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The Milliman Mortgage Default Index (MMDI) is a lifetime default rate estimate calculated at the loan level for a portfolio of single-family mortgages. For the purposes of this index, default is defined as a loan that is expected to become 180 days or more delinquent over the life of the loan.1 The results of the MMDI reflect the most recent data acquisition available from Freddie Mac and Fannie Mae, with measurement dates starting from January 1, 2014.
Mortgage originations declined during the fourth quarter (Q4) of 2021 compared to the third quarter (Q3) of 2021. Purchase mortgage originations are typically lower during Q4, so this decrease is not unexpected. For refinance mortgage originations, rising interest rates have reduced the incentive for borrowers to refinance, resulting in lower refinance volume.
The index value of the MMDI was 1.98% for loans originating in 2021 Q4 compared to 1.65% for 2021 Q3 originations. Figure 1 provides the quarter-end index results for these loans, segmented by purchase and refinance. For both purchase and refinance, the primary driver of this increased default risk is an expected slowdown of home price growth over the next several years.
Beginning with this release, the MMDI publication will primarily focus on Freddie and Fannie (GSE) loan originations, and no longer include commentary on Ginnie Mae loans—although the index will continue to include this data. We are making this change because Ginnie Mae data is released much later relative to the data published by Freddie and Fannie, and focusing on GSE originations will provide more timely insights into mortgage credit risk trends.
FIGURE 1: MMDI 2021 Q4 DASHBOARD FOR GSE LOANS
To explore the MMDI data on a more granular level, including loan origination and type, click here.
The value of the MMDI increased for Freddie and Fannie acquisitions over 2021 Q4. There are three components of the MMDI: borrower risk, underwriting risk, and economic risk. Borrower risk measures the risk of the loan defaulting due to borrower credit quality, initial equity position, and debt-to-income ratio. Underwriting risk measures the risk of the loan defaulting due to mortgage product features such as amortization type, occupancy status, and other factors. Economic risk measures the risk of the loan defaulting due to historical and forecasted economic conditions.
For GSE loans, borrower risk decreased from 1.33% in 2021 Q3, to 1.25% in 2021 Q4. Refinance loans made up about 58% of the total loan pool in Q3, compared to 61% in Q4. Refinance loans typically have lower borrower risk as it is typical for the borrowers to have higher credit scores and lower loan-to-value ratios.
Underwriting risk represents additional risk adjustments for property and loan characteristics such as occupancy status, amortization type, documentation types, loan term, and others. Underwriting risk after the global financial crisis remains low and is negative for purchase mortgages, which were generally full-documentation, fully amortizing loans. Underwriting risk is not a large contributor to the MMDI given the tight underwriting requirements for conventional mortgages.
Economic risk is measured by looking at historical and forecasted home prices. Actual home price appreciation has been robust from 2014 through 2021, which has resulted in embedded appreciation for older originations. This results in reduced default risk for older cohorts. For more recent cohorts, we anticipate slower home price growth (or negative growth for some local geographies) after the housing supply returns post-pandemic, which contributes to increases in economic risk for recent origination years.
Figure 2 shows the economic risk component of the MMDI for GSE mortgages stated as of 2021 Q2 and 2021 Q4. We notice from the chart that economic risk has remained steady for older originations, while economic risk for newer originations has sharply increased, as we anticipate slower home price growth in the future. However, in the 2021 Q4 release economic risk decreased quarter over quarter (i.e., the lines in the chart for the 2021 Q4 release are lower relative to the 2021 Q2 release). This is because actual home price movements were more favorable than previously forecasted. As previously noted, this publication of the MMDI uses the most recent data available to provide timely information on credit trends. Therefore, comparable Q3 data is not available.
FIGURE 2: ECONOMIC RISK BY ORIGINATION
While the current level of robust home price growth is certainly a function of the pandemic and supply/demand imbalances, it is difficult to estimate how home prices may react post-pandemic. The MMDI reflects a baseline forecast of future home prices. To the extent actual or baseline forecasts diverge from the current forecast, future publications of the MMDI will change accordingly. Please read the disclaimer for COVID-19 for more context on economic risk.
Milliman is expert in analyzing complex data and building econometric models that are transparent, intuitive, and informative. We have used our expertise to assist multiple clients in developing econometric models for evaluating mortgage risk both at the point of sale and for seasoned mortgages.
The Milliman Mortgage Default Index (MMDI) uses econometric modeling to develop a dynamic model that is used by clients in multiple ways, including analyzing, monitoring, and ranking the credit quality of new production, allocating servicing sources, and developing underwriting guidelines and pricing. Because the MMDI produces a lifetime default rate estimate at the loan level, it is used by clients as a benchmarking tool in origination and servicing. The MMDI is constructed by combining three important components of mortgage risk: borrower credit quality, underwriting characteristics of the mortgage, and the economic environment presented to the mortgage. The MMDI uses a robust data set of over 30 million mortgage loans, which is updated frequently to ensure it maintains the highest level of accuracy.
Milliman is one of the largest independent consulting firms in the world and has pioneered strategies, tools, and solutions worldwide. We are recognized leaders in the markets we serve. Milliman insight reaches across global boundaries, offering specialized consulting services in mortgage banking, employee benefits, healthcare, life insurance and financial services, and property and casualty insurance. Within these sectors, Milliman consultants serve a wide range of current and emerging markets. Clients know they can depend on us as industry experts, trusted advisers, and creative problem-solvers.
Milliman's Mortgage Practice in Milwaukee is dedicated to providing strategic, quantitative, and other consulting services to leading organizations in the mortgage banking industry. Past and current clients include many of the nation's largest banks, private mortgage guaranty insurers, financial guaranty insurers, institutional investors, and governmental organizations.
Significant uncertainty continues regarding how mortgage performance may be affected by the COVID-19 pandemic and its associated economic impacts. While unemployment rates, delinquency rates, and the percentage of loans in forbearance have increased rapidly since the start of the pandemic (and remain at elevated levels), the housing market has remained resilient. Please refer to prior releases of the MMDI,2 as well as a recent Milliman article on the topic,3 for more detailed discussions of the potential impact of the pandemic on mortgage performance.
2The MMDI report on 2019 Q2, for example, is available at https://us.milliman.com/en/insight/mortgage-default-index-2019-q2.