January 30, 2018
How it can boost transparency and confidence for borrowers, lenders, insurers, and other ecosystem participants.
We’ve written before about how all parties in a mortgage transaction can benefit from blockchain technology. Private mortgage insurance (PMI) companies offer an excellent example of the ways in which distributed ledgers can help industry participants. PMIs can validate flow or bulk loans of which they are taking a financial interest, and the benefits don’t stop there.
Current state of mortgage insurance
Currently, mortgage insurance (MI) companies form relationships with lenders that operate locally and nationally. They establish a master policy allowing a lender to source loans that require mortgage insurance. A borrower pays a premium for this coverage directly to the mortgage insurance company. For loans with a loan-to-value (LTV) ratio greater than 80%, PMIs insure the lender against borrower default, either on a flow (loan-by-loan) or bulk (book of business) basis. Pricing is set by the borrower’s LTV and FICO score, and may include basis point premium adjustments associated with factors like insuring a second home, investment properties, or cash-out refis.
If the borrower stays current with the loan, payments are recorded by the owner of the mortgage servicing rights (MSR). But if the borrower defaults, the owner of the MSR can file a claim, and the MI company reimburses the owner based on the unpaid loan balance, delinquent interest, and any associated foreclosure costs.
The mortgage ecosystem
Originators, investors, servicers, and other industry participants have an opportunity to streamline operations considerably, validating a loan from its origination through maturity by using blockchain-based technology. PMIs could participate in the validation too, along with the rest of the mortgage ecosystem, by maintaining a node on the network. PMIs and lenders would benefit from real-time information updates about loan status, of course, but this also offers reassurance to an investor who has a vested interest that their loan has the appropriate in-force mortgage insurance. Certifying the loan and subsequent insurance ultimately helps generate greater investor confidence and improves secondary market loan liquidity.
Here are four ways in which blockchain can transform the ecosystem.
1. Automating MI certifications and pricing through smart contracts
PMIs can set up smart contracts with originators so each party agrees to the loan attributes, type of insurance, and ultimate insurance premium pricing. For example, both parties might agree to the loan’s LTV, FICO score, loan amount, loan type, and premium type (month, semi-annual, single premium, etc.). This ultimately drives the subsequent MI pricing agreed by both parties, just as it does today, but a blockchain system could allow all parties to certify and agree to conditions in a transparent and verifiable way.
By including a PMI in the ecosystem’s certification program, all parties could agree the loans are appropriately underwritten and have the proper in-force insurance.
2. Tracking the MI certificate and filing a claim
Once the loan is insured, an MI certificate is assigned by an MI vendor. To increase transparency, that certificate could be hashed within a blockchain and all parties could track the performance of new insurance written (NIW). If a borrower fails to repay the mortgage, blockchain would track the loan’s delinquency, default, and subsequent foreclosure. The servicer wouldn’t need to manually file a claim with the mortgage insurer, as all parties would know and agree that the conditions for an insurance claim had been met through a smart contract. Then the mortgage insurer could review the claim, make any adjustments between fair market and book value, and account for any appropriate fees. If all parties agreed to the mortgage insurer’s claim decision and payout amounts, the claim payment would be certified and, again, recorded on blockchain.
3. Enhancing relationships with reinsurers
This isn’t just an opportunity for primary insurers. PMIs’ relationships with reinsurers on bulk business could also benefit by creating three-way smart contracts between an originator, a PMI, and a reinsurer. In fact, reinsurance could automatically be established through the smart contract as long as the reinsurer also maintained a node and certified the transaction along with the originator and mortgage insurer. By automating the PMI’s relationship between the originator and reinsurer, we believe this would create additional liquidity and decrease capital requirements for mortgage insurers.
4. Certifying PMIER Requirements
Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that play a critical role in housing finance, are required to get credit enhancement for highly leveraged loans, typically by turning to PMI. The Private Mortgage Insurer Eligibility Requirements (PMIERs) establish requirements that a private MI company must meet to be an approved insurer and provide mortgage guaranty insurance on loans that GSEs will acquire. To remain an approved insurer, PMIs must meet minimum requirements including risk-based required asset amounts, capital ratios, performance scorecards, and so on. If the mortgage insurer were to maintain records on a blockchain, GSEs would have immediate confirmation that its requirements were being met, and these PMIER requirements could be readily certified by GSEs. Even on a granular-level, GSEs could certify each in-force insurance cert status (current, delinquent, or default) against the PMI’s minimal capital ratio. In fact, as long as you can measure requirements to be a PMIER-approved insurer, those requirements (and the calculations) can be maintained and certified by the GSE’s node on a blockchain.
The more transparent the mortgage industry is, the more confident investors will be and the more liquid the markets will be. This is in everyone’s interest, and private mortgage insurers can use blockchain technology to help make it happen. By adding reinsurers and GSEs to the equation, the benefits could be shared even more widely. The mortgage industry offers a terrific example of the power of blockchain, because of its decentralized nature, demand for accurate recordkeeping, and more, and we’re looking forward to seeing how this develops.
Scott Randa also contributed to this piece.