Risk-based pricing of mortgage insurance could actually increase homeowners’ costs, expert says

By Garry Marr, Financial Post, April 3, 2014 - A Bay St. analyst suggests any move to risk-based pricing system for mortgage default insurance could actually cost consumers more money. “A move to risk-based pricing would likely involve increased expenses (which might be effectively passed onto consumers) to do pricing individually despite insurers having comprehensive underwriting criteria. It is unclear to us whether risk-based pricing would be a net-benefit for all stakeholders involved,” says Geoffrey Kwan, of RBC Dominion Securities Inc.

The Financial Post reported this week that Canada Mortgage and Housing Corp. chief executive Evan Siddall has been asked by stakeholders whether he would consider a pricing model based on things like credit score. He has told people he doesn’t disagree with the idea in principle.

Mr. Kwan noted CMHC does offer some differences in pricing and it’s not solely dependent on down payment. Self-employed people pay more as do people who own vacation property.

The Canadian government sets the criteria based on things like credit scores, debt service ratios, minimum down payments for what types of mortgages the insurers can underwrite with a government-backed guarantee, so insurers are effectively restricted from offering insurance to non-creditworthy borrowers,” he wrote.

“We believe insurer underwriting is such that certain risk factors (e.g., is the home purchased in a “hot” housing market?) may have the insurer keep the premium rate paid unchanged, but require some changes to mortgage terms (e.g., a higher down payment),” says Mr. Kwan.

He says the current pricing system has the benefit of being transparent to borrowers. In most cases buyers with 5% down pay a 2.75% premium on the value of their mortgage up front. That rises to 3.15% on May 1. Borrowers must get insurance is they have less than a 20% down payment.

“Given mortgage insurance premiums are typically amortized over the life of the mortgage, changes to premium rates if risk-based pricing were adopted probably would not materially change the size of a mortgage payment, but the current system largely gives certainty to borrowers about home ownership costs,” says Mr. Kwan.

He added that insurers manage risks in other ways that are a form of risk-based pricing:

“Geographic diversification (e.g., by region, city, neighbourhood, housing type) We believe insurers evaluate each borrower on a multitude of parameters to assess risk and may adjust their underwriting decision accordingly,” the analyst wrote.

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