook for tht industry
What is United Guaranty's outlook for private mortgage insurance? "I'm bullish for several reasons. If you look at the trends for the last couple of years, you'll see business shifting back from FHA to private mortgage insurers. We believe that trend will continue," says Garland.
"Another thing we see is that there are still high-quality loans that are going to FHA. And when you look at the difference in private market insurance premium and the FHA mortgage insurance premium, and you add in all things - for higher-quality borrowers, going conventional is a better deal for them," Garland says.
"The other thing that makes me bullish is the desire to have more private capital at risk and less public capital at risk in the mortgage system. Expanding the use of private MI is one important way to do that," he continues.
"Private MIs are in a first-loss position. You can't come up with a system where private capital is more at risk," Garland says.
To the extent policymakers in Washington and shifts in the private sector move toward putting more private money at risk in financing mortgages, it is "a good thing for the mortgage insurers," he says.
United Guaranty traces its to a period of searching the financial that broke out in September 2008.
"I could not be prouder of our salespeople," Garland says. "They are part of the lore of our company. Without their success, we would not be where we are today."
Robert Stowe England is a freelance writer based in Arlington. Virginia, and author of Black Box Casino: How Wall Street's Risky Shadow Banking Crashed Global Finance, published by Praeger and available at Amazon.com. He can be reached at firstname.lastname@example.org.