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Post-pandemic: Mortgage impairment – will your insurance respond?

Financial, Executive and Professional Risks (FINEX)
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By Maria Costiuc, CIP | August 17, 2020

As the consequences of the COVID-19 pandemic emerge, we discuss the implications for mortgage impairment and the insurance solutions available to lenders.

Overview of mortgage impairment

Mortgage Impairment coverage has always been a unique product offering within the insurance industry, as it is specifically tailored to meet the needs of mortgage lending and servicing clients. The base form is an all-risk property policy, incorporating common property policy exclusions as well as some that are specific to mortgage impairment insureds.

The policy is generally broken up into three sections:

  1. 01

    Mortgage Impairment Coverage

    Coverage is contingent upon the borrower having defaulted on the mortgage loan and lapsed or cancelled insurance on their mortgaged property, unbeknownst to the lender. It is triggered when there is physical loss or damage to the mortgaged property. The requirement to default is critical as, typically, a lender’s interest in the mortgaged property is not known to be impaired until the borrower stops making their mortgage payments.

  2. 02

    Forced Placed Property Coverage

    In certain scenarios, a lender may become aware that property coverage has been lapsed by the borrower, or that the limits being purchased are insufficient to cover the lender’s interest in the property. This scenario usually comes to light when the lender receives a notice of cancellation from the borrower’s property insurer, however, it can also be discovered during their loan underwriting diligence review of the borrower’s insurance at the time of origination of the mortgage or at renewal. If the borrower is a commercial client, it is common for the insurance to be reviewed on an annual basis.

    Once the lender becomes aware that the borrower’s insurance has been lapsed or is insufficient, the lender typically notifies their mortgage impairment insurer of impaired properties via a bordereau report and the frequency of the report can be negotiated on a monthly, quarterly or annual basis. The lender’s insurer extends property coverage on reported properties, on a primary basis. Once again, coverage is not generally triggered until the borrower defaults and physical loss or damage to the insured property occurs. The policy is only intended to respond for the lender’s financial interest in the property.

  3. 03

    Foreclosed Property Coverage

    The final element of coverage is intended to protect lenders when the default occurs prior to the physical loss or damage. The lender has repossessed the borrower’s property and they are interested in protecting their collateral until the property is sold. Properties protected under this section of coverage must also be reported via a bordereau report, so that mortgage impairment insurers can track the vacancy and potential catastrophe exposure they are now covering on a primary basis.

    Additional coverages can be purchased to protect the lender from liabilities they assume by virtue of originating or servicing mortgages, including but not limited to: Chattel Impairment Coverage, Real Estate Tax Liability, Title Insurance Liability, Tax Arrears Coverage, and many more.

Will the current pandemic environment lead to an increase in mortgage impairment claims?

Market cycles and mortgage impairment coverage are inevitably interlinked. A downturn in the economy generally results in an increase in the number of mortgage defaults, and therefore increases the exposure for physical loss or damage across the lender’s mortgage portfolio. The COVID-19 pandemic has resulted in over one million job losses for Canadians as of March 20201, and this number does not include Canadians that are still employed but working significantly fewer hours. As mortgage debt is the single largest source of debt for most individuals, lenders are proactively monitoring their mortgage portfolio for signs of impaired loans and taking the required steps to protect their interests. As one example, one large Canadian bank has leveraged predictive artificial intelligence tools provided by the AI startup Layer 6 that it acquired in 2018 to prepare for economic uncertainty. The technology developed by Layer 6 can be used to predict which customers will experience financial hardship2.

COVID-19 presents the biggest challenge to global mortgage markets since the 2008 financial crisis, and mortgage lenders are taking decisive and strategic action to adapt3. With many lenders having approved deferred mortgage payments as a strategy to help alleviate the financial burden on their borrowers, they have also inevitably increased the likelihood of mortgage and tax arrears. The most significant exposure to lenders, as a result, is the scenario where the borrower defaults and the lender is responsible for protecting the property on a primary basis until it is sold. In addition, when borrowers are struggling financially, and especially as a result of the current pandemic, the likelihood of insurance policies being cancelled or lapsed due to non-payment increases significantly, putting the lender’s collateral at risk for physical loss or damage. The ultimate impact to the lender can be severe when you consider that residential mortgages are typically the most significant asset on a lender’s balance sheet.

How do you measure the potential exposure to losses on a mortgage impairment policy? Lenders can consider past default rates during economic downturns to determine how much capital is at risk, however, that is not necessarily indicative of future physical loss or damage, especially when you consider key aggregations within the mortgage portfolio. Lenders can undertake a geographic portfolio review of their mortgage portfolio to understand their maximum foreseeable loss and make informed decisions around their potential exposure to loss. Most mortgage impairment insurance policies have a per occurrence limit, that reinstates after every loss, except for certain catastrophe perils that are subject to aggregate limits and other small sub-limits for minor extensions of coverage. Lenders should ensure the per occurrence limit purchased, in the very least, aligns with the average outstanding loan balance for a single loan, and the aggregate limit purchased for catastrophe perils adequately contemplates the maximum foreseeable loss across the portfolio in these geographic zones (ex. such as Earthquake in B.C.). Finally, and most importantly, the mortgage impairment insurance policy provides all-risk coverage, as mentioned above and it is important for lenders to review the various of exclusions in the policy with your broker as well as any applicable warranties, to ensure that your policy responds as intended in the event of a rise in claims post-pandemic.

Footnotes

1 https://www.cbc.ca/news/business/canada-jobs-march-covid-19-1.5527359

2 https://www.theglobeandmail.com/business/article-td-chief-executive-sees-more-tough-times-ahead-for-retail-customers/

3 https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Financial-Services/gx-fsi-covid-19-the-impacts-on-global-residential-mortgage-markets.pdf

Disclaimer

Willis Towers Watson is a trading name of Willis Canada Inc. Registered address: 4700-145 King St. W., Toronto, ON 5X 1E4 This article offers a general overview of its subject matter. It does not necessarily address every aspect of its subject or every product available in the market. It is not intended to be, and should not be, used to replace specific advice relating to individual situations and we do not offer, and this should not be seen as, legal, accounting or tax advice. If you intend to take any action or make any decision on the basis of the content of this publication you should first seek specific advice from an appropriate professional. Some of the information in this publication may be compiled from third party sources we consider to be reliable, however we do not guarantee and are not responsible for the accuracy of such. The information given in this publication is believed to be accurate at the date of publication shown at the top of this document. This information may have subsequently changed or have been superseded, and should not be relied upon to be accurate or suitable after this date. The views expressed are not necessarily those of Willis Towers Watson. Copyright Willis Canada Inc. 2020. All rights reserved.

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Financial Institutions Practice

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