On June 1 higher insurance premiums kick in for those buying a home with less than 10% down. These folks will cough up another 0.45 percentage points of their home’s value to get an insured mortgage.
That’s got some wondering, why are insurers picking on people with small down payments? Why not raise default premiums on all insured borrowers?
We posed that question to CMHC and here’s the answer we got:
As we continue to refine and improve our stress-testing and capital modelling capabilities in line with global and industry trends, recent improvements have allowed us to be more refined in our pricing decisions and modelling has indicated a greater sensitivity to the level of down payment.
In order to achieve a reasonable rate of return on its capital holding target, premiums for all segments were considered for potential increases and given the relative strength of the higher equity segments, we are able to continue to offer mortgage insurance premiums at their existing levels for the lower LTV tiers.
Source: CMHC Spokesperson, Charles Sauriol
In other words, borrowers with down payments less than 10% deserve to pay more as the arrears performance of higher loan-to-values isn’t as “strong.” In turn, said mortgages require CMHC to apportion more capital to cover potential losses.
Speaking of capital, “…mortgage insurers, including [Genworth Canada], have been advised by OSFI to maintain a minimum capital test holding target of 220% until a new framework for regulatory capital is finalized,” according to a recent National Bank Financial (NBF) report. What’s interesting is that CMHC hiked premiums avowedly to boost its capital. Yet its capital ratio (294% as of Sept. 2014) is well above that 220%. That’s led NBF to suggest that the price hike was “designed to help private insurers” boost their revenue (since they are price takers, not price setters, and they don’t have as big of a capital buffer).
You’d think that if this were the case the privates might have known about CMHC’s premium hike in advance. But a high-level Genworth executive assured me that the insurer was unaware of CMHC’s coming premium increase, citing competition rules as the reason.
Whatever the case, CMHC’s new fee incentivizes bigger down payments and spares 10%+ down borrowers from higher premiums. Much like pay-per-use models, default insurance works most equitably under a “pay-per-risk” model.