NAIC MORTGAGE GUARANTY INSURANCE STANDARDS MANUAL

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NAICMORTGAGEGUARANTYINSURANCESTANDARDS MANUAL(Version 7)

MORTGAGE GUARANTY INSURANCE STANDARDSMANUALPurpose and ScopeThe Mortgage Guaranty Insurance Standards Manual is designed to:1) Provide a background history of the evolution of the Mortgage Guaranty InsuranceIndustry including the public and private mortgage environment2) Provide a background description of operating characteristics unique to the MortgageGuaranty Insurance environment3) Provide a background description of the Mortgage Guaranty Insurance riskenvironment4) Provide a background history of the Mortgage Guaranty Insurance Working Groupefforts, reasons and results contributing to the Mortgage Guaranty Insurance ModelAct update5) Provide an understanding of the NAIC Risk Based Capital framework, as modified forMortgage Guaranty Insurance, to support requirements referenced in the MortgageGuaranty Insurance Model Act6) Provide an understanding of the Mortgage Guaranty Insurance Loan Level Cash FlowCapital framework to support requirements referenced in the Mortgage GuarantyInsurance Model Act7) Document additional supporting Mortgage Guaranty Insurance standards andrequirements referenced but not detailed in the Mortgage Guaranty Insurance ModelAct because of the potential for ongoing change triggered by economic conditions8) Facilitate periodic update of technical requirements for Mortgage Guaranty InsuranceThe background and guidance outlined in this manual are based on and integral to therequirements established under the Mortgage Guaranty Insurance Model Act (#630), whichshould be referenced when determining adopted mortgage guaranty insurance law.Sections I through VII of this Standards Manual provide background information forregulators and mortgage guaranty insurance companies, while Section VIII representsstandards intended for enforcement purposes. 2019 National Association of Insurance Commissionersi

MORTGAGE GUARANTY INSURANCE STANDARDSMANUALTable of ContentsPurpose and Scope .iTable of Contents . iiI.Mortgage Guaranty Insurance Overview . 1A. Definition . 1B. Sources of Mortgage Guaranty Insurance . 11. Private2. PublicII.Private Mortgage Guaranty Insurance Environment (PMI). 3A. Original Pre-1933 “Great Depression” Programs . 3B. Post “Great Depression” Programs . 3C. Mortgage Guaranty Insurance Role and Benefits . 3D. Key PMI Industry Participants . 41. Loan Originator (Lender or Creditor)2. Mortgage Guaranty Insurer3. Loan Securitizer (GSEs or Investment Banks)III.Public Mortgage Guaranty Insurance Environment . 7A. Homeowners’ Loan Corporation (HOLC) . 7B. Federal Housing Administration (FHA) . 7C. Federal National Mortgage Association (Fannie Mae) . 7D. Government National Mortgage Association (Ginnie Mae) . 7E. Federal Home Loan Mortgage Corporation (Freddie Mac) . 8 2019 National Association of Insurance Commissionersii

F. Federal Housing Finance Agency (FHFA) . 81. Role2. Eligibility Standardsa. Overviewb. Business Requirementsc. Policy Underwritingd. Quality Controle. Financial Requirementsf. Failure to Meet Requirementsg. Newly Appointed Insurer Requirementsh. ConclusionG. Limited Federal Role in Regulation . .11IV.Operating Characteristics Unique to Mortgage Guaranty Insurance. 12A. Private Mortgage Insurance Origination Types . 121. Primarya. Flowb. Bulk2. PoolB. Mortgage Guaranty Insurance Environment . 131. Business Line Unique Characteristics (SSAP 58)2. Monoline Considerations3. Conflict of Interest ConsiderationsC. Underwriting Standards . 141. Master Policy Concepts2. Direct Underwriting Role and Responsibilities3. Delegated Underwriting Role and Responsibilities4. Automated Underwriting Systems Role5. Borrower Credit Worthiness Evaluation6. Property Value Evaluation7. Loan DocumentationD. Quality Control Standards. 181. Loan Origination Integrity Objectives2. Organizational Considerations3. Quality Control Best Practicesa. Separation of Responsibilitiesb. Quality Control Program Documentationc. Post-Closing Reviewsd. Loan Sampling / Selection 2019 National Association of Insurance Commissionersiii

e. Re-verification Proceduresf. File Documentation Review Proceduresg. Loan Review Results ReportingE. Reserving Principles . 221. Typical Reserving Practices2. Loss Reserves3. Unearned Premium Reserves4. Contingency Reserves5. Premium Deficiency ReservesF. Reinsurance Principles . 231. Affiliate Reinsurance2. Captive Reinsurance3. External ReinsuranceG. Rescission Principles . 251. Mandatory Rescission Relief2. Early Rescission Relief3. Material Misrepresentations or Fraud ImpactsV.Mortgage Guaranty Insurance Risk Environment . 27A. Traditional Mortgage Loan Default Factors . 271. Unemployment2. Medical Expense3. Income ReductionB. Mortgage Loan Sub-Prime Crisis and Risk Factors. 271. Sub-Prime Crisis Overview2. Sub-Prime Crisis Background / Timeline3. Sub-Prime Crisis Causes4. Housing Market Boom / Bust Cycle5. Lending / Borrowing Practice Deterioration6. Securitization Practices Impact7. Mortgage Rating Agency ImpactVI.Mortgage Guaranty Insurance Working Group (MGIWG) Role & History . 32A. Working Group Charge . 321. Solvency Improvement2. Mortgage Guaranty Model Act EnhancementB. Working Group Major Concerns Promoting Reform . 32 2019 National Association of Insurance Commissionersiv

C. Mortgage Guaranty Insurance Industry Considerations . 33D. Mortgage Guaranty Insurance Model Act Summary Reforms . 341. Capital Standards2. Underwriting Standards3. Quality Assurance Standards4. Concentration Limits5. Investment Limitations6. Reinsurance7. RescissionVII.Mortgage Guaranty Insurance Capital Requirements . 37A. One Capital Standard with a Dual Reporting Structure . 371. Introduction to the NAIC State Regulatory Mortgage Insurer Capital Standard2. Dual Reporting Structurea. State Regulatory Mortgage Insurer Capital Standard Reportb. Mortgage Guaranty Insurance Loan Level ReportB. State Regulatory Mortgage Insurer Capital Standard Concepts. 401. Overview2. Purpose3. Applicability4. High-Level Methodologya. SRMICS Capital Formulab. Mortgage Guaranty Insurance Model Actc. Regulatory Action Levels5. Phases, Steps, and Distinct Considerations of the State Regulatory MortgageInsurance Capital Standarda. Individual Mortgage Loan Phaseb. Book Years Phasec. Aggregation Phased. Evaluation Phase6. Description of Distinct Considerations in the State Regulatory Mortgage InsurerCapital Standarda. Base Rate Factorb. FICO Score Factorc. Loan-to-Value Ratio Factord. Alternative Risk Factore. High Risk Factorf. Risk Offset Factorg. Economic Factorh. Severity Rate 2019 National Association of Insurance Commissionersv

i.j.k.l.m.n.o.Seasoning FactorCredit for Reinsurance CededMargin for ExpensePremium Credit by Book YearCapital Charge for Risk in Force on Pool Mortgage Guaranty InsuranceCapital Charge for Risk in Force on Assumed ReinsuranceCredit for Single Premium Policies and CertificatesC. Mortgage Guaranty Insurance Loan Level Report Concepts . 501. Overview2. Purpose3. Key Assumptions4. Loan Level Methodology – Overviewa. Claims Paying Resources and Other Input Captureb. Sources and Uses of Capital Projectionc. Capital Solvency Measurement5. Loan Level Methodology – Claim Payment Resources6. Loan Level Methodology – Macroeconomic Scenario Parametersa. Home Price Index (HPI) Scenariob. Unemployment Rate Scenarioc. Interest Rate Scenario7. Loan Level Methodology – In-Force Portfolio8. Loan Level Methodology – Probability of Default Forecasta. Loan Type Segmentationb. Loan Level Characteristicsc. Underwriting Quality9. Loan Level Methodology - Probability of Prepayment Forecasta. Product Segmentationb. Loan Level Characteristics10. Loan Level Methodology – Loss Given Default Forecasta. Default Loan Transition to Post Default Outcomesb. Credit Loss Modeling for Claims Made11. Loan Level Methodology – MI Structures12. Loan Level Methodology – Premium Income Forecast13. Loan Level Methodology – Investment Income Forecasta. Long-Term Bondsb. Cash and Short-Term Investmentsc. Equity Investmentsd. Other Invested Assets14. Loan Level Methodology – Expense Forecasta. Loss Adjustment Expenseb. Expenses Other Than LAE15. Loan Level Capital Model Conversion to RBCa. Key Risk Attribute Identification 2019 National Association of Insurance Commissionersvi

b.c.d.e.VIII.Variable Risk Attribute DeterminationLoan Sample DevelopmentClaim and Premium Forecast EstimationMultiplier DeterminationOther Mortgage Guaranty Insurance Mandated Requirements . 64A. Underwriting Standards – Documentation and Approval Considerations . 641. Lender Loan Submission Requirements2. Loan Documentation & Underwriting Compliance Evaluation Responsibilities3. Minimum Mortgage Documentation Standards4. Loan Program or Type Qualification Requirements5. Minimum Borrower Repayment Qualification Requirements6. Minimum Property Marketability QualificationsB. Quality Assurance Standards . 661. Segregation of Duties2. Senior Management Oversight3. Board of Director Oversight4. Policy and Procedure Documentation5. Underwriting Risk Reviews6. Lender Performance Reviews7. Underwriting Performance Reviews8. Problem Loan Trend Reviews9. Underwriting System Change Oversight10. Pricing and Performance Oversight11. Internal Audit Validation12. Regulator AccessC. Records Retention Standards . 681. Records Retention Requirements2. Retention Period3. Record Format4. Records MaintenanceD. NAIC State Regulatory Mortgage Insurer Capital Standard. 701. Overall Sequence of Operations to Arrive at the NAIC State Regulatory MortgageInsurer Capital Standard2. Step 1 – Calculate the Risk-Modeled Ultimate Net Loss for Each Insurer Loan3. Step 2 – Aggregate the Risk-Modeled Ultimate Loss for each InsuredLoan Outstanding by Book Year4. Step 3 – Apply the Appropriate Seasoning Factor to the Risk Modeled FutureLoss for Each Book Year5. Step 4 – Calculate and Subtract Risk Ceded through Reinsurance by Book Year 2019 National Association of Insurance Commissionersvii

6. Step 5 – Calculate and Add the Margin for Expense by Book Year7. Step 6 – Calculate and Subtract the Premium Credit by Book Year8. Step 7 – Aggregate the Results of Steps 1 through 6 for the Past TwentyCalendar Book Years9. Step 8 – Add 10% of the Risk In-Force on Pool Mortgage Guaranty Insurance10. Step 9 – Add 5% of the Risk In-Force on Reinsurance Assumed11. Step 10 – Subtract Single Premium Credit to Obtain the State RegulatoryMortgage Insurer Capital Standard12. Step 11 – Compute Total Adjusted Capital13. Step 12 – Divide Total Adjusted Capital by the State Regulatory MortgageInsurer Capital Standard to Determine Applicability of Regulatory ActionE. Loan Level Capital Standards . . 771. Overall Methodology2. Probability of Default Projection3. Probability of Prepayment Projection4. Loss Given Default Projection5. Premium Income Projection6. Investment Income Projection7. Expense Projection 2019 National Association of Insurance Commissionersviii

I. MORTGAGE GUARANTY INSURANCE OVERVIEWA. Mortgage Guaranty Insurance DefinitionMortgage guaranty insurance provides mortgage lenders with insurance against loss due toborrower non-payment and default on mortgage indebtedness. Specifically, “mortgageguaranty insurance” is:(1) Insurance against financial loss by reason of nonpayment of principal, interest or othersums agreed to be paid under the terms of any authorized real estate security; and(2) Insurance against financial loss by reason of nonpayment of rent or other sums agreedto be paid under the terms of a written lease for the possession, use or occupancy ofreal estate.B. Sources of Mortgage Guaranty InsuranceThe primary sources of mortgage guaranty insurance include the following:1. Private Mortgage Guaranty InsurancePrivate mortgage guaranty insurance, referred to as PMI, is provided by commercialinsurance companies, typically when the loan to value ratio is greater than 80% of theproperty’s appraisal value in recognition of the added risk. Private mortgage insuranceis designed to indemnify the mortgage loan owner for the outstanding balance andaccrued interest due on loan payments in default, as well as real estate taxes andvarious maintenance costs until claim settlement. The cost of private mortgageguaranty insurance is typically added to the borrower’s mortgage payments. The lendermay transfer title to the mortgage insurer, who uses the proceeds from resale to reduceclaim costs, upon full claim settlement. Alternatively, the mortgage insurer has theoption to pay the limit of coverage and forego the right to acquire title.2. Public Mortgage Guaranty InsurancePublic mortgage guaranty insurance provides similar mortgage owner insurance througha government agency. The private mortgage insurance industry competes with certaingovernmental agencies and products.The majority of public mortgage insurance is provided by governmental agencies thatsponsor government backed mortgage insurance programs, primarily the FederalHousing Administration (FHA) and the Veteran’s Administration (VA). During the period2011, 2012 and 2013, public mortgage guaranty insurance accounted for approximately77%, 68% and 63% of the total low down payment residential mortgages subject tomortgage guaranty insurance.The Federal National Mortgage Association (Fannie Mae) and the Federal Home LoanMortgage Corporation (Freddie Mac) purchase residential mortgages as part of theirgovernment mandate to provide liquidity in the secondary mortgage market. These 2019 National Association of Insurance Commissioners1

government sponsored entities (GSEs) have been the major purchaser of mortgagesinsured by private insurers. GSE purchase of such low down payment mortgage loansrequires credit enhancement, of which private mortgage insurance is key.In 2008, the Federal Housing Finance Agency (FHFA) was appointed as the conservatorof the GSEs with authority to control and direct their operations. As conservator,various GSE reforms are under review to reduce the government’s overall footprint inhousing finance, including the recent development of “Private Mortgage InsurerEligibility Requirements.” 2019 National Association of Insurance Commissioners2

II.PRIVATE MORTGAGE GUARANTY INSURANCE ENVIRONMENTA. Pre “Great Depression” ProgramsThe original form of pre “great depression” era mortgage guaranty insurance was anoutgrowth of the title insurance business. Coverage insured whole mortgages andguaranteed participation certificates representing a share in either a single mortgage orpool of mortgages originated by either the insuring entity itself or an affiliate.This mortgage insurance industry collapsed in 1933 as a result of the placement of themajority of industry participants in rehabilitation, which was attributed to a combination offactors, including: Market competition among mortgage lenders directing business to companies thatwould make the largest loanInaccurate property appraisals reflecting values necessary to obtain loan approvalLoan packaging favoring larger institutions with less desirable mortgages packagedfor sale to those of more limited meansSubstitution of less desirable mortgages in poolsSale of participations on vacant or foreclosed propertiesMortgage lender and mortgage guaranty corporation affiliations creating conflicts ofinterestB. Post “Great Depression” ProgramsMax Karl, a Milwaukee-based attorney, subsequently studied the causes of the originalmortgage guaranty insurance industry failure of the 1930’s and reestablished the mortgageguaranty industry in the United States by founding Mortgage Guaranty InsuranceCorporation in 1956.The new business model emphasized: Non-affiliation of the mortgage lender and mortgage guaranty insurerMonoline licensing requirementsInvestment restrictions on mortgage and mortgage backed securitiesSingle family coverageActuarial based premium chargesPremium income allocation into loss, unearned and contingency reservesCommission, rebate and fee prohibitions for placement or purchase of PMIC. Mortgage Guaranty Insurance Role and BenefitsPrivate mortgage guaranty insurance provides the following mortgage and borrower relatedbenefits: 2019 National Association of Insurance Commissioners3

Facilitation of earlier home ownership and equity buildup through low downpayment mortgage supportBorrower expense control through automatic mortgage guaranty insurance lendercancellation on the date when the principal mortgage balance is scheduled to reach78% of the original property value per the Homeowners Protection Act of 1998Borrower financial assistance through private mortgage insurer and lender efforts toprotect their housing investment through the restructuring of loan payments orterms and collection efforts to prevent foreclosure in many instancesMortgage lender expansion of lendable sources of funds through loan originationcredit enhancementD. Key Private Mortgage ParticipantsThe key participants in the mortgage guaranty insurance environment consist of thefollowing:1. Loan OriginatorThe loan originator is the bank or other financial lending institution which creates amortgage loan to finance ownership of property. The mortgage loan is used byborrowers to obtain funds to purchase real property. The loan is secured by a lien onthe borrower’s property, which allows the lender to take possession and sell thesecured property

The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) purchase residential mortgages as part of their government mandate to provide liquidity in the secondary mortgage market.