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MORTGAGE INSURANCE: COMPARING 

PRIVATE SECTOR AND 

GOVERNMENT-SUBSIDIZED APPROACHES 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

HOUSING AND INSURANCE 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

MARCH 13, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–6 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

SUBCOMMITTEE ON HOUSING AND INSURANCE

RANDY NEUGEBAUER, Texas, Chairman 

BLAINE LUETKEMEYER, Missouri, Vice 

Chairman 

EDWARD R. ROYCE, California 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

LYNN A. WESTMORELAND, Georgia 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

STEVE STIVERS, Ohio 

MICHAEL E. CAPUANO, Massachusetts, 

Ranking Member 

NYDIA M. VELA ́ ZQUEZ, New York 

EMANUEL CLEAVER, Missouri 

WM. LACY CLAY, Missouri 

BRAD SHERMAN, California 

JAMES A. HIMES, Connecticut 

CAROLYN MCCARTHY, New York 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

March 13, 2013 ................................................................................................. 1 

Appendix: 

March 13, 2013 ................................................................................................. 43 

WITNESSES 

WEDNESDAY, MARCH 13, 2013 

Bazemore, Teresa Bryce, President, Radian Guaranty, Inc. ................................ 15 

Bjurstrom, Kenneth A., Principal and Financial Consultant, Milliman ............. 7 

Chappelle, Brian, Partner, Potomac Partners LLC .............................................. 11 

Shapo, Nat, Partner, Katten Muchin Rosenman LLP .......................................... 9 

Stelmach, Stephen, Senior Vice President and Research Analyst, FBR Capital 

Markets & Co. ...................................................................................................... 13 

APPENDIX 

Prepared statements: 

Neugebauer, Hon. Randy ................................................................................. 44 

Bazemore, Teresa Bryce ................................................................................... 46 

Bjurstrom, Kenneth A. ..................................................................................... 65 

Chappelle, Brian ............................................................................................... 76 

Shapo, Nat ........................................................................................................ 88 

Stelmach, Stephen ............................................................................................ 99 

(1) 

MORTGAGE INSURANCE: COMPARING 

PRIVATE SECTOR AND 

GOVERNMENT-SUBSIDIZED APPROACHES 

Wednesday, March 13, 2013 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON HOUSING

AND INSURANCE, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:02 a.m., in room 

2128, Rayburn House Office Building, Hon. Randy Neugebauer 

[chairman of the subcommittee] presiding. 

Members present: Representatives Neugebauer, Luetkemeyer, 

Royce, Miller, Capito, Garrett, Westmoreland, Hurt, Stivers; 

Capuano, Velazquez, Cleaver, Sherman, Himes, Sinema, and 

Beatty. 

Ex officio present: Representative Hensarling. 

Also present: Representative Green. 

Chairman NEUGEBAUER. Good morning. This hearing of the 

Housing and Insurance Subcommittee will come to order. By mutual agreement, we will have opening statements, about 10 minutes on each side, as previously agreed. And there may be members 

of the full Financial Services Committee who want to participate 

in this hearing today, so I ask unanimous consent that members 

of the Financial Services Committee who are not members of the 

subcommittee and who have joined us today will be entitled to participate. Without objection, it is so ordered. 

This is our third hearing that we have done on FHA. And the 

reason we have had so many hearings is that FHA is an important 

component of the housing and the finance markets in this country. 

And they have become a larger and larger portion of the business, 

in controlling over 50 percent, for example, of the mortgage insurance premium in this country. 

This is no small insurance company. This insurance company has 

over a trillion dollars worth of business on the books. What does 

that mean? It means that because it is a government-backed entity, 

the taxpayers are, in fact, on the hook for over a trillion dollars 

worth of mortgages in this country. 

But the other aspect of it is that it is disturbing to find that this 

entity—as we have learned in previous hearings—is somewhat in 

financial straits. It is an entity that basically, has a negative net 

worth. And so, you have an over-trillion-dollar entity that is backed 

by the American taxpayers that has a negative net worth. 

2 

Now, any other company like that would be in bankruptcy or receivership. And so, I think that this may be the most important 

hearing we have had so far. Because today what we are going to 

analyze is if FHA is, in fact, an insurance company, which they 

are, then are they operating like traditional insurance companies? 

And we are going to hear from witnesses today who will tell us a 

little bit about what the profile of a entity like this should look like 

if it were in the private sector. Why is it important that we compare them to the private sector? It is important that we compare 

them to the private sector because they are competing with the private sector. That is one reason. But the other reason for them to 

be run in a financially sound way is the fact that the taxpayers are 

on the hook for these mortgages. And so, we need to make sure 

that the people who are enjoying the benefits of having an FHA 

loan in this country are actually carrying their load, and that they 

are not actually putting the taxpayers at risk. 

Because for those people who don’t have an FHA mortgage or 

have a private mortgage, they are, in fact, being penalized because 

they are paying their mortgage and they are paying the risk premium for having a privately-insured mortgage. But at the same 

time, they are at risk of also subsidizing the premium for people 

who have an FHA loan. So there are a number of areas where we 

are going to explore today. 

I want to make sure that we have an open and honest discussion. 

And one of the things that we want to make sure of is that as we 

move forward, we make sure that FHA is operating within what 

I think is the congressional intent. It has gotten to be a much bigger organization, and it is actually growing at an exponential rate. 

It is growing faster than it is ever grown and it is bigger than it 

has ever been. And the question is, is this the FHA that Congress 

intended, and is this FHA being run in an appropriate way for the 

American taxpayers? 

So, I look forward to the hearing, and I look forward to hearing 

from the witnesses today. And with that, I will yield back my time 

and recognize the ranking member of the subcommittee, Mr. 

Capuano, for 5 minutes. 

Mr. CAPUANO. Thank you, Mr. Chairman, for holding this hearing, and I certainly welcome our witnesses. I look forward to your 

testimony. 

The bottom line is, I agree with many of the things that the 

chairman said. The FHA, we all know, has grown. We have differences of opinion as to why it has grown and what would have 

happened had it not grown. I happen to believe that had it not 

grown at the time it did, there would be no housing market right 

now. Now, granted, that is past tense in 2008 and 2009 and 2010. 

The question is, what do we do from this point forward? 

From what I see, things are moving in the right direction. The 

FHA is slowly but surely and steadily, thoughtfully decreasing its 

share of the market, and private enterprise is coming back into the 

market the way it should. Nonetheless, I think it is fair and reasonable to ask all these questions. And also to oversee to make 

sure the FHA is doing what Congress wants it to do. I think all 

that is fine, I think it is good, and I think it is useful. 

3 

And those are the aspects on which I agree with the chairman. 

I do have some concern, however, that a lot of these hearings are 

being used simply as a setup to make sure that when the time 

comes, private enterprise will be able to grab a larger share than 

they have ever had in any traditional sense of the word. We will 

be a little bit careful of that, only because I like the housing market that we had for 40 years. 

Granted, it got out of whack and we need to put it back in 

whack. But I don’t want to go overboard and completely 

disincentivize the entire middle class from ever being able to purchase a home. I think that is part of the balance here. I am also 

a little concerned that some of the things that are happening might 

be used, at some point, to make a political point. For instance, as 

I understand the law, the FHA is required by law to access certain 

Treasury funds even though they don’t need them. 

So I will be asking each witness if you think the FHA will actually need to borrow Federal dollars this fiscal year regardless of 

what the law says. Not access the money, because as I understand 

the law they have to, but do you think the FHA this year will have 

to access anything outside of their own funds? And if the answer 

is yes, you will have to explain to me why. And that is why I filed 

H.R. 1028, which simply repeals the section of the law that requires the FHA to access Treasury funds when they don’t need 

them. 

It is a ridiculous law that I never knew existed until we hit this 

particular situation. I guess it is excessive. It is belt-and-suspenders, and maybe two-belts-and-two-suspenders. It is a little bit 

of overkill to make sure that the FHA stays whole. And I think it 

is unnecessary and inappropriate. But nonetheless, we will see if 

some of my colleagues will help pass that bill to get the FHA on 

the footing that it deserves and to not jeopardize taxpayer dollars 

unless it is absolutely necessary. 

So I look forward to your testimony today, and I look forward to 

making sure, together with the chairman and other members, that 

the FHA is doing what we wanted it to do when it was originally 

created. 

Thank you, Mr. Chairman. I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now, the vice chairman of the subcommittee, Mr. 

Luetkemeyer from Missouri. 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. And thank you for 

the important salient hearing we are having today. 

Regardless of political ideology, there are certain facts about 

FHA that can’t be denied: one, FHA’s market share has grown considerably over time; two, FHA insures more than $1 trillion worth 

of mortgages on more than 7 million loans; three, FHA has the authority to draw funds directly from the U.S. Treasury; and four, 

FHA’s Mutual Mortgage Insurance Fund, or MMIF, has a capital 

ratio that has fallen below the statutorily-required level of 2 percent. 

In fact, during Fiscal Year 2012, the capital reserve ratio fell to 

a negative 1.44 percent. Despite these facts, FHA’s book of business 

continues to grow as the private market is being forced to comply 

with stricter regulations and standards. As someone who has spent 

4 

many years in the banking and insurance industry, I respect and 

understand the importance of the sound tenets in lending and underwriting. And looking at the data surrounding FHA’s finances, it 

is clear that they are not employing sound practices. 

What is most disturbing about this is that the taxpayers are the 

ultimate backstop for FHA’s sloppy work. The simple truth of the 

matter is that FHA needs to be examined and needs to be held to 

the same standards, high standards, that they are currently operating under. I look forward to hearing from our witnesses today, 

particularly about how we can return FHA to its original mission, 

ensure that they follow the sound tenets in lending and underwriting, and help spur growth in the private mortgage insurance 

market. 

Thank you, Mr. Chairman. I yield back. 

Chairman NEUGEBAUER. I thank the gentleman, and I also want 

to recognize that the chairman of the full Financial Services Committee, Mr. Hensarling, has joined us today. It is good to have you 

in the hearing. 

Now, I recognize the gentleman from Missouri, Mr. Cleaver, for 

2 minutes. 

Mr. CLEAVER. Thank you, Mr. Chairman, and I do appreciate 

very much the fact that you have called three hearings to deal with 

FHA. And I think a part of this committee’s benefit to the entire 

body is, you have been in municipal government and our ranking 

member came out of municipal government. And FHA has played 

a role since the Depression in keeping the housing market in this 

country sound. 

I am not sure I would agree that FHA is crowding out the private industry. Because when you think about it, before the housing 

crisis, there were 10 private mortgage insurance companies. Almost 

all of them went bankrupt, almost all of them. And it was at a time 

that we needed FHA to step in, and they did. And with recovery 

on its way, I think it is on the horizon. 

Private mortgage insurance posted their best year since the collapse in 2008. I was looking at this report from Inside Mortgage 

Finance that they put out, I think, on a monthly basis. Private 

mortgage insurance reported $175 billion in total new insurance 

written in 2012, more than doubling the amount of the business 

they did the year before, according to Inside Mortgage. So I do 

think that there may be a need for us to discuss this and massage 

it. 

But the truth of the matter is, FHA is still providing a service 

that we desperately need, and I look forward to interacting with 

our panel. 

I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now Gary Miller, the vice chairman of the full Financial 

Services Committee, is recognized for 2 minutes. 

Mr. MILLER. Thank you, Mr. Chairman. I don’t think that we can 

argue that we must respond to the reality the FHA wasn’t prepared to have the pressure it faced during the downturn crisis. But 

we also face the reality that the private sector and FHA are somewhat different. FHA was driven by a mission structure. The private 

5 

sector is driven by a profit structure, which is most appropriate. 

But let’s look at fair competition. 

I guess the question we need to ask is, was the FHA crowding 

out, or was there no crowding-in by the private sector? I think that 

is something we don’t have an answer to right now. And I think 

we need to look at the structure that caused the lack of crowdingin. If you look at Basel QM—QRM, we are doing everything from 

a structural perspective from Congress to basically make sure the 

private sector does not come in when they should be. 

And if you look at the FHA, they play a countercyclical role. 

They grew when the private sector didn’t come in. But now it is 

time to look at how do we ratchet back the FHA and other groups 

to let the private sector come in. That is something we need to really look at. And the latest actuarial review makes it clear that FHA 

wasn’t fully prepared for the strains they faced during the downturn. They had five increases in fees. Were they appropriately 

timed, could they have moved in quicker? 

We need to explore the mechanics of the private sector mortgage 

market and ask, how do we evaluate their operational structure 

and apply that to FHA, determine where reforms are needed, to 

make sure FHA can play this countercyclical role they are intended 

to play? But we need to respond to certain things that FHA has 

done to make sure they can perform their function in the future. 

We need to ensure their management system and technology are 

appropriate to do the job they are supposed to do. 

We need to make sure that they ensure that appropriate credit 

quality is preserved in the system. I have introduced legislation in 

the past to make sure they would do that and, for some reason, 

that is not occurred. And we need to demand that FHA remain 

adequately capitalized. There are a lot of questions and a lot of concerns I have, and I am sad to say my time has expired. 

I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now the gentleman from California, Mr. Sherman, is recognized for 2 minutes. 

Mr. SHERMAN. Yes, indeed, FHA’s market share has grown, as 

the gentleman from California points out. That is FHA’s mission, 

to step forward and play a larger role when we have a downturn, 

in this case the largest downturn in the housing economy in modern times. FHA has lost money on the guarantees that it made of 

mortgages in 2007 and 2008. Who hasn’t? 

Very few people realized we were headed for a huge decline in 

home prices. And even the most carefully selected mortgages made 

in 2007 and 2008 had a higher than expected default rate, as people became unemployed and as they were unable to sell their 

homes at a profit when they were forced to sell them by unemployment or divorce or whatever. Moody’s Analytics estimated that if 

the FHA hadn’t stepped forward, then by 2010 we would have seen 

another 25 percent decline in home prices around this country. 

That would have been terrible for our economy, and even terrible 

for the private mortgage insurance industry. I look forward to restoring a more orderly market, one in which private mortgage insurance will be playing a bigger role, and FHA will be playing a 

smaller one, as we stabilize this economy and stabilize home prices. 

6 

Finally, I come from a high-cost area, where $729,000 is still a 

middle-class family. And to have Fannie Mae and Freddie Mac 

shut out of that market, but the FHA in it, I think is unfair to the 

private mortgage insurance industry. People with those mortgages 

ought to be eligible for a combination of private mortgage insurance and Fannie Mae and Freddie Mac. I look forward to restoring 

the situation where Fannie and Freddie have limits at least as 

high as FHA. 

And I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now the gentleman, Mr. Westmoreland, is recognized for 2 

minutes. 

Mr. WESTMORELAND. Thank you, Mr. Chairman. I have said this 

many times before: The FHA is insolvent. If FHA were a private 

mortgage insurance company or one of my community banks, it 

would have failed a long time ago. We don’t want FHA to fail. We 

want it to do what it was created to do. Instead of focusing on fundamentals like shrinking their portfolio, reducing risk, and charging a premium that is in line with risk, FHA has advanced a policy 

that can only be described as out of bounds from its original intent. 

In fact, the administrator admitted to this committee last month 

that people earning over $100,000 are eligible for an FHA loan. Are 

these the low-income borrowers FHA is supposed to be serving? 

FHA is in markets and arenas that they don’t need to be in. Further, Dodd-Frank, the QM, and Federal housing policies are driving 

businesses to FHA rather than away from the private sector. The 

list of FHA advantages over the private market is long, and I have 

fought to bring private mortgage financing and PMI back into the 

market. 

We need to reduce the 100 percent guarantee to 25 to 50 percent 

to be in line with the VA program and what private mortgage insurance offers. We need to reduce the loan limit to be in line with 

the area medium income, and tie FHA loans to the income. We 

need to restructure FHA premiums so that they can recapitalize 

their fund. And we need to be sure FHA uses the same standards 

for underwriting that are used in the private market. 

I hope Chairman Hensarling and Chairman Neugebauer work towards a conservative bill that ends these subsidies and refocuses 

FHA on its core mission to serve first-time and low-income borrowers. 

Thank you, Mr. Chairman, and I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now the gentlewoman from Ohio, Mrs. Beatty, is recognized 

for 2 minutes. 

Mrs. BEATTY. Thank you, Mr. Chairman, and Mr. Ranking Member. I, too, join my colleagues in looking forward to continuing to 

discuss FHA’s financial position and, in particular, the notion of 

government crowding out private mortgage insurance from the residential mortgage insurance market. 

FHA has, indeed, become a much more significant player in the 

mortgage insurance market. But this reflects the fact that private 

mortgage insurers all but pulled out of the market during the housing downturn. According to Moody’s Analytics, the FHA’s response 

to the housing collapse prevented house prices from falling an addiVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
7 

tional 25 percent, which would have resulted in 3 million more jobs 

lost and a reduction in the economic output of $500 million. 

So I think when we discuss FHA’s larger market share, let’s do 

so with a clear understanding of what precipitated this increased 

growth, which is first, the FHA’s fulfillment of its statutorily-defined mission to promote long-term stability in the U.S. housing 

market by providing countercyclical support. Second, despite playing such a critical role in the crisis, the FHA has already begun 

taking steps to shore up the MMIF and to also refocus its efforts 

towards the primary market for FHA-insured loans, first-time 

homeowners, and low- and middle-income borrowers. 

And lastly, by increasing, up front, annual fees, and making 

mortgage insurance premium payments due for the life of the loan, 

rather than just until the borrower’s equity reaches a certain level, 

the FHA has actually strengthened the position of private mortgage insurances. And I certainly look forward to hearing from our 

witnesses today and continuing these hearings. 

I yield back my time. 

Chairman NEUGEBAUER. I thank the gentlewoman. 

And now the gentleman from Texas, Mr. Green, is recognized for 

1 minute. 

Mr. GREEN. Thank you, Mr. Chairman, and thank you for allowing me to be a part of this subcommittee hearing. 

I am here to say to FHA, ‘‘Thank God for you.’’ I really do believe 

that FHA has been of great benefit to this country. It was formed 

at a time of crisis in 1934 when loans were hard to acquire, if you 

could acquire one at all. They were short-term, they had balloons. 

FHA was born out of a crisis with the intent of responding to a crisis, and that is exactly what it has done. 

It has responded to the ‘‘Great Recession’’ by allowing people to 

acquire homes who probably could not have acquired them otherwise, given that so many of these other companies have gone out 

of business. If not for FHA, we would be in dire straits today. I believe that FHA can do some things to improve its position, and I 

look forward to tweaking it, and mending it, but not ending it. 

Chairman NEUGEBAUER. I thank the gentleman. And now, we 

will recognize our panel. Each of you will be recognized for 5 minutes. Your written statements will be made a part of the record. 

The panel today consists of: Mr. Ken Bjurstrom, principal and financial consultant from Milliman; Mr. Nat Shapo, a partner at 

Katten Muchin Rosenman; Mr. Brian Chappelle, a partner at Potomac Partners; Mr. Steve Stelmach, senior vice president and research analyst at FBR Capital Markets & Company; and Ms. Teresa Bryce Bazemore, president of Radian Guaranty, Inc. 

Thank you for being here today. And with that, Mr. Bjurstrom, 

we will recognize you for 5 minutes. 

STATEMENT OF KENNETH A. BJURSTROM, PRINCIPAL AND 

FINANCIAL CONSULTANT, MILLIMAN 

Mr. BJURSTROM. Good morning. Chairman Neugebauer, Ranking 

Member Capuano, and members of the subcommittee, thank you 

for the privilege of appearing here today. 

My name is Ken Bjurstrom. I am a principal at Milliman, where 

my practice focuses on mortgage credit risk analysis for the mortVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
8 

gage insurance and mortgage banking industry, both for private 

and government organizations. In association with Milliman, I 

have conducted analyses of the private MI industry and, at the request of HUD’s Inspector General, I have conducted several reviews of the actuarial report for the FHA’s mutual mortgage insurance fund. 

During the early 1980s and again in the early 1990s, as well as 

over the last few years, the economy has suffered declines in home 

prices or increases in unemployment resulting in mortgage insurance claims. Subsequent to each of these periods of economic stress, 

the MMIF experienced substantial losses. For endorsement year 

1981, roughly 22 out of every 100 FHA borrowers defaulted and 

lost their home, resulting in a mortgage insurance claim to the 

FHA. 

For endorsement years 1990 through 2003, relatively good times, 

the comparable rate was 8 out of 100 borrowers. And for the 2007 

endorsement year, according to the FHA’s MMIF actuarial report, 

the rate is estimated at over 30 out of every 100 FHA borrowers. 

All mortgage insurers are exposed to considerable risks which, in 

turn, require them to maintain basic disciplines, including underwriting, ratemaking, loss reserving, and also a commitment to high 

capital levels. 

Historically, insurers have generally used the size of the downpayment or loan-to-value product type in the amount of coverage 

in their underwriting and ratemaking approach. Relatively recently, private MIs have expanded their premium rate programs to 

recognize the importance of borrower credit scores and other factors. In contrast, the FHA currently utilizes fewer tools available 

to them to manage their insurance exposures. Without a more 

granular approach to ratemaking, the FHA may be encouraging adverse selection with respect to obtaining FHA mortgage insurance 

protection. 

State insurance laws require private MIs to adequately maintain 

multiple reserves. These reserve requirements require the MI to account for near-term expected losses, restrict shorter-term dividends, and measure the company’s ability to write new business. 

The FHA, in contrast, does not have a comparable reserving methodology. Private MIs are generally subject to a maximum risk to 

capital ratio when combined with reserve requirements, require it 

to build reserves and surpluses during periods of economic growth 

so that they are in a position to cover substantial levels of claims 

during periods of economic downturn. 

The FHA, on the other hand, is not required to hold equivalent 

statutory reserve requirements or comparable capital requirements. 

FHA’s Mutual Mortgage Insurance Fund is required to have an 

independent actuarial analysis of its economic net worth and financial soundness to determine whether it has maintained a 2 percent 

ratio of the economic value to its insurance in force. This ratio requirement, and the economic valuation from which it is derived, is 

the only gauge of FHA’s ability to withstand losses. 

FHA’s economic value calculation has several inherent weaknesses. The long-term forecast used generates significant positive 

economic value for the most recent endorsement years, as if these 

economic forecasts were certain. It considers anticipated future preVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
9 

miums from these books and their future losses. But these recent 

books are very large and have the potential for significant variability over the long-term. 

In contrast, private MIs do not take credit for the economic value 

reflected in future premiums and terms of their statutory requirements. If we were to re-look at history and forecasted FHA claim 

rates and the economic environments that caused them, it is clear 

that the FHA should establish a capital threshold that reflects a 

more risk-based probability of stress losses in the future. 

Additionally, the FHA should be allowed to establish loss reserves and account for estimated loss liabilities prior to determining its capital ratio or other assessments of its financial 

strength. Loss reserves are a critical part of determining the actuarial health of any insurance fund, and should be part of the MMIF 

capital assessment to give Congress a more accurate view as to the 

capital adequacy of the FHA’s single-family operations. 

Since the early 1980s, when I began working in this industry, I 

have witnessed multiple economic downturns which created tremendous losses for both private MIs and government-run funds at 

both the State and Federal levels. It is therefore important to continue to work diligently to protect the FHA program. To that end, 

I recommend that the FHA evaluate and adopt many of the private 

MI statutory accounting provisions described above, better understand and modify their exposures to support their mission, and retain the necessary capital that is required to protect the program 

now and for the next economic downturn that will most definitely 

occur. 

Thank you for inviting me and for your consideration of my 

views. I would be pleased to answer any questions. 

[The prepared statement of Mr. Bjurstrom can be found on page 

65 of the appendix.] 

Chairman NEUGEBAUER. I thank the gentleman. 

Mr. Shapo, you are recognized for 5 minutes. 

STATEMENT OF NAT SHAPO, PARTNER, KATTEN MUCHIN 

ROSENMAN LLP 

Mr. SHAPO. Thank you, and good morning, Mr. Chairman, Ranking Member Capuano, and members of the subcommittee. Thank 

you for inviting me. It is a privilege to participate as the subcommittee performs its important work. 

My name is Nat Shapo. I am a partner at Katten Muchin 

Rosenman LLP in Chicago. I practice mainly in insurance, litigation, and regulatory matters. I am also a lecturer at the University 

of Chicago law school, where I teach insurance law. And I was privileged to be the Illinois Insurance Commissioner from 1999 to 2003. 

At the subcommittee’s request, I have analyzed the FHA Mutual 

Mortgage Insurance Fund from a regulatory perspective. From 

what I found, based on GAO audits and other public record, the 

fund appears to have been, and to be, operating and overseeing in 

a manner that conflicts with basic regulatory principles. 

Insurance is regulated in the United States primarily by the 

States per the Congress’ direction in the McCarran-Ferguson Act. 

The State insurance department is generally divided into solvency 

regulation and market practice oversight. The former, solvency regVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
10 

ulation, is usually looked at as the most important function of insurance regulation, since financial impairment jeopardizes the carrier’s ability to carry through on the heart of the insurance contract, the promise to pay. 

Nearly a century ago, the Supreme Court nicely explained the 

key place that solvency regulation has in protecting the well-being 

of the common fund that all consumers rely upon. Insurance companies, the court said, create a fund of assurance and credit, with 

companies becoming the depositories of the money of the insured, 

possessing great power thereby and are thereby charged with great 

responsibility. How necessary their solvency is, is manifest. 

With respect to solvency regulation, requiring capitalization commensurate with risk is a basic pillar. Thus, a common requirement 

in the States, based on a National Association of Insurance Commissioners model, is a risk to capital ratio limiting outstanding liability on the insurer’s aggregate policies to 25 times its capital 

surplus and contingents in reserve. In other words, the carrier 

must have real money, at least 4 percent of its liabilities, on hand. 

The 4 percent capital to risk ratio is backed up in the NAIC 

model. If it is pierced, the carrier may not write new business. This 

protects both current and potential new consumers by preventing 

an impairment from becoming a catastrophe. The FHA fund’s risk 

to capital ratio of 50 to one, which means capital in the amount of 

2 percent of exposure, is half as stringent as the NAIC model’s 4 

percent. Certainly, the weaker standard is relevant. 

But my bigger concern is that the standard, at whichever level, 

is not enforced, as a regulatory requirement, in practice. The GAO 

found that the capital ratio fell from about 7 percent in 2006 to 3 

percent in 2008, below 2 percent in 2009. It is not expected to 

reach 2 percent again until 2017, meaning it will likely be below 

its statutorily-mandated level for 8 years. This extended failure to 

meet the legal minimum is exacerbated by the FHA’s practice of attempting to write its way out of trouble. 

An impaired insurer is generally not allowed to write new business absent very stringent additional requirements. But FHA’s exposure has ballooned, according to the GAO. In 2006, FHA insured 

approximately 4.5 percent. Today, it insures at its peak, though in 

2009, it insured 32.6 percent. Today, we are still over a quarter. 

The results have been predictable, and exactly what insurance regulation is designed to prevent; the deepening of the crisis, and a 

full-blown negative balance sheet. 

GAO explained that in 2012, the capital ratio fell below zero, to 

negative 1.44 percent. The fund is expected to be in negative balance for at least 2 years. A private insurer in such insolvent condition would be put in liquidation. The commonly-adopted NAIC hazardous financial condition regulation establishes a number of other 

different standards that would be triggered by an insurer in the 

fund’s condition, which I have covered in my written testimony. 

Adverse findings in audits—we have seen that with the GAO. An 

insurer’s operating loss in a 12-month period greater than 50 percent of the insurer’s remaining surplus. The fund has no surplus. 

The insurer growing so rapidly that it lacks adequate financial capacity. The fund’s increased market share by 700 percent, while 

turning into a balance sheet insolvency. So the fund would be in 

11 

violation of those basic standards of the NAIC hazardous financial 

condition regulation. 

I was asked to provide a regulatory analysis, and the ultimate 

policy issues here are well beyond my proverbial pay grade so I will 

only briefly comment. Insurance is complicated, but its basics are 

straightforward. The Supreme Court explained that Congress understood the business of insurance to be underwriting the and 

spreading of risk. The fund operates apart from the basic rule. It 

does not evaluated hazards according to actuarial principles or correlated premiums-to-risk. 

The capital in this common fund does not support its exposure. 

Government intervention in the distribution of risk never ends 

well, and does not ultimately protect consumers that it is meant to. 

We have seen that in the New Jersey auto market and other places 

with heavy government intervention. By doing so, FEIA makes obtaining business and attracting capital, the core functions of any 

business, more difficult for carriers, distorts the entire market as 

a whole, and deepens the spirals already in place both at the FHA 

and among private carriers. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Shapo can be found on page 88 

of the appendix.] 

Chairman NEUGEBAUER. I thank the gentleman. 

And now, Mr. Chappelle, you are recognized for 5 minutes. 

STATEMENT OF BRIAN CHAPPELLE, PARTNER, POTOMAC 

PARTNERS LLC 

Mr. CHAPPELLE. Thank you, Mr. Chairman, Ranking Member 

Capuano, and members of the subcommittee. I am Brian Chappelle 

with Potomac Partners. 

I believe that a strong and viable private mortgage insurance industry is an integral part of the mortgage market. I also believe 

that the MIs’ challenges today have little to do with FHA. The MIs 

benefited from FHA’s support of the mortgage market at the height 

of the crisis in 2008. By helping to stabilize home prices, FHA reduced MI losses. However, as the FHA audit shows, FHA will incur 

significant losses on loans made during that period. 

The good news is that loans made since then have strengthened 

the fund. FHA has taken numerous steps to shore up its reserves. 

Its rate increases are also pushing more business back to the MIs. 

FHA has raised its premium 5 times, with another coming next 

month. Even an MI said, in its annual earnings filing just last 

week, ‘‘We believe that the FHA’s current premium pricing has allowed us to be more competitive with the FHA than in the recent 

past for loans with high FICO credit scores.’’ 

And that was before the FHA’s upcoming increase. For all the attention given FHA’s mortgage limits, the data shows that FHA activity is concentrated in lower-priced homes. FHA’s median loan 

amount was $147,000 in 2011. Seventy-one percent of FHA loans 

insured in 2012 were below $200,000; $200,000 is below the base 

loan limit in effect prior to the Economic Stimulus Act of 2008. 

Over 80 percent of FHA loans insured last year were also below the 

pre-stimulus limit when high-cost areas were included. 

12 

FHA did more loans under $50,000 than over $500,000. FHA did 

twice as many loans under $100,000 as they did over $300,000. 

Concerning borrower income, the FHA median was $56,000 in 

2011. FHA’s median was only 12 percent above the U.S. median 

family income that year. That is lower than FHA’s borrower profile 

in 1971, 40 years ago, when the FHA median was 22 percent higher than the U.S. median. 

There are three ways that FHA achieves the balance between its 

mission, its responsibility to the taxpayer, while also minimizing 

overlap with the private sector. First, FHA’s premium structure reduces overlap. Unlike many types of insurance, FHA charges all 

borrowers the same premium regardless of credit characteristics, 

thereby helping the private insurers to compete for better-quality 

loans. 

Second, FHA uses reasonable mortgage limits to minimize overlap. As the above data showed, high-balance loans are a very small 

part of FHA’s business, or the MIs problem. However, some highbalance loans can help FHA cushion taxpayer risk because every 

audit I can remember has said higher-balance loans perform better. 

Third, FHA provides 100 percent insurance coverage. A 1997 

GAO audit concluded, ‘‘Reducing coverage would increase borrower 

costs and reduce borrower eligibility.’’ In addition, lenders are now 

taking the unprecedented step of adding their own underwriting requirements on top of FHA’s. Reducing coverage would exacerbate 

this current problem. 

There is a more immediate problem facing the mortgage market 

today, however. As Federal Reserve Governor Duke noted in a 

speech last Friday, purchase mortgages hit their lowest level since 

the early 1990s. That is 22 percent fewer purchases than in 2008 

at the height of the crisis. Younger home buyers are being particularly hard hit by tight credit. According to Governor Duke, from 

late 2009 to 2011, the number of first-time home buyers under 40 

was half of what it was in the early 2000s. 

She added that since 2007, there has been a fall of about 90 percent for borrowers with credit scores between 620 and 680. At the 

same time, about 30 percent of all purchase transactions in 2012 

had home buyers paying cash. They did not need or want a mortgage. For the first time I also can remember, all cash sales are now 

the number one source for home purchases in our country, ahead 

of FHA, Fannie Mae or Freddie Mac. 

In other words, the private sector has returned to the housing 

market, just not to the mortgage market. I am worried that we 

may well be moving backwards towards the housing market where 

homeownership is limited to those who are wealthy or have 

wealthy parents, and a dwindling few whose credit is stellar 

enough to qualify for a mortgage. I believe that we must first solve 

this challenge before worrying about carving up a depressed purchase mortgage market. 

The fundamental problem with the current market today is not 

that FHA is doing too many purchase loans, but that, combined, 

FHA, the private mortgage insurers, and the GSEs are not backing 

enough of them. 

Thank you very much, and I look forward to answering any questions you may have. 

13 

[The prepared statement of Mr. Chappelle can be found on page 

76 of the appendix.] 

Chairman NEUGEBAUER. I thank the gentleman. 

Mr. Stelmach, you are recognized for 5 minutes. 

STATEMENT OF STEPHEN STELMACH, SENIOR VICE PRESIDENT AND RESEARCH ANALYST, FBR CAPITAL MARKETS & 

CO. 

Mr. STELMACH. Good morning. My name is Steve Stelmach. I am 

senior vice president at FBR Capital Markets, an investment banking firm headquartered in Arlington, Virginia. I would like to 

thank Chairman Neugebauer and Ranking Member Capuano for 

my invitation today. 

Among the issues that the subcommittee asked to be addressed 

today is the impact of the FHA’s policies and practices on investments in private mortgage insurance. This is a topic for which I 

can offer a unique perspective. In my role at FBR Capital Markets, 

I have 10 years of experience in advising our clients on the merits 

and risks of investing in particular industries and companies 

My particular area of focus is U.S. housing, mortgage finance, 

and, relevant to the subcommittee, mortgage insurance. FBR’s clients are pension funds, endowments, mutual funds, and asset managers in the United States and in Europe. Collectively, these clients match assets in the trillions of dollars. Having participated in 

countless conversations with these institutional investors over 

many years, I can attest that the actions of the FHA have a direct 

influence on investor decisions to allocate or not allocate capital to 

the private mortgage insurance industry. 

Today, I would like to address three main topics on which investors tend to focus: first, how the FHA has historically crowded out 

private capital; second, how recent changes at the FHA has actually encouraged new capital into the market; and third, how FHA 

policy changes can have the impact of expanding mortgage availability. 

First, on the issue of crowding out private capital, the FHA has 

a fixed insurance premium structure, which means the borrowers 

are all charged the same insurance premium. Until recently, that 

premium was at or below rates charged by private mortgage insurers. This premium, combined with the downpayment requirements, 

are less than those required by private mortgage insurance, higher 

FHA seller concessions, lower perceived repurchase risks for defaulted loans, and higher gain on sale margins pushed lenders and 

borrowers into the FHA product. 

With capacity constraints within the mortgage origination channels, uncertainty of our future liabilities, the creditworthiness of 

the average FHA borrower is much higher than historical levels. 

Currently, the average credit score of an FHA-insured loan hovers 

around 700. This is safely in prime credit territory, and well above 

the average FICO score for many low- and moderate-income households that the FHA has traditionally served. 

When the FHA premium was capped at 55 basis points, FHA 

charged a lower insurance premium for this prime quality borrower 

than premiums charged by the private mortgage insurers, making 

it exceedingly difficult for the private mortgage insurers to compete 

14 

for that business. Turning to the issue of private industry, or private capital returns in the mortgage insurance industry, we see investor interest as very strong. 

Following the passage of the FHA Reform Act of 2010, the FHA 

was given the authority to raise annual premiums to 155 basis 

points, or 1.55 percent. Following a series of premium increases, 

the current FHA premium is 1.35 percent. Additionally, the FHA 

has taken further steps to shore up its finances, making FHA loans 

less attractive to higher credit quality borrowers, expanding the 

market share from private mortgage insurers. 

Since the FHA began to institute premium increases in 2012, FBR has helped to raise $550 million in capital for a new mortgage 

insurance company, and recently participated in raising a billion in 

capital for an existing mortgage insurance company. In total, the 

mortgage insurance industry has attracted nearly $3 billion in new 

capital in the last 12 months. Notably, investors chose to invest 

this capital only after FHA instituted premium increases. 

Despite the sums raised in the past 12 months, it is a far cry from the roughly $20 billion of capital that the private industry enjoyed just a few years ago. While much of the decline in industry 

capital is a result of extraordinary claims that the industry has 

paid in recent years, investors have been hesitant to provide capital to the industry, given persistent regulatory uncertainty, including GSE reform, FHA reform, Qualified Mortgage definitions under 

Dodd-Frank, and Qualified Residential Mortgage definitions under 

Dodd-Frank. 

We believe that as the market receives greater clarity on these 

issues, this clarity can facilitate even greater investment in private 

mortgage insurance. As a public policy, it could be seen as self-defeating for the FHA to allocate precious dollars for borrowers who 

would otherwise qualify for private mortgage insurance, while 

other borrowers struggle to get financing. As a means of expanding 

mortgage availability to those less-served segments of our country, 

the FHA has a critical role to play. 

And this dynamic leads to my final point. Higher premiums and 

other actions taken by the FHA can actually increase mortgage 

availability, up to a point. Now, this may sound inconsistent with 

policymakers’ objectives but, in fact, we expect FHA premium increases to widen mortgage availability to less-served segments of 

our community. As premium increases take hold at the FHA, the 

FHA will price itself out of the prime credit market that I mentioned earlier. 

Private mortgage insurers are willing to serve this market. And 

if the government backs away, investors are more willing to invest 

in this private industry. In fact, we have started to see this play 

out. Importantly, however, now that the FHA capacity is not being 

allocated to this higher credit quality borrower, the FHA’s precious 

resources can be directed to qualified but less creditworthy households. Under this scenario, we see the FHA fulfilling a very important policy objective of providing mortgage credit to underserved 

borrowers, while private capital becomes increasingly available to 

meet growing mortgage market demand. 

Again, I thank the committee for inviting me today. I am happy 

to answer any questions that you may have. 

15 

[The prepared statement of Mr. Stelmach can be found on page 

99 of the appendix.] 

Chairman NEUGEBAUER. I thank the gentleman. 

And finally, Ms. Bazemore, you are recognized for 5 minutes. 

STATEMENT OF TERESA BRYCE BAZEMORE, PRESIDENT, 

RADIAN GUARANTY, INC. 

Ms. BAZEMORE. Thank you. Good morning. I am Teresa Bryce 

Bazemore, president of Radian Guaranty, a leading private mortgage insurance company. For decades, FHA and private MI have 

worked together in housing finance to ensure that low- and moderate-income families could purchase homes, often their first 

homes, with low downpayments. 

In fact, my first loan was an FHA loan for a condo, and so I have 

personally benefited from receiving both FHA and privately insured mortgage loans. FHA has been, and remains, a valuable part 

of the housing finance system. However, in the past few years FHA 

has dominated the mortgage insurance market due to housing policies and practices that provide competitive advantages to FHA, 

while crowding out private capital. 

By way of background, the private mortgage insurance, or MI, industry is the private sector alternative to loans insured by FHA. 

Private mortgage insurers help qualified, low-downpayment borrowers obtain an affordable and sustainable mortgage. When a borrower places less than 20 percent down, the lender is required to 

obtain private MI in order for that loan to be eligible for subsequent sale to Fannie Mae or Freddie Mac. 

Even during the recent challenging times, the MI industry raised 

over $8 billion in new capital, paid approximately $34 billion to the 

GSEs in claims resulting from foreclosure losses, and has reserved 

another $16 billion for this purpose. This is $50 billion taxpayers 

do not have to pay. We are able to pay claims at these levels in 

part because of the rigorous countercyclical reserve requirements 

and loan loss reserve requirements imposed by State insurance 

commissioners. 

A requirement to reserve half of every premium for 10 years ensures that significant capital reserves are accumulated during good 

times, and then drawn upon to absorb the losses during downturns. 

While private MI and FHA are similar in that they enable borrowers to buy a home with less than a 20 percent downpayment, 

there are some significant differences that Congress should consider. 

First, private MI places private capital at risk in a first-loss position after the borrower’s equity. FHA relies on Federal funding, so 

that taxpayers currently are on the hook for over $1 trillion in 

mortgages. 

Second, private MI covers 25 to 35 percent of the loan amount, 

whereas FHA insures 100 percent of the loan amount, meaning the 

lender lacks any meaningful risk of loss. 

Third, private MI companies adjust premiums depending on the 

underlying loan characteristics. FHA premiums, on the other hand, 

do not reflect the true overall risk of the loans that FHA insures. 

Fourth, loans insured by FHA and guaranteed by Ginnie Mae are 

16 

priced more favorably in the market than conventional loans guaranteed by Fannie and Freddie and insured by private MI. 

Keeping these differences in mind, I would like to offer five recommendations. 

First, authorize risk-sharing between FHA and private mortgage 

insurers. The private mortgage insurer will conduct an independent underwriting, and take a first-loss position ahead of the 

taxpayer. 

Second, alter FHA borrower eligibility standards to refocus FHA 

on serving lower- and moderate-income borrowers who need their 

help, as proposed in the Administration’s February 2011 White 

Paper on housing finance reform. 

Third, consider reducing FHA’s guarantee below its current 100 

percent level, much like the VA mortgage program. A lower level 

of insurance coverage results in better underwriting and loan performance, which reduces both the probability of default and the severity of loss. 

Fourth, authorize FHA to adjust its premiums to levels that reflect the true risk of the loans that it insures. 

And fifth, avoid government actions that unintentionally steer 

borrowers to FHA, such as GSE guarantee fees and loan level price 

adjustments that are not actuarially based. 

The result is to make privately insured loans purchased by the 

GSEs more expensive than FHA-insured loans, thereby steering 

borrowers to FHA loans. Finally, I would like to say that unless the 

QRM and Basel III rules recognize private MI as a risk mitigant, 

low- downpayment borrowers will find it much harder to obtain a 

mortgage. 

Thank you, and I will be glad to answer any questions. 

[The prepared statement of Ms. Bazemore can be found on page 

46 of the appendix.] 

Chairman NEUGEBAUER. I thank the gentlewoman. And now, 

each Member will be recognized for 5 minutes for questions. 

I will begin by recognizing myself for the first question. Mr. 

Shapo, according to the NAIC Model Act, and I am going to read 

from that, ‘‘In the event that any mortgage insurer has an outstanding total liability exceeding 25 times its capital, surplus and 

contingency reserve, it shall cease operating until it can build sufficient reserves.’’ Why do you believe that State regulators put that 

in place? 

Mr. SHAPO. It is part of the risk. The risk to capital ratio is a 

pillar of the system. There are minimum capital requirements in 

the low seven figures, but for a larger company, that is not the 

most important requirement. The most important requirement, as 

the company grows and as its exposure changes, the capital has to 

change and increase as the risk increases. So the baseline requirement is risk to capital. 

The requirements in different lines of insurance all follow that, 

in one form or fashion, the risk to capital ratio. And so that is the 

baseline requirement. And then the most important remedy, the 

most important follow-up to that is that if you don’t meet that 

ratio, you can’t continue to write business. It is essential that a 

company that is not able to support its level of exposure with real 

money in hand cannot continue to write more business and, potenVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
17 

tially, increase and take basically an impairment and turn it into 

an— 

Chairman NEUGEBAUER. So to if I am following you here then, 

if FHA were an insurance company in Illinois, where you were a 

former insurance commissioner, and they had a negative net worth 

and they were writing 52 percent of the business, would they be 

allowed to continue to do that? 

Mr. SHAPO. No. The basic purpose of the regulation is to keep, 

is to try to cabin the risk. You need to cabin the risk because you 

need to protect the current policyholders, you want—you need to— 

Chairman NEUGEBAUER. My time is limited. I intended for that 

to be a yes-or-no question. 

Mr. SHAPO. I am sorry. 

Chairman NEUGEBAUER. So would they be allowed to continue to 

operate in Illinois if they had a negative net worth and they were 

increasing the amount of business that they were getting? 

Mr. SHAPO. No, the purpose would be to avoid the negative net 

worth. And so the answer is they would not be allowed to continue. 

Chairman NEUGEBAUER. So I want to get consensus here because 

I think an important piece of this hearing is to establish what FHA 

is. And so, Mr. Bjurstrom, is FHA a mortgage insurance entity? 

Mr. BJURSTROM. I believe it is, yes. 

Chairman NEUGEBAUER. Yes. And so is it being run, and is the 

oversight consistent with other mortgage insurance companies in 

this country? 

Mr. BJURSTROM. I think over the last 20 years, there have been 

several attempts to perform actuarial credibility as well as capital 

modeling. But due to the single-premium-fits-all type of structure, 

and the lack of actual reserving for losses, there is a lot of confusion with respect to how much the capital ratio or even just the 

capital account has in order to pay losses. 

So if you look over the last 20 years, they have lowered their premiums. I think they began about 380 basis points about 20 years 

ago. They reduced them down, thinking that they had enough 

money after the last crisis. But we went into this next crisis in 

such a manner where now they are increasing premiums again. 

And it is that kind of fluctuation and lack of temporal diversification that creates a lot of confusion. Therefore, the standards aren’t 

set and regulated enough in order for them to maintain a high 

enough water level to meet their expected claim liabilities. 

Chairman NEUGEBAUER. And my final question—and I have 

asked this a couple of times in previous hearings. One of the concerns I have is, almost that FHA manages their fund based on cash 

flow. In other words, as long as they have enough cash flow coming 

in to cover the losses for this year, they kind of think they deem 

themselves sufficiently capitalized. And if you run business on that 

model, then you are not ready for the big hit down the road. 

But the question I would have today is, I wonder what the numbers would look like. The fund is now underwater to the tune of 

about, I think, 1.7 percent or something like that. If they didn’t 

have the current levels of business of the market that they have, 

if they had a more traditional level, would that number—you have 

done a lot of analysis—be much lower? In other words, their capital 

18 

would be actually more negative if they didn’t have the cash flow 

day after day from the fact that they are dominating the market? 

Mr. BJURSTROM. Yes, they operate on a cash basis, and they have 

operated in that manner until they actually—until they were held 

to hold a—to perform the capital ratio test. But the capital ratio 

test is just a number of financial strength. They still operate on a 

cash basis. So at the end of the day, there are roughly 750,000-plus 

serious delinquent borrowers right now. So that if they were to 

have to reserve immediately for those losses, and pull that cash 

into a reserve and then recalculate their capital ratio, you are correct that capital ratio, or financial ability to serve future borrowers, 

is much less. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now the ranking member, Mr. Capuano, is recognized for 5 

minutes. 

Mr. CAPUANO. Thank you, Mr. Chairman. And again, I thank the 

witnesses for your testimony. Thank you for being here today. 

Mr. Bjurstrom, do you think the FHA should be shut down because it is bankrupt? 

Mr. BJURSTROM. I do not. 

Mr. CAPUANO. Mr. Shapo, do you think the FHA should be shut 

down? 

Mr. SHAPO. No, sir. 

Mr. CAPUANO. Mr. Chappelle? 

Mr. CHAPPELLE. No, sir. 

Mr. CAPUANO. Mr. Stelmach? 

Mr. STELMACH. No, sir. 

Mr. CAPUANO. Ms. Bazemore? 

Ms. BAZEMORE. No. 

Mr. CAPUANO. Good. We agree. Thanks for coming. 

[laughter]. 

But we all agree that the FHA has some current issues. We all 

agree with that, no doubt, no debate. Mr. Bjurstrom, as I understand it, the FHA now has approximately $30 billion, give or take, 

in reserves. Do you believe that they will exceed those reserves in 

this year? Do you think they will dip beyond that, into taxpayer 

funds, to meet their requirements this coming fiscal year? 

Mr. BJURSTROM. I think it will be close. 

Mr. CAPUANO. Do you think they are going to need taxpayer 

funds this year? 

Mr. BJURSTROM. No. 

Mr. CAPUANO. Mr. Shapo, do you think they are going to need 

taxpayer funds this year? 

Mr. SHAPO. Not to my knowledge. 

Mr. CAPUANO. Mr. Chappelle? 

Mr. CHAPPELLE. No, sir. 

Mr. CAPUANO. Mr. Stelmach? 

Mr. STELMACH. Not to my knowledge. 

Mr. CAPUANO. Ms. Bazemore? 

Ms. BAZEMORE. I don’t have a basis to make that assumption. 

Mr. CAPUANO. Fair enough. So of those of you who have an opinion agree they are not going to have to access taxpayer funds. Yet 

the law requires them to access that because the law, in my opinion, is stupid. Mr. Bjurstrom, do you think that law should conVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
19 

tinue? Do you think we should keep a stupid law, or do you think 

we should change a stupid law? 

Mr. BJURSTROM. I don’t have enough of a legal background to answer that question. I think that the— 

Mr. CAPUANO. You learned from Ms. Bazemore, didn’t you? 

Mr. BJURSTROM. No, I think at the end of the day, the fund is 

the way—the accounting of the FHA is such that it relies on this 

water balance between the number of claims that they have to 

pay— 

Mr. CAPUANO. No, I understand. They—I apologize, but my time 

is short. 

Mr. BJURSTROM. Sure. 

Mr. CAPUANO. I am not going to go through this because I think 

I just made the point that none of us think they are going to have 

to dip into taxpayer funds this year. I can’t imagine that anyone 

would defend a stupid law, and therefore we should change a stupid law. And therefore, I invite my colleagues again to sign on to 

H.R. 1028, which will stop and prevent a stupid law from occurring 

and therefore exposing taxpayers to paying for something they 

don’t have to pay for. 

But we will see who actually signs on to that. I guess—what we 

are talking today is—I guess Ms. Bazemore, you have been in this 

business for awhile, correct? 

Ms. BAZEMORE. Yes. 

Mr. CAPUANO. Okay. Are all of the companies that were in business in 2007, all the PMI companies, still in business today and 

writing insurance today? 

Ms. BAZEMORE. No. There were eight companies prior to the crisis, and three of them are no longer writing business. They are 

managing the portfolios that— 

Mr. CAPUANO. So 3 out of 8 is what, 40 percent? 

Ms. BAZEMORE. Five. So five are left. And three new entrants 

have come into the market. 

Mr. CAPUANO. So approximately 40 percent of the companies 

have disappeared because of the crisis, and yet I am supposed to 

say when 40 percent of the companies have disappeared those 

losses have been probably been shifted over to government responsibility. And I understand that, I am not blaming them. Everybody 

lost money in 2008, a lot of people made bad assumptions and bad 

bets. But at least 40 percent of the PMI industry somehow made 

those same bets. 

And yet, I am supposed to say everything was fine, we should 

just ignore that? The States can take care of it? 

Ms. BAZEMORE. Actually— 

Mr. CAPUANO. I think it speaks for itself, when you lose 40 percent of the companies doing the business, that there is an inherent 

problem that everybody has to share. I have no doubt that your 

business model has shifted today from what it was in 2007 and 

2008. 

Ms. BAZEMORE. I would just point that the loss reserves that 

were being discussed earlier, each of the companies that are—even 

though they are no longer allowed to write business, they had significant loss reserves to pay claims. So—okay. 

20 

Mr. CAPUANO. I understand that. And so is the FHA, obviously. 

So therefore, I understand that part of the reserve has worked. But 

they are out of business, so there is some problem. I guess I am 

trying to make the point that private insurance is a good thing. 

And I think that there is certainly a role for it, and I actually agree 

that it is upside-down now. 

But I am looking at a chart that indicates in 2002, private insurance had 70 percent of the market and the FHA had 30 percent. 

Is that the right number? And in 2007, private insurance had 82 

percent of the market and FHA had 18 percent. The question is, 

what is the right balance? And I guess we will find out as the market goes on. Today—in the last 2 years, private insurance had actually increased its share of the market by 21⁄2 times. In 2008, did 

the FHA crowd you out? 

Ms. BAZEMORE. I would say that the FHA actually didn’t take actions to crowd us out. I think there were other government policies, 

such as the GSE increases in their fees, their LLPAs as well as— 

Mr. CAPUANO. You do agree that we had to do something in 2008 

and 2009? 

Ms. BAZEMORE. Those two things happened in the 2008–2009 

timeframe, and we saw a precipitous decline. 

Mr. CAPUANO. Bingo. 

Ms. BAZEMORE. And we have done a number of things as private 

MIs to get that business back. 

Mr. CAPUANO. And I think that is fine. So has the FHA, and 

right now we are still in the process of trying to find that right balance, which I agree with. That is where I agree with the whole 

premise of these hearings, that we have to find the right balance, 

exactly where it is. But there is no given that somehow the FHA 

or government involvement in certain aspects of the market is a 

good thing. The question is, where is the line, let’s fine tune it a 

little bit. 

And by the way, before my time runs out, I just need to make the same point I always make, that when you talk about $200,000 

limits, you are basically taking about a third of the country and 

saying we are not going to do any loans in your district. Because 

in Massachusetts last year, they had 83,000 FHA loans. Texas had 

815,000. That is 9.7 times more FHA loans than Massachusetts 

did. 

And if you limited it to $200,000, because the market in Massachusetts is so much more expensive, it would have been 24 times 

more loans. Because Texas is a relatively modest-priced State, and 

Massachusetts is not. And we are not alone. California, New York, 

Philadelphia. To understand the market, you have to understand 

there are regional differences in both real estate prices and wages. 

And I know you know that, but I say that because my time is running out. 

Chairman NEUGEBAUER. I thank the gentleman. And that is one 

reason a lot of people are moving to Texas. 

[laughter]. 

Mr. CAPUANO. Mr. Chairman, then why haven’t our real estate 

prices gone down? 

Chairman NEUGEBAUER. I now recognize the vice chairman of 

the subcommittee, Mr. Luetkemeyer, for 5 minutes. 

21 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. The gentleman 

next to me from California is wanting all of those folks to come out 

to California, as well, so—thank you all for being here this morning. And to follow up a little bit on the ranking member’s line of 

questioning there with regards to the size of the loans, the other 

day when we had the FHA individual in here talking about their 

model of how they were doing things, over the last couple of years 

they indicated that they have actually expanded the larger part of 

their—or the portfolio part of their business to making larger 

loans. 

And they did it, they said, to—obviously, because of the increasing amount of premium they can get to shore up their bottom line. 

It would be counter to what I have heard this morning from, I 

think, two or three of you with regard to the data here that you 

are quoting this morning indicates that FHA actually has not been 

making larger loans in increasing numbers. 

Can you give me some information? Mr. Chappelle, I know you 

were—you had a lot of information in your testimony. 

Mr. CHAPPELLE. Thank you, Congressman. The Congress gave 

FHA the authority, in 2008, to expand its mortgage limits to help 

ensure there was liquidity in the entire mortgage market. Because 

private businesses made the decision, the smart decision, to pull 

back. But Congress wanted to make sure that there was money 

available so that the market would not collapse as far—worse than 

it actually did. And so, they gave the authority to the FHA to raise 

their limits. 

FHA raised the limits. But the point is, they have done very few 

loans over $400,000; only 9 percent of their business is over 

$400,000. 

Mr. LUETKEMEYER. Is it increasing, though? That was the point 

they made the other day. 

Mr. CHAPPELLE. No, it is going the other way. 

Mr. LUETKEMEYER. That they are increasing those numbers, and 

they are looking at the last couple of years of loans they have 

made. And they keep coming back and saying their portfolio has 

improved, our past dues are less, our loss ratios are less, and are 

pointing to that portion of their business as improving their overall 

picture. 

Mr. CHAPPELLE. But the key issue is, structurally, in the FHA 

program, FHA charges every borrower the same premium. By 

charging every borrower the same premium, which some of my colleagues here aren’t too crazy about—but by charging everybody the 

same premium, that means people with lower risk are paying 

more. It has been a fundamental part of every audit that I can remember that higher-balance loans perform better than lower-balance loans. 

So by definition, if you are charging those borrowers here—if 

your premium is here on those borrowers, they are overpaying 

their premium. Consequently, they will go to the private MI because it is a better deal, unless they have no other choice. So the— 

Mr. LUETKEMEYER. My comeback to that would be—I am not trying to argue with you here, but I—it is—I am getting some different information from those other folks who testified earlier. And 

having been in the financial services industry for 35 years, I can 

22 

tell you that, yes, the bigger loans, they may make more money on. 

But you also have more exposure to loss because there is a bigger 

loan there. 

And if you don’t have better criteria on those larger loans, and 

you don’t do a better job of underwriting those loans, your exposure 

is greater. On the front end, you may make a few more dollars, but 

on the back end, your exposure is huge because it is a larger loan. 

If it goes south, you have a bigger problem. So I am not sure that 

they are actually solving the problem; I think they are probably 

taking on more risk in the long term, if that is the case. 

But if you are saying they are not doing that, why, I appreciate 

your testimony this morning. From the standpoint of—Ms. 

Bazemore, you had some interesting comments here with regard to 

a number of suggestions on how to price risk and how FHA could 

improve their book of business. Could you go back over those? I 

thought some of those were pretty salient. And I guess my initial 

question would be, as you go through them, has FHA thought 

about doing some of these things? 

Are you talking with them, do they have an ombudsman program, for instance, that you would be able to communicate with 

them on to be able to have some interaction and then have them 

take up some of these suggestions? 

Ms. BAZEMORE. I would say that clearly they have made some 

changes in terms of increasing their pricing. I think part of it is 

just to understand what their risk is and making sure the pricing 

is commensurate with the risk that they are taking on. But with 

respect to risk-sharing, I think the concept there—which is something that we have had some engaged conversation about—is with 

the idea of being able to bring some of what we have built in the 

private mortgage insurance industry to bear in a way that would 

be really a partnership. 

And we have built a lot in terms of risk analytics, we have built 

a lot in terms of our ability to analyze portfolios, even on a weekly 

basis, what is being submitted. And to communicate back with the 

lenders who are originating those loans to help them understand 

what is going on. 

Mr. LUETKEMEYER. Thank you. My time is about ready to run 

out. I want to make one quick point. There are certain tenets of 

sound lending that are inescapable regardless of whether it is a 

large loan or a small loan. And if you get away from those sound 

tenets of lending, you are going to lose. It seems to me that we 

have continually done that with some of our GSEs. We continually—we know what we need to be doing, and yet we fall away 

from that. And then when—as soon as we do, we wind up in trouble. 

Mr. Chairman, I yield back. Thank you. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now the gentlewoman from New York, Ms. Velazquez, is recognized for 5 minutes. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. Mr. Bjurstrom, following the housing bubble-burst, three of the eight largest private 

mortgage insurance companies went out of business. Those that 

survived suffered significant losses. Could you please explain the 

23 

reasons why many of the major private mortgage insurers suffered 

such losses during that economic recession? 

Mr. BJURSTROM. I would be happy to. I think during that period 

of time there were a lot of new types of products that were brought 

to the market. And from an actuarial pricing standpoint, there was 

not a lot of information to judge the way they price their products. 

And therefore— 

Ms. VELAZQUEZ. It didn’t have anything to do with the fact that 

your industry relaxed the standards? 

Mr. BJURSTROM. Yes. 

Ms. VELAZQUEZ. Borrower standard and underwriting requirements, pressure by the lenders? 

Mr. BJURSTROM. That is correct. 

Ms. VELAZQUEZ. Okay. So why were some of these companies not 

able to pay these claims without going bankrupt? 

Mr. BJURSTROM. Actually, they have been put into receivership 

and they have been under the department of insurance of their 

State of domicile. They are restricted from writing new business, 

but they are still paying claims and setting up reserves for those 

losses. 

Ms. VELAZQUEZ. But still, can you explain to me why they were 

not able to pay the claims without going bankrupt? 

Mr. BJURSTROM. Without going bankrupt? 

Ms. VELAZQUEZ. Yes. 

Mr. BJURSTROM. I think Mr. Shapo had indicated that they 

reached their statutory risk to capital. 

Ms. VELAZQUEZ. Okay. Mr. Chappelle, Fannie Mae noted in its 

most recent report to the SEC that many of its private mortgage 

insurance counterparties were struggling to meet their current 

State regulatory capital reserve requirements. Based on your experience as a former insurance commissioner, would you be concerned 

about this company’s current financial conditions? What about 

their obligations to fulfill future claims? Why or why not? 

Mr. SHAPO. Why what? I am sorry, ma’am. 

Ms. VELAZQUEZ. Why, or why not? 

Mr. SHAPO. No. The purpose of the regulation is to keep the companies from going bankrupt. They are not bankrupt. The purpose 

of the regulation is to make sure that the risk to capital ratios are 

in line. 

Ms. VELAZQUEZ. Would you please comment on the Fannie Mae 

recent report to the SEC? 

Mr. SHAPO. I think I am commenting on it. What the States are 

doing is, they are preventing the companies from expanding their 

potential exposure at a time when their financial condition cannot 

support it. The whole purpose of that is to keep the companies from 

actually going bankrupt. They are not bankrupt. That is the purpose of requiring a minimum ratio. What has happened in some 

cases is the companies have been put in runoff, prevented from 

continuing to write new business. 

They are put in runoff for the whole purpose of protecting the 

common fund and protecting the ability to pay clients. 

Ms. VELAZQUEZ. Mr. Chappelle, recent reports from Fannie Mae 

on the Bank for International Settlements indicate that private 

mortgage insurers are still in a wait position and are susceptible 

24 

to significant risk. If private mortgage insurers were to obtain a 

larger share of the market as they claim they want, would they be 

in a good position to weather another economic downturn? Why or 

why not? 

Mr. CHAPPELLE. That is a good question, Congresswoman. And 

it is an uncertain thing. None of the MIs have the rating that 

Fannie and Freddie required before the housing crisis, which was 

a AA rating. The good news is that the ratings are improving. But 

they are still well below an A rating, and that is a problem. 

Ms. VELAZQUEZ. Thank you. Could you, Mr. Chappelle, discuss 

the importance of FHA’s countercyclical role during periods of economic recession, when private mortgage insurers are absent from 

the market? How bad could the downturn have been if FHA was 

not present to keep the housing finance market afloat? 

Mr. CHAPPELLE. Sure. I worked at FHA from 1975 to 1986, so 

I saw what happened in the oil patch States in 1982 to 1986. When 

we were at FHA, we continued to stay in those markets after the 

private sector made the right business decision to pull back. I remember a statistic that we had from back then, that 19 percent of 

FHA’s business came from the 6 oil patch States, but 50 percent 

of their claims came from those 6 States. 

Now, it would have been easy for FHA at the time to pull out 

of those six States. But if they had done that, it would have been 

devastating for Texas, Oklahoma, Colorado, Louisiana, Alaska, and 

another State. And so the value that played there is—what they 

are doing now is the same thing—at the national level, what it did 

in 2007 and 2008. 

Ms. VELAZQUEZ. And can we talk about FHA solvency? Do you 

think that the agency has taken steps that will address its underlying solvency issue? 

Mr. CHAPPELLE. Absolutely, Congresswoman. Their MIP for the 

period from the 1930s to the 1980s was roughly 3.5 percent, what 

they were collecting. They are now collecting 9 points today; 9 percent is their premium, effectively. That is going to allow them to 

shore up the fund immediately and build reserves so that hopefully, they will be above the 20 percent capital ratio much sooner 

than the actuary audit anticipated. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

Mr. MILLER [presiding]. Thank you. 

Mr. Chappelle, you made a good point. Mr. Luetkemeyer made 

a statement, and he was correct, that when the larger loans do default, it is a large amount of money. But if you look at the reality, 

only 1.6 percent of FHA loans were made above $500,000; only 3.5 

percent were made above $400,000; and only 9 percent were made 

above that range. 

Mr. CHAPPELLE. Correct. 

Mr. MILLER. But if you look at the default rate, above $400,000 

the default rate was about 33 percent lower. 

Mr. CHAPPELLE. Correct. 

Mr. MILLER. As you go up, they even went down. So the FHA 

was right to a point. The loans they made that were the safest and 

best-performing are in the higher-cost areas, but they are not making that many of them. 

Mr. CHAPPELLE. Exactly. 

25 

Mr. MILLER. Because of the cost. 

Mr. Bjurstrom, you made a statement that their rates were much 

higher 20 years ago than today, but CDs were 6 and 7 percent 20 

years ago, and they are less than 1 percent today. So everything 

has come down dramatically in that time. 

But I am kind of curious how you perceive FHA’s performance 

compared to the private sector in four ways: first, adequate internal controls and technology systems in place—how do they currently compare to the private sector; second, appropriate accounting standards; third, real-time risk management; and fourth, their 

capital ratios. Can you address those? 

Mr. BJURSTROM. Yes. I think there is really—I can address it 

with two points. One is, is in any insurance company with respect 

to enterprise risk management, having a lot of change in any given 

year or over a very short period of time is never good. A few years 

ago, the FHA had a very low share of the market. And then as they 

came in, in the latter part of 2008 and 2009, they went from 

400,000 policies to over a million policies. 

That puts a lot of stress on an organization. So at the end of the 

day, working through that additional business puts a lot of stress— 

Mr. MILLER. But that doesn’t address the questions. Are their internal controls and technology systems, compared to the private 

sector, adequate? Are their appropriate accounting standards compared to the private sector, adequate? Real-time management? Are 

they responding in an adequate timeframe in their capital ratios? 

Mr. BJURSTROM. Yes, I think their accounting needs to be 

changed to recognize the more certainty—certain liabilities that 

one can— 

Mr. MILLER. So we need to provide better assets for them to 

make sure they can do their job. 

Mr. BJURSTROM. That is correct. 

Mr. MILLER. Okay. 

Mr. BJURSTROM. That is correct. 

Mr. MILLER. And how about their appropriate accounting standards and real-time management? Are they responding adequately 

today to the market changes? They weren’t a year or 2 ago, but are 

they today? Have they upgraded their standards on risk management? 

Mr. BJURSTROM. I believe they are working on it, to achieve a 

certain level of standards. But according to the GAO, I think there 

are a lot of improvements to be made. 

Mr. MILLER. Okay. For everybody on the panel, do you think 

FHA operational technology and the cutting tools it needs are 

available to them today to minimize taxpayer risk? Ms. Bazemore? 

Ms. BAZEMORE. I believe they need additional tools. 

Mr. MILLER. Okay. 

Mr. STELMACH. I don’t have the ability to judge the FHA’s internal— 

Mr. MILLER. I couldn’t hear you. 

Mr. STELMACH. I don’t have the ability to judge FHA’s operations. 

Mr. MILLER. Okay. Mr. Chappelle? 

Mr. CHAPPELLE. They can always improve, but they are doing it 

at an acceptable level right now, I believe. 

26 

Mr. MILLER. Okay. Mr. Shapo? 

Mr. SHAPO. I don’t have the factual basis to be able to have a 

full answer to the question. But clearly, they are not—they do not 

have the same kind of enterprise risk management practices and 

self-assessment tools that regulated carriers do. 

Mr. MILLER. Okay. 

Mr. BJURSTROM. I agree with Mr. Shapo’s point that the regulation is such a—in such a manner that those—that transparency is 

not there. 

Mr. MILLER. Okay. Yes, sir— 

Mr. CHAPPELLE. The legislation that this committee passed last 

year would go a long way to helping along that issue, though, also. 

Mr. MILLER. Okay. 

Ms. Bazemore, you commented on the lack of involvement of the 

private sector. And what I am seeing out there from people wanting loans is, the private sector is just not moving back in adequately. And the only option out there, in many cases, is FHA. 

That is the reality I see builders are going through when they are 

building homes and selling them. 

And you say FHA premiums are harming the private sector return to the marketplace. They have increased them 5 times. So is 

it the premium problem, or is it the QM, QRM and Basel? All the 

private sector issues that we are trying to deal with, and we have 

made more difficult, are those keeping the private sector out more 

than just more the cost differential? 

Ms. BAZEMORE. I think the first thing I would say is, you have 

to think of the private sector as sort of two parts. So when you 

think of private MI, we are really part of the GSEs. And so we insure GSEs, essentially bring private capital to that. That has always been there, we have never left the market. However, I think 

there was a perception with lenders in terms of going to FHA because that is where the decision is made about whether to use FHA 

or to use private mortgage insurance. 

And so, for instance, over the last year we have trained 15,000 

loan officers on the fact that many times it is better for the borrower to have a mortgage-insured loan than— 

Mr. MILLER. No borrower with common sense would use FHA 

over private sector mortgage insurance, because of cost alone, if it 

were available. So, if you look at the cost differential between the 

two, it is huge. So if you are going to get an FHA loan, your fees 

and costs are much greater than if you went to a PMI in a private 

sector. So there has to be more keeping the private sector out than 

we are addressing. 

Ms. BAZEMORE. You have to really look at the FHA and Ginnie 

Mae execution together, and that is the real comparison with MI 

and the GSEs. And it is still more favorable to have FHA and GSE, 

with a Ginnie Mae guarantee in terms of the loan in the marketplace. 

Mr. MILLER. My time has expired. I would like to go into that 

more. 

But, Mr. Cleaver, you are recognized for 5 minutes. 

Mr. CLEAVER. Thank you, Mr. Chairman. This is one of the committees, I think, where there is an attempt to avoid having factfree debates. So I would like to know whether any of you disagree 

27 

with the report from Inside Mortgage Finance which says the private mortgage insurance—insurers were able to write $175 billion 

in 2012. Does everyone agree with that? 

Ms. BAZEMORE. Yes. 

Mr. CLEAVER. So how do you juxtapose that with the subject of 

this hearing? FHA is crowding out the PMIs? Yes, Ms. Bazemore? 

Ms. BAZEMORE. Congressman Cleaver, I think that a lot of the 

crowding out took place in sort of the 2009—late 2008–2009 timeframe. And since then, there have been efforts, I think, both by the 

FHA—because even Secretary Donovan stated that he felt they had 

too large of a share of the market. So FHA has taken steps, 

through premium increases. The private industry, private MI, we 

have also taken a number of steps to try to increase the share. 

And I think that it is slowly working, and that is what you are 

seeing in Inside Mortgage Finance, that sort of has continued. The 

difficulty is that things like increased GSE fees, can have the effect 

of changing that. And so other benefits, when you see what is happening with QRM or Basel III—where FHA may get benefits—all 

of those things could actually reverse the benefits that we have 

been seeing. And that is one of the points of my testimony. 

Mr. CLEAVER. Mr. Chappelle? 

Mr. CHAPPELLE. Yes, I agree with your point, Congressman. The 

problems from the MI industry are not FHA-related. As Ms. 

Bazemore pointed out, it was QRM, it was loan level price adjustments from the GSEs. But also equally important, when you pull 

out of a market in 2008 and 2009, the mortgage business is a relationship business. If you pull out, you just can’t flick a switch and 

come back in. It is going to take time. 

And as Ms. Bazemore said, they are training loan officers about 

the benefits of private mortgage insurance. But I know a lot of 

lenders, going back to the oil patch days in the 1980s, who still 

have trouble doing business with MIs because they felt they had 

policies rescinded without having the coverage of insurance. So 

there are a lot of other factors that have nothing to do with FHA. 

And, hopefully, the LLPAs are a critical—the GSE LLPAs are a 

critical part of that. And I know we agree that needs to be looked 

at. But it is far more of these other issues than it is the FHA issue. 

Mr. CLEAVER. Yes, and if you listen to all of you, each of you has, 

at times, made statements that would suggest that you all agree 

that FHA is not the problem. But—and Ms. Bazemore, to go back 

to what you said, in 2007, the housing market collapsed. It collapsed. And so, these private companies did what they do at a time 

when things go bad. They pulled back. They stopped lending. Do 

you agree? 

Ms. BAZEMORE. I don’t think we stopped lending. I think, in fact, 

we changed our underwriting guidelines because we saw so many 

borrowers were being put into homes that they couldn’t afford and 

we thought the loans should be affordable and sustainable. So 

many of the changes are in alignment with Dodd-Frank and QM. 

Mr. CLEAVER. Yes. We probably have a slight disagreement. Because I think they stopped lending, and we actually had committee 

hearings where we dealt with that with banks. They stopped. And 

it is true that some of the exotic products had created problems, 

28 

and that was pushed aside as it never should have been brought 

to the surface. 

But, there was some robust and reckless lending. Does anybody 

disagree with that? Okay. And so those companies—you can—I 

don’t know how you want to—if you are going to say they came— 

that they had more intelligent lending. But the fact is, the percentage of the mortgage insurance written fell back, right? 

Ms. BAZEMORE. Yes. 

Mr. CLEAVER. So that, in and of itself, I think, would suggest the 

need to maintain FHA. I think we need to tweak a lot of things, 

including Dodd-Frank. But I don’t think we can attribute everything bad to FHA. I am out of time. 

Thank you, Mr. Chairman. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now the gentleman, Mr. Westmoreland, is recognized for 5 

minutes. 

Mr. WESTMORELAND. Thank you, Mr. Chairman. 

Mr. Chappelle, I was noticing in your resume, or biography, that 

when you were with FHA you actually maybe had the responsibility for the development of the adjustable rate mortgage program. 

Is that true? 

Mr. CHAPPELLE. Yes, I worked on the implementation of it. Yes. 

Mr. WESTMORELAND. Okay. Originally, did FHA make that 

buyer, as part of the loan guarantee, qualify for the adjustable 

rate, or what the rate could eventually go to? 

Mr. CHAPPELLE. We surely didn’t use what it could eventually go 

to, Congressman. It was 30 years ago, so I am going to have to— 

I would have to go back and read the mortgagee letter. 

Mr. WESTMORELAND. Okay. I was just thinking that you might 

remember it because it was a pretty important part, and you were 

there. 

Mr. CHAPPELLE. The only thing I would say is adjustable rate 

mortgages are probably 1 percent of FHA’s business today, a very 

small portion of it. 

Mr. WESTMORELAND. Okay. But if you were making somebody 

qualify for what the rate could have been versus what the adjustment rate was, that would have been a smarter move, don’t you 

think? 

Mr. CHAPPELLE. Absolutely. 

Mr. WESTMORELAND. Mr. Bjurstrom, you evidently counsel, I 

guess, businesses on how to compete against FHA. What are some 

of your recommendations that you give them to be able to compete, 

and what level can these private industries—do they play on the 

same level, the same guidelines, as what FHA does? 

Mr. BJURSTROM. I think the MI companies try to price their 

products so that they achieve the amount of loss-paying ability and 

capital accretiveness that is necessary to remain a viable company. 

I think it is difficult to compete with one price that the FHA has 

with their—because it creates a sort of adverse selection between 

the products and programs that are being targeted for a capital accretive and solvent—on a solvent basis versus an all-in. 

And from time to time it works out, but with one price for all 

borrowers over all times the underlying mix of the underwriting 

characteristics of the borrowers changes. So in some years, when 

29 

the economy is good, you may have additional premium because 

losses are low. But in times that it is bad, you have more losses, 

and therefore you are going to need more premium to cover those. 

So to basically—the way I advise my clients is just to make sure 

that they understand the risks and exposures associated with originating a borrower, and then price it effectively. 

Mr. WESTMORELAND. So, basically, are you saying that FHA may 

have some different guidelines as far as the quality of the credit? 

Mr. BJURSTROM. Yes. 

Mr. WESTMORELAND. Okay. Now, let me ask you this. And we 

agree—at least I agree coming from a building background, real estate background—that we need FHA. And FHA was started with 

great intentions as far as first-time home buyers, and low- to moderate-income. Do any of you on the panel see that FHA has gotten 

out of that original intent and gotten into some places where 

maybe the private sector, private mortgage insurance, has more expertise in that area of lending than what FHA was really created 

to do? 

Ms. Bazemore? 

Ms. BAZEMORE. I would just say that I think that while it is continuing to serve some of its historical mission, I think just because 

of some of these policies we have talked about, it has broadened 

out further than that. And a significant amount of loans that they 

are doing fall within what the private sector could be doing. And 

the capacity is there, certainly, to do it. 

A comment came up earlier, just in the last 2 weeks, that two 

of our companies have raised $1.8 billion in capital. So the capacity 

is actually growing, and I think the model is working as it was intended to. 

Mr. WESTMORELAND. Mr. Chappelle? 

Mr. CHAPPELLE. Congressman, it is important to remember that 

the loans that the FHA is getting, these higher credit score borrower loans, are helping the solvency of the fund. But they charge 

a premium structure that discourages those borrowers from coming 

into the program unless they have no other option. So they are 

not—those borrowers are not getting a good deal because FHA 

charges that borrower the same price they charge the borrower 

with credit deficiencies. 

So if they are coming in, they are coming in because they have 

no other option, because it wouldn’t be the right business decision. 

But by the fact they are coming in, they are helping to strengthen 

the portfolio and the solvency of the fund. 

Mr. WESTMORELAND. I am out of time. I will yield back. But I 

can appreciate that fact that they wouldn’t be coming to FHA if 

they could go somewhere else. But to me, that is also a telltale sign 

of the quality of some of the loans that actually may be coming 

through. 

So with that, I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. Mr. Sherman is 

recognized for 5 minutes. 

Mr. SHERMAN. Ms. Bazemore, I was interested in your testimony 

on Basel III. I agree with you that obviously mortgage insurance 

is a risk mitigant. What can the Administration and/or this committee do to make sure that in calculating bank capital, the obviVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
30 

ous risk mitigant effect of insurance, mortgage insurance, is taken 

into account? 

Ms. BAZEMORE. I think the easiest thing to do would be to stay 

with what has been the current practice through Basel I of recognizing private mortgage insurance as a risk mitigant rather than 

the proposal that would not give any weight to it, but would give 

full weight to government loans. 

Mr. SHERMAN. I would hope that this committee would join with 

you and others in the industry in making sure those who are 

crafting Basel III get that issue right. We all agree that we want 

private sector capital to be part of mortgage insurance. And I understand the private mortgage industry has recently attracted new 

capital. How much have you attracted? 

Ms. BAZEMORE. Our company, about 2 weeks ago, raised a net 

$689 million. One of the other legacy mortgage insurer—insurance 

companies, in fact, just released today that they had netted, I 

think, about $1.1 billion. So just for those two companies, there 

was significant capital that came into the market. 

Mr. SHERMAN. Now, are there changes that can be made in the 

FHA to increase the role of the private sector and to attract more 

capital into mortgage insurance? 

Ms. BAZEMORE. I think the focus really is on moving FHA to 

more of its historical mission, understanding that may have 

changed over the last few years. And it is moving back, but looking 

at practices that really make sure that when private mortgage insurance is in the best interest of the borrower, it is being used. And 

that there aren’t other sorts of decisions that are made, or policies 

that are put in place, that it would encourage otherwise. 

Mr. SHERMAN. Now—and I don’t know which person to address 

this to, so I will kind of see who seems interested in answering it— 

I understand that under the proposed QRM rule, loans insured by 

FHA are automatically exempted from the risk retention requirements, while loans insured by private insurance are not necessarily 

exempted. 

Is this because meeting FHA standards somehow means that it 

is a wonderful, pristine loan? Or that the value of FHA insurance 

is so—that value means it is a Qualifying Mortgage, and why 

wouldn’t we also exempt from the risk retention private mortgage 

insurance? 

Always the same hands. I am used to that. 

Ms. BAZEMORE. I think, first of all, the reason why FHA is given 

full credit is because it is fully backed, 100 percent explicitly, by 

the Federal Government, and so the banking regulators are essentially looking at that. I think that with respect to—there has been 

a huge coalition that has come together of industry, trade groups, 

and consumer groups that are very concerned about the QRM rule, 

because we believe that it could actually reduce the availability of 

low-downpayment loans. 

And so, there has been a lot of focus on the fact that low- downpayment loans with MI should also be included in the QRM rule. 

Mr. SHERMAN. So the reason for the exemption is not that FHA 

has standards that are so good that if you meet those standards 

it must be a Qualifying Mortgage. It is simply that if the lender 

31 

has that insurance, they are pretty well-insured from loss. Mr. 

Stelmach, I see you nodding. 

Mr. STELMACH. I simply agree with Ms. Bazemore, that there is 

a 100 percent government guarantee on GMA securities, which are 

ultimately the destination for FHA loans. Those loans trade more— 

are more profitable to make than those in the mortgage origination 

market. And it makes more sense, perhaps, from a QRM definition. 

But it also will introduce distortions in market share between FHA 

and private capital, which may exacerbate the current situation. 

Mr. SHERMAN. My time has expired. 

Chairman NEUGEBAUER. Yes. Thanks to the gentleman. 

And now the gentleman, Mr. Stivers, is recognized for 5 minutes. 

Mr. STIVERS. Thank you, Mr. Chairman. I appreciate you holding 

this hearing. 

My first question is for Ms. Bazemore. Do you believe that FHA 

underprices the risk that they insure? Because we talked about 

how they have gained a lot of market share from private mortgage 

insurance. PMI premiums have gone up because of the risk experience, but FHA hasn’t gone up as much. Do you believe they underprice their risk? 

Ms. BAZEMORE. Without doing a true actuarial review, it is hard 

for me to say at this point whether or not they are— 

Mr. STIVERS. Let me ask it another way. Does private mortgage 

insurance charge an actuarially sound premium? 

Ms. BAZEMORE. Yes, we believe we do. 

Mr. STIVERS. Does FHA underprice PMI? 

Ms. BAZEMORE. I think, based on the comparison, we would think 

that it is somewhat underpriced because of the risk profile of the 

loans that they are insuring. 

Mr. STIVERS. I won’t ask you take the next logical step, but everybody can do that for themselves. If PMI is actuarially priced 

soundly, and FHA underprices PMI, everybody else can do the rest 

of the equation for themselves. 

One of the loss reserve accounts that are used by private mortgage insurance companies is the contingency reserve, where 50 percent of each premium collected from each given year’s book of business is required to be held in reserve for a period of about 10 years 

to pay claims that might arise out of a specific book of business in 

the event of some kind of severe problem like we experienced over 

the last few years. 

Which means private mortgage insurance can’t earn all their premiums through short-term distortions in the marketplace of low default rates. Do you know if FHA follows that same reserving procedure? 

Ms. BAZEMORE. That might be a better question for— 

Mr. STIVERS. Does anybody on the panel know if FHA uses that 

same procedure? 

Mr. BJURSTROM. They currently do not use that standard. 

Mr. STIVERS. And if FHA doesn’t have a contingency reserve, 

should it have one? I will go ahead and—we can go straight down 

the panel. Does everybody think that would be a good idea? 

Mr. BJURSTROM. I think it would be a good idea. 

Mr. SHAPO. It would be a sound way to manage risk in a way 

that they are not doing now. 

32 

Mr. CHAPPELLE. FHA does have $38 billion in reserve. 

Mr. STIVERS. And what did they have last year? 

Mr. CHAPPELLE. Thirty-three billion dollars, $32 billion. It has 

gone up. 

Mr. STIVERS. Okay. Still going down there. 

Mr. STELMACH. Yes, I believe that would be a sound practice, absolutely. 

Mr. STIVERS. Thank you. The other thing that Ms. Bazemore 

talked about that I think is an interesting idea is to have partnerships with FHA and private mortgage insurance companies. Does 

anybody else on the panel—she was the only one who really spoke 

in depth about that. Somebody else mentioned it a little bit. 

Mr. BJURSTROM. I have some—actually, there are examples of 

private-pubic partnerships now. A number of State housing finance 

agencies have mortgage insurance funds in which they actually reinsure 75 to 90 percent of the risk to the private MIs. 

Mr. STIVERS. And do you think that is a good idea? 

Mr. BJURSTROM. I do think— 

Mr. STIVERS. I guess I want to go straight down the line again 

and see if everybody thinks that is a good idea. Because it sounds 

like a great idea to me. 

Mr. SHAPO. In theory, it sounds like a great idea. I am not as 

familiar with the proposals as Ms. Bazemore and Mr. Bjurstrom. 

Mr. STIVERS. Sure. 

Mr. CHAPPELLE. I agree, Congressman. The Congress did give 

that legislation back in 1992, and the MI industry and FHA were 

both interested in doing it. But there are factors. The economic factors of pricing, counterparty risk, sharing of the risk, and never— 

nothing ever came of it back then. 

Mr. STELMACH. I would agree that is a good idea. But we also 

need a balance between public policy and expanding homeownership with private capital. And that sounds a lot like some of the 

issues we had when the GSEs were in existence with trying to balance those same issues. So yes, a good idea, but balance. 

Mr. STIVERS. Thanks. I think there are some ideas that we can 

pursue to have a more sound policy that charges actuarially sound 

rates, and still encourages homeownership. But when you encourage homeownership in a way that somebody can’t sustain it, that 

is not really encouraging responsible homeownership. So I think 

charging rates that are inappropriate or low isn’t fair to FHA or 

their long-term mission and their viability. 

So I think there are some simple reforms that we can enact, common sense reforms, that I think would make the program better. 

I really appreciate all of you coming today. I appreciate your 

thoughtful testimony and ideas. 

Thank you, Mr. Chairman. I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. 

And now the gentlewoman from Ohio, Mrs. Beatty, is recognized 

for 5 minutes. 

Mrs. BEATTY. Thank you, Mr. Chairman, and Mr. Ranking Member. 

Mr. Shapo, I believe you stated in your testimony that the FHA 

has expanded its business in a time when it is—I think it was impaired, insolvent and undercapitalized. With that said, what do you 

33 

make of the fact that since its peak in 2009, FHA’s market share 

has been steadily declining while the private mortgage insurance 

share has been increasing at roughly the same pace? 

Mr. SHAPO. I think that the more important question is what 

would—the way I look at it is, what would happen—what would 

the ratios be now if it were not for the distortions to the market. 

The fact that FHA has reserves doesn’t mean that it is not impaired and it doesn’t mean that it is not in a negative position. 

The fact that the FHA—that the loss history is improving doesn’t 

mean that it should have continued to write more policies after it 

went under its minimum ratio and after it went into a negative 

balance. By doing those things, by expanding beyond its position 

before, it has distorted the marketplace. And so the question would 

be, would the private companies have been able to take a larger 

market share if they had been able to get some more of that good 

business that FHA was able to get after the worst of the financial 

crisis. 

So I think that—my answer is, is that even though the private 

carriers have more market share, they do not necessarily have any 

market share that they could have gotten in the market share that 

could have properly supported their risk if there hadn’t been distortions in the market. 

Mrs. BEATTY. Mr. Shapo, with that said, maybe a better question, or response, would be if I put it this way. If you take, for example, the credit ratings, which I am sure we will all agree plays 

a key factor—so if you look at the world out here of the market 

share, and I have a credit rating that is on the high end. And if 

I then look at what the percentage cost for that loan would be, if 

I have a high rating and I am getting it for 4.3 percent, why would 

I then go to FHA, which is going to be a higher rating if my credit 

rating is a good rate? 

So then those who would be in that same market share, with the 

higher—why would they go to FHA? You would, in fact, get those 

folks because most of us would understand a lower percentage, 

which you would get in the private market versus FHA. So I don’t 

get that FHA would be hurting the private market, or insurers, because I am not going to pay 1.5 percent higher when I know I can 

come over here. 

It tends to be into FHA’s mission, which I am glad we agree on 

and we have heard in the other hearings, what their mission is 

core to. So those folks who fall to the left of the higher end are paying that flat rate because they are not going to be engaged with 

the private insurers. 

Mr. SHAPO. My take on it would be that because of the—FHA 

has brought artificial factors into the starting—during the crisis. 

And then if it does so, it is going to be in a position to take those 

better risks because it has become a larger player. Therefore, keeping the private companies away from getting those better risks 

when the market got better probably affected their ability to attract capital. 

They have attracted capital. But the question is, could they have 

attracted more capital? The mortgage insurance market, like all insurance markets but in particular the mortgage insurance market, 

is subject to pretty substantial fluctuations. And so the question is, 

34 

would the degree of the comeback been higher if there hadn’t been 

as much distortion to the market between the government— 

Mrs. BEATTY. I guess for me, it is not the distortion. And rest assured that I am comfortable in saying FHA does not set the credit 

scoring. So based on those folks going in on—the credit scoring is 

not established by FHA. They would not go to FHA when they can 

get a better rate. 

Mr. SHAPO. But FHA’s market position, I think, has distorted the 

market and restricted the ability of the private carriers to take in— 

to get the better risks, and then to attract more capital. 

Mrs. BEATTY. I think we just have a difference of opinion. Thank 

you. 

Chairman NEUGEBAUER. I thank the gentlewoman. 

Now the gentleman from California, Mr. Royce, is recognized for 

5 minutes. 

Mr. ROYCE. Thank you, Mr. Chairman. Mr. Chairman, I think we 

have had a very good round of hearings on the future of FHA. It 

is not my goal to do away with FHA, but I do think we have to 

force the FHA to deal with its fiscal woes. We have to stop attempting to grow out of that situation with the approach that they are 

on now, and figure out a way to allow the private market to regain 

market share. 

And when you think it through, I think that is the best scenario 

that we have for the taxpayers, but also for future homeowners if 

we can do that. I think we have already pretty clearly established 

that current policies at the FHA have led to the crowding out of 

the private market. So the concern here is, in the future, going forward, are there policies that are going to further aggravate that 

situation. And specifically, the proposed Qualified Residential 

Mortgage rule and the proposed Basel III capital rules provide special dispensation to FHA loans. 

The former gives a safe harbor from the risk retention requirements for FHA loans, and the latter allows a zero-risk weight to 

loans insured by FHA. So the net result is that government policies, I presume here, are going to steer borrowers to the FHA and 

further crowd out the private market, which certainly was not the 

congressional intent. What will be the impact, is the question here, 

on the mortgage insurance marketplace if these rules are finalized 

in their current form? 

And I would ask Mr. Bjurstrom and Ms. Bazemore for opinions 

on that. 

Mr. BJURSTROM. I think the execution gets incredibly more expensive, and therefore the alternative FHA programs will dominate 

the market. 

Ms. BAZEMORE. I would agree with that. I think that the concern 

is that the cost will become significantly higher, and so FHA would 

again be favored in the marketplace. 

Mr. ROYCE. Would anyone else like to weigh in on that scenario, 

or do you agree with that assumption, or— 

Mr. CHAPPELLE. I agree, Congressman. And I think it is important for private MI loans to receive the same general—be in the 

same general category as FHA or Fannie-Freddie loans are. Because we need more loans being made in the country, and we don’t 

35 

need anything that is going to restrict or leave out loans. So I 

would heartily endorse it. 

Mr. STELMACH. I would endorse that, as well. If you think about a $9 trillion mortgage market in the United States, there is only 

one industry right now, private industry, that provides some sort 

of credit enhancement with only $6 billion of capital to support 

that. So in a $9 trillion market with only $6 billion of private capital, I think there is ample room on a regulatory basis, on a Basel 

III basis, to expand that private capital. 

Mr. ROYCE. Mr. Shapo, you say in your testimony you have seen 

many times, in the insurance marketplace, when government programs like residential risk pools put in place to try to help hard 

markets have ballooned in market share and only ultimately distorted the market and destroyed any chance the market had of 

pulling out of a crisis. And you cite the New Jersey automobile insurance markets as an example there. 

That appears a good reference point for what we see now with 

the FHA, with market share rising I think it is about 56 percent 

or over that. And private insurers pressed to leave the market. As 

you say, this is just one of many examples of government intervention in the marketplace. Can you describe, then, the impact that 

this has on competition as a result of these interventions? Could 

you explain the result to consumers, and what other examples are 

out there that you might want to give us? 

Mr. SHAPO. Thank you, Representative. Yes, the common thread 

in all these is substantial government intervention. Sometimes taking different forms, but substantial government intervention to try 

to enhance availability and/or affordability of insurance products. 

And my point is that an insurance market is like any other market. 

Insurance has many complexities, but the basic ways that the market works are not complex. 

I quoted the Supreme Court, which quoted a House report, in 

McCarran-Ferguson: ‘‘The theory of insurance is the distribution of 

risk according to hazard, experience and the laws of averages.’’ It 

is pretty straightforward stuff. And to the extent that the outcomes 

are not pleasing to policymakers, and that they try to affect those 

outcomes, that will affect the ways the market works. 

Subsidies will develop, risk will be mispriced, capital formation— 

Mr. ROYCE. Capital formation will be impacted negatively. 

Mr. SHAPO. I’m sorry? 

Mr. ROYCE. Capital formation is impacted negatively. 

Mr. SHAPO. That becomes the most important factor, is that capital formation is negatively impacted. Money does not flow to the 

marketplace. And what happens is, you tend to get a double spiral. 

You get a spiral in the government-encouraged pool because it is 

not properly pricing risk. So it tends to balloon out of—and we 

have an extreme example here, where you have a negative cash 

balance and a negative capital position with the FHA program. 

Mr. ROYCE. It can lead to insolvency, yes. 

Mr. SHAPO. And it impairs the private market, too, because no 

capital comes in and they can’t properly compete. 

Mr. ROYCE. Thank you. Thank you, Mr. Chairman. 

Chairman NEUGEBAUER. Now, the gentleman from New Jersey, 

Mr. Garrett. 

36 

Mr. GARRETT. I thank the chairman. I just have a couple of questions. 

Mr. Bjurstrom, can you talk to me about accounting? GAAP accounting? 

Mr. BJURSTROM. I am not an accountant, but I will do my best. 

Mr. GARRETT. Is there any reason why the FHA could not be 

using GAAP accounting? 

Mr. BJURSTROM. I don’t—I believe they can account for it any 

way that you direct them to. 

Mr. GARRETT. Okay. Is there any reason why other agencies or 

entities should not be using GAAP accounting, on the Federal 

level? 

Mr. BJURSTROM. I am not familiar with the ability of other entities to do that. 

Mr. GARRETT. All right. But as far as the FHA? 

Mr. BJURSTROM. No, I believe that you have the ability to tell 

them specifically how to account. 

Mr. GARRETT. Okay. So when you talked about the GSEs previously, you talked about them having stakeholders, which would 

be the investors in it, right? Now when you talk about the FHA, 

we don’t have investors in the FHA in the typical sense of the 

word. But you do have shareholders, you might say, if you described the American taxpayer in the FHA. 

And I guess this is open to the panel, as the taxpayer being the 

shareholder of the FHA, should we not be looking to them to factor 

in market risk, FHA, when they make their—when they do their 

accounting? I will start at the end, and anybody else who wants to 

comment on it. 

Mr. BJURSTROM. Pricing is the art of factoring in all risks. And 

if you look at the exposures and the mission and the purpose, and 

then after you have figured that out and then you then back into 

pricing. And along with that pricing is a component for volatility, 

which would include a lot of the market risk which this industry 

has a lot of market risk volatility. 

Mr. GARRETT. Right. And—so anybody else? Wouldn’t that be 

more transparent if it was a private corporation? You would be requiring transparency to the investor. Here, the stakeholder is the 

taxpayer. So wouldn’t that be good for the stakeholder, the taxpayer, to have that information, that transparency? Does anybody 

disagree with that? You disagree with that. 

Mr. BJURSTROM. I like the transparency question just because of 

the fact that instead of it just being a single entity like the FHA 

pricing its own insurance, I think that is where they need to start. 

But I also like the benchmarking against others that are pricing 

for the same risk. 

Mr. GARRETT. Right. 

Mr. BJURSTROM. As well as the opportunity to do reinsurance or 

risk share. Because then you get many multiple points of validation 

that you agree with others that your price is commensurate with 

the risk, not just individually promoting price changes individually. 

Mr. GARRETT. I understand. Mr. Chappelle, do you disagree with 

the idea of transparency? 

Mr. CHAPPELLE. I don’t disagree with the idea of transparency, 

but I do have trouble—FHA is a government program. If you are 

37 

going to compare it to the private sector, it is impossible to come 

up with a legitimate comparison. You are going to have to make 

estimates as part of that process. There was already a say to evaluate FHA’s soundness through the 1990 Budget Act. 

And if you want to move the goal posts and change how they do 

it, you could do it. But it is a government program. I think we all 

recognize that, and it is hard to apply to a government program 

what the private sector has. They don’t have the profit motive. 

They can’t withdraw from markets. They can’t do the things the 

private sector— 

Mr. GARRETT. Right. So you take that out. But as—your initial 

testimony was that you can factor in the market risk. So that 

would be one aspect that GAAP accounting would be providing to 

the public, the taxpayer, to understand better what their actual financial posture is. Notwithstanding that they don’t make a profit, 

and notwithstanding that they are backstopped, correct? 

Mr. CHAPPELLE. It wasn’t my testimony that said that. 

Mr. GARRETT. No, I am just saying would that—is that not true? 

Mr. BJURSTROM. I think, at a minimum, doing the analysis in 

order to create the right policy and the right information concerning that policy is most appropriate. 

Mr. GARRETT. In my minute that I have left here, the role of 

FHA, what it should be, what it was designed for. The President 

has talked famously about how we should be raising taxes on the 

proverbial rich. And they define the rich as those people making 

over $200,000, $250,000. If that is the rich, then should the FHA 

be put back to its original foundational format to say that it is not 

there to help the rich, it is to help out first-time homeowners and 

lower- and middle-income people making under $250,000? 

Does anybody disagree with that assessment? You do? 

Mr. CHAPPELLE. Congressman, it is an insurance program. 

Mr. GARRETT. Right. 

Mr. CHAPPELLE. And like everybody has said on this panel, it has 

to spread risk. There is a cornerstone of the FHA program that 

higher-balance loans perform better than lower-balance loans. So if 

we are going to protect the taxpayer, you need some of those borrowers. But the news is, FHA charges a premium structure that if 

someone who is ‘‘rich’’ wants to use the program, I would welcome 

it. Because they would be overpaying their insurance. 

Mr. GARRETT. That is—okay, just to know, then, that we will establish one program that is for the rich, then, yes. That is fair. 

I yield back, I guess. It is the Chair’s prerogative. 

Chairman NEUGEBAUER. I thank the gentleman. 

I want to follow up here because a couple of points have been 

made. This hearing is really about a number of things, but one of 

them is that—and Mr. Chappelle just made this point—this is an 

insurance program. But it is an insurance program that is not 

being run like an insurance program, in that when you look at the 

industry standards that governments have basically established for 

people in this kind of business, model legislation, models of how 

much leverage is—should be—is reasonable, and reserves that 

should be there to protect people. 

So I think the question is, is why would there be any argument 

that if we are going to have an insurance program, and the shareVerDate Nov 24 2008 11:34 Jun 20, 2013 Jkt 080872 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 K:\DOCS\80872.TXT TERRI
38 

holders are American taxpayers, why wouldn’t we run it like an insurance company and have it adhere to the same standards that 

other insurance companies have to adhere to? Mr. Bjurstrom? 

Mr. BJURSTROM. I agree. If you need to run it like an insurance 

program and price it appropriately, reserve for it appropriately, 

and capitalize it appropriately, then you would have a better idea 

of what your future expected outlook looks like. And that is really 

the—from a financial, accounting and modeling and actuarial 

standpoint, that is all we are really suggesting and trying to 

achieve. 

Chairman NEUGEBAUER. I think the other issue is—and I support what the gentleman from New Jersey said about using GAAP 

accounting or what I call ‘‘accrual accounting’’ to be able to establish what is the value of the portfolio and what is the potential risk 

of the portfolio so that you can price it. 

The other piece of the pricing currently is the fact that FHA 

doesn’t factor in their operating costs into setting their price because we appropriate money for that. So at the very least, it would 

appear to me that if you are going—that entity should be at least, 

if it is not going to pay a dividend, if it doesn’t have shareholders, 

it is going to operate as a nonprofit, it ought to at least, then, have 

to factor in the cost of operation. 

Because it is not so much that we are trying to steer business 

to the private mortgage insurance companies, but what we are trying to do is find a balance in the marketplace of the total housing 

finance picture. And while we may be pushing some more business 

to the PMI companies, the private companies, today, unfortunately, 

about 90 percent of the mortgages in this country are still being 

backed by the American taxpayers. 

And so it is the policy that we are driving, that we continue to, 

I think, put inhibition—or inhibit the ability of the private sector 

to be into the marketplace today. Because this has been brought 

out, the risk retention issues. But it is not so much the pricing differentiation of the premium law. That is a piece of it. But it is the 

fact that, overall, a FHA loan today is a lower-cost loan overall because of the fact that it is backed by the Federal Government. 

And so when—and Ms. Bazemore brought this point up—you put 

the fact that you have Ginnie and FHA together, then the borrowing cost in the capital markets is much less. And so, it pushes 

it automatically. It doesn’t—really, almost to a point where the differentiation in premium maybe is negated by the fact that the overall lower borrowing cost is compensating for any premium differentiation in the marketplace. 

And so, I think one of the things that I would hope, as we are 

moving forward, is that we have two responsibilities here. One is 

to make sure that a program that we have oversight over as a government is being run appropriately. And that if we take a look at 

something that has been in place for a number of years without— 

not a lot of changes, and understanding that the world has 

changed. Back when FHA was originally put in place, there wasn’t 

a lot of securitization going on. 

Most of the loan sales were individual sales. Now we have 

securitization, so should we take a look at how we—how that impacts the way we run these businesses? But more importantly, I 

39 

think, for many of us is trying to get back—and I think Mr. 

Capuano made a great point earlier—what is the right formula. 

What is the role of—what is the marketplace for FHA? And then 

what is the marketplace for the private market to be in there? 

We have to fix all of the pieces. But we can only fix them one 

at a time. And so as we move forward, I hope that we can have 

a meaningful dialogue about how we look at the FHA piece. I think 

there is some room here to shore it up, and I think there is room 

here to make sure that we don’t—that there are not some market 

distortions there that are driving people to FHA other than the 

mortgage premium, or mortgage insurance premium, that FHA is 

charging. 

And I think that is really, hopefully—we heard some very good 

testimony today, and I look forward to probably having some ongoing dialogue with some of the market participants here. Because 

the ultimate goal here is for all us to do the right thing. And I am 

concerned right now that we are running FHA kind of on an ad hoc 

basis. And if it had a little better structure that overall it would 

be a more sustainable program. 

We wouldn’t need to have hearings about why you have a negative net worth. Those are not the kind of oversight hearings that 

we need to be having. We need to be having oversight hearings 

where things are getting better. And unfortunately, we have been 

told that things are getting better, but the results have not proven 

that fact. And then the other point is the fact that since we are not 

using Generally Accepted Accounting Practices, we really don’t 

know if this entity is actuarially, how sound it is or isn’t. 

So with that, I am going to yield to my colleague, Mr. Capuano, 

for any remarks that he may have. 

Mr. CAPUANO. Thank you, Mr. Chairman. And again, I agree 

with you. I think that the whole idea of this is try to figure out 

exactly what we want the FHA to do. But I do caution people that 

no government program should be run as a private program. We 

don’t have the profit motive. And if you want to look at the model, 

look at the model of private insurance, private mortgages before 

the FHA. 

There were no middle-class mortgages, period, end of issue. Only 

rich people or people who inherited a house could afford to buy a 

home. And the FHA allowed people to get into the middle class by 

buying a home. So there is a balance. And I agree, our job is to 

try to find that balance. Ms. Bazemore, if I told you that in 2 years 

you could increase your share of the current business by 21⁄2 times, 

do you think that would be a good deal? 

Ms. BAZEMORE. Yes. But it would also depend on where I started. 

Mr. CAPUANO. No, and I don’t blame you. Of course, if you told 

me you were going to increase my salary 21⁄2 times, I would say 

okay, I am in, sign me up. It’s not happening, I know. PMI has increased its share of the mortgage businesses by 21⁄2 times in the 

last 2 years. And yet I keep hearing from some people that it is 

absolutely proven, without question, without a doubt that the FHA 

is squeezing private enterprise out. 

I find that hard to believe when you are increasing your mortgage here. You are going back to what appears to be a more normal 

time. We are not there yet. And I agree with that, there needs to 

40 

be more done. And my fear is that if we don’t get this right, if we 

allow the FHA to continue going where it is going, which I don’t 

like some of the things they have done. I understand them in the 

short term, but in the long term we will be doing, effectively, what 

we shouldn’t be doing, which is making mortgages so expensive or 

mortgage insurance so expensive, again, there will be no middleclass people. 

I guess I just want to reemphasize that as we rebalance this, as 

we look at it, the basic question is, how much is enough? And 

maybe I am wrong, but I don’t think that the private mortgage industry would be well-served if we drive the middle class out. You 

have done a good job over the years finding a niche in balance with 

the FHA. Now, again, that niche, that whole system, was messed 

up in 2008 for everybody, and we need to re-find that balances. 

But prior to that, I didn’t hear any complaints. No one was complaining then. And so the question is, do we or do we want to have 

any government involvement in allowing the middle class to continue being able to afford a mortgage. And for me, that is where 

we are trying to go. I have no philosophical viewpoint here, except 

that I know—and again, I never qualified for an FHA loan because 

I do come from a high-cost area and because I have been fortunate 

in my life. 

Fine. But I know one thing. If there were no GSEs and there was 

no FHA across the country, my mortgage rates would be through 

the roof and I never would have bought a home. Because I own, 

currently—the home that I bought in 1980 is a two-family home. 

Why did I buy a two-family home? I needed the rent to pay the 

mortgage. And I had to fight with the bank to accept that. 

So without that, I wouldn’t be in the middle class, and my children would not have had a college education because I, like many 

Americans, remortgaged my house to pay for their college education. And for me, I thank God there was a system in place that 

allowed me the opportunity to buy a home. And I need to make 

sure that is the case for the next generation. Which, by the way, 

as a point of fact, is not there in many parts of this country today. 

People 30, 40 years old cannot afford to buy a home. They can’t 

get the downpayments together because the house prices are too 

high, and they can’t afford the monthly mortgage. Especially if you 

add that on top of the student loans they are paying. That is not 

good for them. It is also not good for America, and it is not good 

for your businesses. So with your help, we will find that way to balance it. 

But I need to make sure that some philosophical viewpoint of 

some greater good doesn’t get in the way of actually finding a way 

to rebalance this system in a manner that keeps it going for the 

next generation. I know that your testimonies I heard today all fit 

in that category, and I thank you for that. And I look forward to 

working with you all as we move forward. 

Thank you. 

Chairman NEUGEBAUER. The gentleman from Texas, Mr. Green, 

is recognized for 5 minutes. 

Mr. GREEN. Thank you very much. And I neglected to thank the 

ranking member earlier for allowing me to be a part of the hearing. 

I did thank the chairman, so I now thank the ranking member. 

41 

And after hearing the ranking member’s statement, I think we 

probably are at the offertory and closing hymn. Because like him, 

I, too, thank God for FHA. 

But I will ask a few questions, if I may, to bring a little bit of 

clarity to your testimony. Because I suspect that some things are 

the case, but sometimes when you finish testifying, persons who 

are viewing this at home are not sure. So perhaps we can bring a 

bit of clarity. Is it true that each of you would keep FHA? Simply 

put, is there anyone who wants to end FHA, have no FHA at all? 

If so, would you kindly raise your hand if you want to end FHA? 

All right, let the record reflect that we have no hands in the air. 

And as a result, we can conclude that no one wants to end FHA. 

Now, let me go further and ask is there anyone who believes that 

FHA as it has functioned traditionally is somehow adverse to the 

market that has developed through the years, that has seen some 

difficult times as of late. But is FHA’s traditional role one that we 

all believe is important and we should maintain. 

And if so, if you do not agree, would you kindly raise your hand? 

If you don’t think its traditional role is one that we should maintain. And for our benefit, Mr. Chappelle, I am going to ask you to 

give us your summary, quickly, of what FHA’s traditional role has 

been and how that role still benefits us, even in these difficult 

times. 

Mr. CHAPPELLE. Sure, Congressman. FHA has helped low-, 

moderate- and middle-income families to be able to buy their home. 

Predominantly first-time home buyers; 75 to 80 percent of their 

loans go to first-time home buyers. Predominantly lower-income 

home buyers, as I noted in my testimony. Their median income was 

$56,000 in 2011. So FHA’s role is to help—it is really the insurer 

of last resort for creditworthy home buyers. 

But to be able to do that, they do need to spread that risk a little 

bit because they have to—they can’t just have the highest-risk pool. 

They have to spread the risk. But they do have structural protections, I believe, which ensure they do not encroach too far into the 

private sector. And that would be the fundamental point I would 

make. 

Mr. GREEN. And do you think that tweaking the 100 percent 

rule—that is what I am calling the rule that allows FHA to insure 

the home for 100 percent— 

Mr. CHAPPELLE. —of the value? 

Mr. GREEN. Of the value, yes. Do you think that can be tweaked 

such that it provides FHA with a greater amount or lesser amount 

of risk? 

Mr. CHAPPELLE. I think it would be a major mistake for the program. That 100 percent insurance is one of the core, structural 

parts of the program. Because what is happening today in the marketplace is that lenders, even with 100 percent insurance, are adding their own underwriting requirements on top of FHA’s. They are 

called ‘‘credit overlays.’’ Because—and I know some of the panelists 

said there are only perceived risks in the FHA program. 

I can assure everybody, lenders feel there is real risk in the FHA 

program. That is why they put these overlays in place. And if you 

go and lower that insurance from 100 percent, that is just going to 

ratchet up that risk factor for the lender, which will exclude the 

42 

people that you would like to see, and we would all like to be—see 

to be part of the FHA program. So I think that would be a serious, 

serious problem for the program to lower that insurance. 

Mr. GREEN. And the final question on this—in this area. What 

do you think that FHA can do to better serve the public? 

Mr. CHAPPELLE. Congressman? 

Mr. GREEN. Yes. Mr. Chappelle? 

Mr. CHAPPELLE. I think the mortgage limits were raised in response to the problems in the marketplace in 2007 and 2008. I, and 

I am sure most other people who would like to see the FHA program continue to prosper recognize those limits should not stay 

there forever. And once the mortgage market recovers—because the 

purchase market is still in a depressed state. But once the purchase market recovers, those limits should come down to more reasonable levels. 

And I think at the appropriate time, that would be the correct 

thing to do. 

Mr. GREEN. I thank all of the witnesses, and I will just have my 

parting comment. I have many constituents who have benefited 

from FHA. And it is the bridge that has brought a good many people over to the promised land, if you will, of homeownership. And 

I think that there may be some things that we can do to tweak it, 

but FHA should not be frowned upon for the good job that it has 

done. 

And to a certain extent, we are condemning it for being successful. Thank you, Mr. Chairman. I yield back. 

Chairman NEUGEBAUER. I thank the gentleman. I would like to 

thank each of our witnesses again for their testimony today. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

And without objection, the hearing is adjourned. 

[Whereupon, at 12:17 p.m., the hearing was adjourned.] 

(43) 

A P P E N D I X 

March 13, 2013 

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Statement of Randy Neugebauer 

Subcommittee on Housing and Insurance 

"Mortgage Insurance: Comparing Private Sector and Government-Subsidized 

Approaches" 

March 13,2013 

Thank you all for attending this hearing examining FHA's role in the mortgage 

insurance market. This is the third in a series of hearings on FHA - and in my 

opinion the most important hearing to truly understand FHA's business model. 

In our previous hearings, we learned that FHA is nearing insolvency, putting 

taxpayers at risk of another government bailout. We learned that FHA is operating 

far outside its historical mission, which is hindering the development of a 

sustainable housing finance market. And finally, we learned that members on both 

sides of the aisle strongly support FHA's core mission of providing access to credit 

for lower-income borrowers and first-time homebuyers. 

Today's hearing will explore the business model of mortgage insurance and 

analyze some of the advantage FHA has relative to private mortgage insurers that 

compete for the same business. 

When we view FHA from a policy perspective, we have to remember that FHA is 

in the business of insurance. But we will find out today that FHA runs its MMI 

Fund contrary to the most basic principles of insurance. FHA does not evaluate its 

risk according to actuarial principles; it does not correlate premiums to risk; it does 

not spread its risk in a manner supported by its financial resources; and it relies on 

treating poor results as a quarantined anomaly. 

With regard to solvency - which is the cornerstone of insurance regulation FHA 

misses the mark by a long shot. FHA's most recent actuarial report showed that its 

MMI Fund capital reserve ratio, which is a major benchmark for solvency, fell to 

negative 1.44% well below the Congressional mandated minimum of 2 percent. 

While private mortgage insurers are instructed to halt all new business once capital 

reserve ratios fall below 4%, FHA has continued to expand business despite being 

vastly undercapitalized. 
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FHA shares other advantages relative to its competitors in the private market. On 

pricing, private insurers use actuarial sound pricing that must include overhead 

expenses; FHA uses artificially low, uniform pricing that excludes administrative 

and technological costs. On reserving for losses, private insurers follow 4 different 

reserve requirements; FHA does not set aside reserves. On accounting, private 

insurers use GAAP accounting; FHA masks its true financial health with 

govermnent accounting. And on risk transfer, private insurers oftentimes pay to 

cede risk to the reinsurance market; FHA has a limitless backstop from the U.S. 

Treasury. 

All of these advantages result in a much lower cost of capital for FHA relative to 

private insurers. This wouldn't necessarily be a problem if FHA stuck to its 

historical mission and narrowly targeted its subsidies to lower-income individuals. 

But, as FHA has attempted to grow out of its past underwriting mistakes, it has 

expanded its subsidies to large areas of the housing finance market- including 

high-income borrowers - that do not need government subsidies. Consequently, 

FHA is directly competing with the private mortgage insurance market on a 

playing field that is anything but fair. 

Not surprisingly, FHA's unwieldy growth has crowded out private capital in the 

mortgage insurance space and has left private insurers struggling to raise new 

capital. According to the GAO, FHA's share of the mortgage insurance market, 

based on volume of loans, stands at 56% compared to just 19% for the private 

insurers. 

There is a proper role for FHA in the housing finance market, but I believe it 

should be a complement to the private market, not a direct competitor. I look 

forward to working with Ranking Member Capuano to address these important 

issues in the months ahead. 

### 
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Statement before the 

Subcommittee on Housing and Insurance 

Of the Committee on Financial Services 

United States House of Representatives 

On "Mortgage Insurance: Comparing Private Sector and GovernmentSubsidized Approaches" 

Teresa Bryce Bazemore 

President 

Radian Guaranty, Inc. 

March 13,2013 
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Introduction 

I am Teresa Bryce Bazemore, President of Radian Guaranty, Inc., a leading 

private mortgage ("MI") insurance company. I am testifYing today to discuss the role of 

private MI in the housing finance system; how private MI differs from governmentsubsidized mortgage insurance that is provided via the Federal Housing Administration 

(FHA); and the ways in which housing policies and practices are providing a competitive 

advantage to federally-insured FHA loans over privately-insured loans. In my testimony, 

I will also provide several recommendations that policy makers should adopt to return 

FHA to its historical role; improve the agency's financial condition; reduce the 

government's role in the housing market; and increase the role of private capital through 

the use of private MI for the protection of taxpayers. 

Private MI is the privatc scctor alternative to loans insurcd by FHA. Private MI, 

like FHA, helps qualified low down paymcnt borrowers to obtain an affordable mortgage. 

Both FHA and private mortgage insurers play an important role in making 

homeownership affordable and possible for millions of Americans. 

FHA has been and remains a valuable part ofthe housing finance system. 

However, in the past few years, FHA has dominated the mortgage insurance market due 

to housing policies and practices that provide competitive advantages to FHA while 

crowding out private capital in the form of privatc MI. These actions include increasing 

Fannie Mae and Freddie Mac ("GSE") guarantee fees ("g-fees") and imposing additional 

GSE "loan level price adjustments" ("LLPAs"), that make privately-insured loans 

purchased by the GSEs more expensive than government-backed FHA loans and, 

therefore, steer borrowers to FHA instead of bringing more private sector capital into the 

housing market. 

Additionally some regulatory proposals, like the proposed risk retention and Basel 

III rules, would provide FHA with a competitive advantage over private MI, and 

therefore, would tilt the playing field even further toward FHA loans and government 

insurance and away from the private sector and private MI. 

While FHA has recently taken modest steps to scale back to its historical mission 

of supporting underserved borrowers, including modestly increasing premiums and 

strengthening underwriting requirements, policy makers should implement additional 

reforms, as discussed in this testimony. Ultimately, housing policies should work to scale 

back FHA to its traditional mission of supporting underserved borrowers, while enabling 

the private market to be used by borrowers in the conventional market. 

The Role of Private MI 

The private MJ industry was founded in 1957 and since then has helped over 25 

million borrowers become homeowners by enabling them to buy homes with small down 

payments. Today, private MI currently insures more than $700 billion in mortgage loans. 

Private MI enables potential homebuyers who cannot make a 20% down payment 

to purchase their homes. Private MI has played an important role in providing first-time 
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homebuyers with access to mortgage fmancing. Private mortgage insurers share this 

important role with FHA. The most recent National Association of Realtors ("NAR") 

rcport on borrower profiles notes that 46% of first-timc buyers had FHA financing while 

33% obtained conventional financing (with private MI being used by those borrowers 

who had down payments ofless than 20%). 

How Private MI Works 

When a borrower places less than 20% down to purchase a home, the lender is 

required to obtain private MI in order for that loan to be eligible to be subscquently sold 

to the GSEs. The GSEs are the key guarantors of conventional financing today, and 

private mortgage insurers are the GSEs' key providers of private capital credit 

enhancement. Lenders are willing to make low down payment loans, and the GSEs are 

willing to purchase them, because in the event of a homeowner's default on the mortgage, 

the private MI company pays the owner of the loan a specificd amount of the unpaid 

mortgage. 

More specifically, the combination ofthe private MI coverage and the borrower's 

down payment will typically cover 25-35% of the loan amount meaning lenders and 

investors are at risk for only the remaining 65-75% of the loan amount. For example, if a 

borrower provides a down payment of 5%, a lender will typically require MI coverage 

sufficient to cover 30% of the loan amount such that the down payment combined with 

the MI cover approximately 35% of the loan amount, leaving lenders and investors at risk 

for only 65% of the loan amount. 

This practice of requiring private MI in an amount that is 25-35% of the loan 

reflects the GSEs' prudent determination that this amount of coverage has historically 

been necessary to cover costs associated with defaulted loans (interest charges during the 

delinquent period and during foreclosure, legal fees, home maintenance and repair costs, 

real estate brokers' fees, and closing costs) and any losses resulting from reselling the 

property for less than the outstanding mortgage loan balance. 

Importantly, placing the MI company's private capital at risk in a "first loss" 

position after the borrower's equity means that both the private mortgage insurer and the 

borrower have a vested interest in making home loans that are affordable not only at thc 

time of purchase, but also throughout the years of homeownership. Having their own 

capital at risk also means that private mortgage insurers have very clear incentives to 

work with lenders, investors, and community groups to help borrowers in default stay in 

their homes. 

How Private MI Uses Private Capital to Protect Taxpayers 

Because the GSEs are now in conservatorship, once the loans are purchascd by 

the GSEs, the government is now responsible for losses that result when borrowers 

default on those loans that are in excess ofthe amount covered by private MI. In other 

words, the claims paid by private mortgage insurers are used to reduce losses that would 

otherwise be paid by the government, and therefore, the taxpayer. 
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Indeed, over the past four years, private mortgage insurers have paid 

approximately $34 billion in claims resulting from foreclosure losses to the GSEs that 

would have otherwise been paid by taxpayers. Moreover, private mortgage insurers are 

projected to pay approximately $50 billion in total to cover losses from this 

unprecedcnted housing downturn. 

Underwriting and Pricing for the Risk 

Underwriting 

In order to be approved for our mortgage insurance, a potential loan is reviewed 

to determine whether it meets our underwriting criteria. Radian typically performs this 

function directly or, alternatively, we delegate to our customers - the lenders - the ability 

to underwrite the loans based on either Radian's underwriting guidelines or, with 

Radian's prior approval, other agreed-upon guidelines. Radian's underwriting guidelines 

are prudently established with a view toward ensuring that the borrower has the ability to 

afford the mortgage at the time of origination and throughout the life of the loan. Loan 

performance is closely monitored to determine when any changes to guidelines are 

warranted, including opportunities to expand guidelines. 

Through our delegated underwriting program, certain lenders that have been 

approved by our risk management group are able to approve loans based on our 

underwriting guidelines. In other words, delegated underwriting allows our customers to 

commit us to insure loans meeting Radian's approved guidelines. We mitigate the risk of 

lender underwriting error through quality control sampling and performance monitoring. 

Lenders that either do not qualifY for or choose not to participate in our delegated 

underwriting program can submit loan files to us, and we will perform the underwriting. 

In addition, lenders participating in our delegated underwriting program may choose not 

to usc their delegated authority, and instead may submit loans directly to us. We currently 

underwrite about one-third of the files, and this direct underwriting also helps inform the 

quality control process for lenders. We mitigate the risk of employee underwriting error 

through quality control sampling and performance monitoring. 

Pricing 

Radian sets its premium rates at the origination ofa mortgage loan when coverage 

is established. Premiums for our mortgage insurance products are established based on 

performance models that consider a broad range of borrower, loan, and property 

characteristics. We set our premium levels commensurate with anticipated policy 

performance assumptions, including our expectations and assumptions about the 

following factors: (I) the likelihood of default; (2) how long the policy will remain in 

place; (3) the costs of establishing the policy; (4) taxes; and (5) the capital that is required 

to support the insurance. Our performance assumptions for claim frequency and policy 

life are developed based on internally developed data, as well as data generated from 

independent, third-party sources. The assumptions used in setting our premiums that 

relate to policy coverage, expenses, and capital are based on data and models that are 
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developed internally. Premium levels are set to achieve an appropriate, risk-adjusted rate 

of return on capital given modeled performance expectations. 

Private mortgage insurers' premium rates and policy forms are generally subject 

to regulation in every state in which our insurers are licensed to transact business. These 

regulations are intended to protect policyholders against the adverse effects of excessive, 

inadequate, or unfairly discriminatory rates and to encourage competition in the insurance 

marketplace. In most states where our insurance subsidiaries arc licensed, insurance 

premium rates and policy forms must be filed with the state insurance regulatory 

authority and, in some states, must be approved, before their usc. Changes in premium 

rates may be subject to actuarial justification, generally on the basis of the insurer's loss 

experience, expenses, and future projections. In addition, states may consider general 

default experience in the mortgage insurance industry in assessing the premium rates 

charged by mortgage insurers. 

The Rigorous Reserve and Regulatory Structure of the Private MI Industry 

The backbone of the industry's financial strength is its state-imposed reserve, 

capital, and regulatory requirements. 

State-imposed Reserve Requirements 

The industry'S state-imposed, counter-cyclical capital reserving method ensures 

that significant reserves are accumulated during good times to enable the industry to 

withstand a sustained period of heavy defaults arisingfrom serious regional or national 

economic downturns. 

Private mortgage insurers are required to keep three types of reserves. The 

reserve requirements were developed in a model private MI act that was established by 

the National Association of Insurance Commissioners ("NAIC") and is primarily 

enforced by the states where private mortgage insurers are domiciled. 

• Contingency Reserves. The most important reserve is the contingency reserve. 

Half of each premium dollar earned goes into the contingency reserve and 

generally cannot be touched by the mortgage insurer for a lO-year period. 

Therefore, unlike other financial institutions that may pay high dividends during 

profitable periods, private MI companies build their contingency reserves during 

these periods in order to have the capital ready to pay the higher claims that 

inevitably occur during periods of market corrections, such as the one the U.S. is 

now experiencing. 

• Case-basis Loss Reserves. Case-basis loss reserves are established for estimated 

losses on individual policies when the insurer is notified of defaults and when 

foreclosures occur. As defaults have increased, the amount of capital put into 

these reserves has increased substantially in order to ensure that the money is 

available to pay claims. 
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• Unearned Premium Reserves. Premiums received for the term of a policy are 

placed in unearned premium reserves and are earned over time in accordance with 

state regulation. 

The state requirements for private MI are specifically structured to address the 

long-term nature of the capital at risk for a private mortgage insurer. They enable the 

private mortgage insurer to withstand a sustained period of heavy defaults arising from 

serious regional or national economic downturns, as well as routine defaults and claims 

that occur throughout the normal course of business. 

Unlike credit default swaps or other forms of credit enhancement, private MI has 

already demonstrated its ability to absorb risk. The history of the private MI industry 

proves that they have paid their claims through good and bad economic cycles. For 

example, in the early 1980s, the mortgage market had to cope with double-digit interest 

rates and inflation in a period of severe recession and, therefore, introduced many 

experimental adjustable-rate mortgages. As economic conditions deterioratedparticularly in energy-oriented regions of the country--defaults began to rise, resulting in 

numerous foreclosures. The private MI industry paid more than $6 billion in claims to its 

policyholders during the 1980s. In the early 1990s, the MI industry paid more than $8 

billion in claims primarily in California and the Northeast. Policyholders included the 

GSEs, commercial banks, savings institutions, institutional mortgage investors, mortgage 

bankers, the Federal Deposit Insurance Corporation, and the Federal Savings and Loan 

Insurance Corporation. 

One reason this mortgage boom was so pronounced is that bank regulatory capital 

requirements permitted speculative growth and then sharply curtailed the ability of 

lenders to support market recovery. Private MI, on the other hand, is supported by a 

unique form of counter-cyclical capital that permits mortgage insurers unlike every 

other provider of mortgage credit risk mitigation - to meet claims and handle new 

business even under unprecedented stress. Private mortgage insurers' contingency 

reserves are directly comparable to the "dynamic provisioning" bank regulators now 

know they need. Bank regulators are only now working to construct a similar system for 

banks in the United States and around the world, with Federal Reserve Chairman Ben 

Bernanke highlighting this as a critical initiative. 

Additional State Regulatory Requirements 

Private MI companies insure mortgages in all 50 states. Private mortgage insurers 

operate under mono line licenses issued by state insurance departments that only permit 

them to write mortgage insurance policies covering the risk of borrower default on 

residential mortgage loans. 

Private mortgage insurers are subject to comprehensive regulation principally 

designed for the protection of policyholders, rather than for the benefit of investors, by 

the insurance departments in the various states where our insurance subsidiaries are 

licensed to transact business. Insurance laws vary from state to state, but generally grant 

broad supervisory powers to agencies or officials to examine insurance companies and 
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80872.009

cnforcc rulcs or cxcrcise discretion affecting almost evcry significant aspect of the 

insurance busincss. 

State regulators requirc privatc mortgagc insurcrs to maintain minimum surplus 

levels and, in ccrtain statcs, a minimum amount of statutory capital rclative to the level of 

net risk in forcc, or "risk-to-capital ratio," typically 25:1, with capital guidclines 

established by state insuranec departments. 

State insurancc rcgulation also addresscs among other issues, the licensing of 

companies to transact busincss, claims handling, reinsurance requirements, prcmium ratcs 

and policy fomls offered to customers, financial statcments, periodic rcporting, 

pcrmissiblc investments and adherence to financial standards rclating to surplus, 

dividends and other measurcs of solvcncy intcndcd to assurc the satisfaction of 

obligations to policyholdcrs. State rcgulations also provide for a structurc that allows 

mortgagc insurers to continue to pay their claims even ifthcy no longer writc ncw 

business. 

Each insurance subsidiary is requircd by the insurancc rcgulatory authority of its 

statc of domicile, and the insurance rcgulatory authority of cach other jurisdiction in 

which it is Iiccnscd to transact business, to make various filings with thosc insurance 

regulatory authorities and with thc NAIC, including quarterly and annual financial 

statements preparcd in accordance with statutory accounting principles. In addition, our 

insurance subsidiaries arc subject to examination by the insurancc rcgulatory authorities 

of each of the states in which they are licensed to transact business. 

Federal Regulatory Requirements 

As the largest purchasers of conventional mortgagc loans, and therefore, the main 

beneficiarics of privatc MI, thc GSEs impose rcquiremcnts on private mortgagc insurers 

that wish to insure loans sold to the GSEs. In ordcr to be cligiblc to insure loans 

purchascd by the GSEs, private mortgage insurcrs must mcct the GSE eligibility 

rcquirements. These eligibility rcquircmcnts are imposcd with respect to the type of risk 

insurcd, standards for the geographic and customcr diversification of risk, procedures for 

claims handling, standards for acceptable underwriting practiccs, master insurance 

policies, standards for certain reinsurance ccssions, loss mitigation, and financial and 

capital requircmcnts that gcncrally mirror statc insurance regulatory requirements. As 

such, the GSEs and FHFA serve as dc facto fcderal regulators of the private MI industry. 

Additionally, private MI companies are subject to rcquircments under various 

fcderallaws, including anti-referral fce provisions under the Real Estate Settlement 

Practices Act of 1974, Iiccnsing and registration provisions nnder the SAFE Mortgage 

LicenSing Act, loan data disclosurc requirements undcr the Home Mortgage Disclosure 

Act of 1975, and covcrage cancellation and tcrmination requircmcnts under the 

Homeowners Protection Act of 1998. 
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Comparison of Private MI vs. FHA 

While private MI and FHA are similar in that they enable borrowers to buy 

homes with less than a 20% down payment by paying lenders and investors if a home 

goes into foreclosure, there are some significant differences in the way that the two 

models are structured. As Congress considers ways to improve FHA's financial health, it 

should consider some of the attributes of the private MI model that have proven to be 

successful. 

• Coverage. FHA insures 100% of the loan amount ifthe home goes into 

foreclosure so that the loan originator lacks any meaningful risk ofloss. 

Currently, taxpayers are on the hook for the over $1 trillion in mortgages that 

FHA is insuring. Private MI, on thc other hand, places private capital in a first 

loss position behind the borrower's equity and generally represents 25% to 35% 

of the loan amount, which covers most, but not all, of the losses that the parties to 

the mortgage transaction experience so there remains an incentive to avoid 

foreclosure. Notably, the federal VA mortgage program provides limited coverage 

of 25% to 50% for the loans insured under its program, and the success of the V A 

program demonstrates that this lower level of coverage results in better 

underwriting and loan performance, which reduccs both probability of default and 

severity ofloss. 

• Capitalization Leverage Ratios. The most recent actuarial report for the FHA 

Mutual Mortgage Insurance ("MMI") fund (excluding reverse mortgages) shows 

total capital resources of$25.6 billion dollars offsetting over $1.1 trillion dollars 

of insurance in force, which for FHA is its risk in force because FHA insures 

100% of the loan amount so that its risk is not capped. However, once the 

projected losses on FHA's existing books of business are added to the calculation, 

these losses wipe away all of the FHA resources resulting in a negative economic 

value to the fund of$13.5 billion. By comparison, private mortgage insurers arc 

generally required to have a risk-to-eapital ratio of25:!. 

• Underwriting. FHA has a "one size fits all" type of underwriting system, which 

does not allow FHA to respond to the build-up or deflation of mortgage market 

bubbles. Private mortgage insurers, on the other hand, have heavily invested in 

analytical tools so that we can make sure the loans we insure meet our 

independent requirements. Private mortgage insurers are constantly monitoring 

the regional mortgage markets and altering their underwriting to ensure that the 

home is affordable for the borrower at closing and over the life of the mortgage. 

• Borrower profiles. Private MI borrowers tend to have slightly higher incomes 

than typical FHA borrowers and higher FICO scores. The different borrower 

profiles are consistent with the different missions of the two models. Private MI 

was designed for first-time and low- to moderate- income borrowers who, but for 

the 20% down payment requirement, would otherwise be able to access financing 

through the conventional market. On the other hand, FHA was designed to make 
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homeownership an option for borrowers who were unable to be served by the 

conventional market 

• The Guarantee. Ginnie Mae charges 6 basis points on all FHA or V A loans to 

lenders (and ultimatcly borrowers) to providc govcmment guarantecd 

"catastrophic loss" protection to investors in Ginnie Mae securities. The GSEs 

provide the same protection on conventional loans, but also frequently take on 

more of the risk resulting in mllch larger guarantee fcc costs to the borrower. 

Fmther, privately-insured GSE loans are backed by private capital, while FHAinsured Ginnie Mae loans are fully guaranteed by the govemment. As a result, 

GSE g-fees arc typically in excess 0[20 basis points on privately-insured 

conventional loans. The difference in cost to the consumer is a material factor in 

lenders favoring FHA loans. 

• Lender Enforcement. In cases of loan default, fraud, and/or misrepresentation, 

FHA may simply require a lender to "indemnify" FHA against losses on the loan. 

However, if the same conditions are found on a conventional loan, the GSEs may 

require a lender to repurchase the loan (with interest). That repurchase 

requirement on conventional GSE loans is far more cumbersome and costly to 

lenders and translates to higher borrowcr costs as well. 

• Analytics. Ovcr the last several years the Department of Housing and Urban 

Development Inspector General and the General Accountability Office have 

enumerated various problems with FHA's automated underwriting systems and 

other operating systems. Because private capital is at risk, private mortgage 

insurers have the ability to receive up-to-date information on their portfolios and 

to use external data sources to do timely comparative analyses oftheir portfolios. 

This enables them to better understand trends in the market and set better criteria. 

A Brief History of the Mortgage Crisis as it Affected Private Mortgage Insurers and 

FHA 

As the housing bubble grew from 2000 to 2007, both FHA and private mortgage 

insurers found themselves at a disadvantage. Their efforts to promote responsible 

underwriting of mortgages for first-time homebuyers was undermined by the 

development of mortgage products the purpose of which was to avoid the use of ANY 

type of mortgage insurance - whether FHA insurance or private ML 

These mortgage products took several forms including piggyback loans where the 

borrower was given two mortgages (a first mortgage and a contemporaneous second 

mortgage) to cover the acquisition of a house with effectively zero cash down payment or 

even a negative down payment. The often advertised purpose of these loans was to avoid 

the payment of mortgage insurance by the borrower and-less advertised but just as 

important-to avoid the review of the borrower's ability to pay the mortgagees) that was 

and is inherent in the use of government or private mortgage insurance. In addition, 

private MI premiums were not yet tax deductible at that time while the higher interest 

paid on the second mortgage was tax deductible. 
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At the height of the boom, the new produets that were developed were based on 

an assumption that house priees eould only rise and eonsequently that, even if the 

borrower could no longer afford the mortgage, the worst that would happen would be that 

they would sell the house and the mortgage investor would be repaid in full at no cost to 

the entity securitizing the mortgage or to the taxpayer. 

Both private MI companies and FHA were challenged by the expansion of these 

products. Indeed, at the height of the mortgage bubble, both FHA and Ginnie Mae 

expressed concern that the volume of new FHA loan originations was insufficient to 

maintain the liquidity of the Ginnie Mae market. 

In order to remain in the market, the underwriting standards and pricing by both 

FHA and private mortgage insurers weakened. This weakening took the form of lower 

insurance premiums by both FHA and private mortgage insurers in an effort to compete 

against the uninsured high loan-to-value ("LTV") mortgage products. The weakening 

also involved greater acceptance by private mortgage insurers of the lenders' 

underwriting decisions of low or no documentation loans and the decisions generated 

through the automated underwriting systems employed by Fannie Mae and Freddie Mac. 

For FHA, the relaxed underwriting included the acceptance of seller paid down payment 

contributions, as well as other underwriting changes. 

As house prices began to fall, certain participants in the mortgage market were 

made aware of problems sooner than others. Lenders holding mortgages on their books 

saw the inerease in delinquencies first and responded by tightening their proprietary 

underwriting requirements. To continue volume, however, many originated loans 

regardless of possible risk if these qualified for FHA or private Ml. The GSEs and 

private mortgage insurers became aware of the higher rate of delinquencies later than the 

lenders and then tightened their underwriting standards and raised their premiums, but 

during the period when lenders shrank their piggy-back loan originations and other risky 

loan originations, private mortgage insurers were adversely selected. This "adverse 

selection" problem is among those proposed for regulatory reform in a reeent paper on 

ways to improve both public and private mortgage insurance that was released earlier this 

year by the Joint Forum. 

Beginning in 2007 and 2008, FHA saw a flood of new mortgage originations 

enter its books as lenders, the GSEs, and private mortgage insurers tightened their own 

underwriting requirements and raised their premiums and delivery fees to respond to 

market conditions. At the time this occurred, FHA had the lowest upfront insurance 

premium in its post-l 990 reform history, and its annual premiums were set at a legislative 

minimum level. As a consequence, loans that otherwise would have gone to the 

subprime market or to the expanded approval, Alt-A, and other programs initiated by the 

GSEs instead were steered by lenders to FHA. This adverse selection of FHA - a 

consequence of inadequate FHA premiums, delegated FHA underwriting to lenders 

without adequate oversight, and the difficulty of a government program to quickly 

respond to a ehanging mortgage market-resulted in FHA holding on its books a large 

share of subprime-like mortgages that were inadequately priced and poorly originated. 
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Private Mortgage Insurers and the Housing Downturn 

The private MI share of the mortgage market contracted significantly as the crisis 

unfolded in 2008-2010. The entire industry faced higher claims requests as house priccs 

fell and borrowers defaulted on their loans. Some private mortgagc insurers stopped 

insuring new mortgages due to capital limitations. Like most financial institutions, 

private mortgage insurcrs were stressed by thc significant nationwide house price 

collapse. But during this period of unprecedented stress to the private MI industry, 

private mortgage insurers continued to pay legitimate claims. From 2007 through the 

third quarter of 20 12, the private MI industry had paid over $30 billion in cash claim 

payments and $3.6 billion in claim receivables to Fannie Mae and Freddie Mac alone as 

verified in their SEC filings. 

Another factor contributing to the declining market sharc of privately insured 

mortgages in this time period were actions by Fannie Mae and Freddie Mac that made the 

loans that they purchased more expensive. After the GSEs entered conservatorship in the 

fall of 2008, they increased the fees they charged to purchase the high LTV loans of 

borrowers with moderate credit scores. The combination of higher GSE delivery fees, 

tighter GSE and private MI underwriting, and higher private MI premiums caused the 

private MI share of the insured low down payment mortgage market to shrink 

significantly. Those actions by the GSEs, combined with higher FHA loan limits 

beginning in 2008, resulted in the private MI share of the insured low down payment 

mortgage market that is served by FHA and private MI combined contracting from 77% 

in 2007 to 16% in 2010. 1 

FHA and the Housing Downturn 

The delegated underwriting concept underlying the operations of FHA, combined 

with the 100% insurance coverage applicable to all FHA-insured loans, resulted in a lack 

of information flowing to FHA as to the weakness in the market in general and the need 

to tighten its underwriting and appraisal requirements in particular. 

FHA did not begin to recognize the negative impact of declining house prices 

until 2010. It was only then that FHA chose to begin tightening its underwriting and 

raise its premiums with increases in the annual premiums occurring in October 2010 in 

response to additional authority given to it by Congress that year. By 2010, FHA's 

market share of the insured market had increased from 17% in 2007 to 68%. By the time 

the FY 2012 actuarial report was issued by HUD, the loans that had been originated in 

2007 through 2010 without tightened underwriting or higher premiums accounted for 

51% of FHA's total insurance in force. 

FHA has taken several steps to tighten its underwriting and raise its premiums in 

subsequent years. Whether these steps will be sufficient to offset the negative financial 

1 The remaining portion of the low down payment market is insured by other entities such as the U.S 

Department of Veterans Affairs ("VA") and the U.S. Department of Agriculture. 
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impact of FHA's rapid growth during a period of collapsing house prices has yet to be 

detennined. 

What is clear, however, is that FHA as a government program provided access to 

credit for many low down paymcnt borrowers as the housing crash unfolded. This is the 

role that a government program should play during a period of economic contraction. 

Unfortunately, the structure of FHA as a 100% insured government program that has 

delegated its underwriting to lenders has resulted in significant losses to the program. 

Private MI: Going Forward 

Private mortgage insurers have the capacity to insure the current and projected 

volume of low down payment loans. Despite having paid over $34 billion in claims since 

the crisis began, private MI companies have also continued to write new insurance 

tbroughout the crisis. Although capital limitations at a few of the companies has meant 

that those companies are unable to write new business, the other private MI companies -

including Radian - have increased the amount of loans they are insuring. In fact, the 

private MI industry has been gradually increasing its market share in recent years. In 

2012, the private MI share of the insured low down payment market increased from 26% 

in the first quarter to 35% in the fourth quarter. 

The industry has attracted over $7 billion in new capital throughout the mortgage 

crisis, two new entrants to the private MI industry havc together brought more than $1 

billion in new capital, and a third company--just announced last month-will be part of a 

well capitalized and well established multi-billion dollar reinsurance company. 

Similarly, private MI companies with legacy books of business have taken steps both to 

raise capital and to reinsure their business in order to effectively bolster their capital 

position. Over the last two weeks, Radian and MGIC have raised almost $1.8 billion in 

private capital. 

Looking ahead, private mortgage insurers stand ready to playa critical role in the 

future of housing finance by continuing to safely and soundly enable first-time and lower 

income families to obtain affordable mortgage loans while protecting taxpayers from the 

losses that result from borrower default. 

Current Housing Policies and Practices Provide FHA with a Competitive Advantage 

over Private MI 

As noted several times throughout this testimony, both FHA and private mortgage 

insurers have important roles to play in promoting a vibrant and sustainable housing 

market. Appropriately, however, there is concern that the mortgage market is 

substantially controlled by FHA and the GSEs, with FHA today insuring approximately 

56.4 percent of all insured mortgages. Meanwhile, private mortgage insurers only 

represent roughly 35% of the market. This is because, in the past few years, FHA has 

dominated the mortgage insurance market due to housing policies and practices that 

provide competitive advantages to FHA while crowding out private capital in the form of 

private MI. 
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Many of the policies and practices described below steer borrowers to FHA either 

by making privately-insured loans purchased by the GSEs more expensive than 

government-backed FHA loans or providing lenders with other incentives to encourage 

borrowers to obtain FHA-insurance over private MI. 

• FHA Loan Limits. Beginning in 2008, Congress temporarily increascd thc FHA 

loan limits in both high-cost and non-high-cost arcas. These limits expired as 

schedulcd in October 2011. However, in November 2011, Congress reinstated the 

increased limits for both high cost and non-high-cost areas. This action restored 

FHA's higher loan limits without commensurately restoring the GSEs' higher 

loan limits, thus making loan limits for government-insured loans higher than loan 

limits for privately-insured loans for the first time in history. This unprecedented 

move permits FHA to service segments ofthe market that are now closed off to 

private mortgage insurers, thereby driving business to the FHA and away from the 

private MI industry. 

• FHA Premiums. FHA currcntly underprices the risk that it insures. FHA 

premiums do not reflect the true risk ofthe loans that FHA insures as reflected by 

comparable private MI premium pricing. 

• FHA Federal Guarantee. FHA insures 100% of the loan amount if the home 

goes into foreclosure so that the loan originator lacks any meaningful risk of loss. 

Private MI, on the other hand, stands in a first loss position behind the borrower's 

equity and generally is 25% to 35% of the loan amount. 

• GSE G-fees. G-fees are additional fees charged for mortgages that are purchased 

and guaranteed by the GSEs. In December 20 II , Congress included a 10 basis 

points g-fee increase as a "pay-for" in a two-month payroll tax cut extension. In 

August 2012, the FHFA directed the GSEs to increase their g-fees again by 10 

basis points, effective November 2012. This legislation increased the GSE g-fee 

to 35 basis points as compared to the 6 basis points guarantee fee that is applied to 

loans that are insured by FHA and guaranteed by Ginnie Mae. The effect of 

increasing GSE g-fees is to make privately-insured loans purchased by the GSEs 

more expensive to originate and sell, thereby driving borrowers to FHA. 

• GSE Loan Level Price Adjustments. Over the past couple of years, the GSEs 

have imposed so-called "loan level price adjustments" ("LLP As") on existing, 

high-performing loans in an attempt to cover losses from the low-performing 

books that the GSEs serviced prior to 2008. The GSEs claim that these LLP As are 

risk-based, but in fact, they are arbitrarily imposed fees that are designed to 

increase revenue. Fannie Mae and Freddie Mac continue to increase the fees that 

they charge to borrowers, including both g-fees and LLPAs, beyond what is 

actuarially sound, thereby steering borrowers away from privately-insured loans 

that are purchased by Fannie Mae and Freddie Mac toward fully governmentbacked FHA-insured loans. 
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• FHA Indemnification Enforcement. The HUD Secretary has the authority to 

require lenders to indemnifY the Secretary for the loss incurred when HUD pays a 

claim on a loan insured by FHA if the loan was not originated according to 

HUD's established guidelines or if fraud or misrepresentation was involved in the 

loan's origination. In practice, however, HUD has not actively or broadly 

exercised its enforcement authority in this area. As a result, lenders, when 

helping a borrower to choose between an FHA-insured loan or a privately-insured 

loan, take into consideration the reality that HUD is unlikely to require the lender 

to indemnifY HUD in the event of borrower default, even if the loan was not 

originated in accordance with HUD's guidelines. On the other hand, in the event 

of improper origination, the GSEs may require the lender to repurchase the loan. 

Thus, HUD's indemnification enforcement practices provide an incentive for 

lenders to steer borrowers to FHA loans. 

• "Qualified Residential Mortgage" Definition. In the proposed "qualified 

residential mortgage" rule ("QRM"), loans with 20% down payments and low 

down payment loans insured by FHA are both exempt from the Dodd-Frank risk 

retention requirements. Loans guaranteed by the GSEs are also exempt from the 

risk retention requirements while the GSEs are in conservatorship. Low down 

payment loans that are privately insured are not included in the QRM exemption. 

This means that, after the GSEs' conservatorship ends, the only low down 

payment loans that would be exempt from the risk retention requirements would 

be those insured by FHA. This would increase FHA's market share while 

decreasing the private MI industry's ability to compete, despite the fact that the 

Congress has made clear to the regulators that they should define the QRM to 

include low down payment loans that are insured by private MI. This could also 

be accomplished by synchronizing the QRM definition with Qualified Mortgage 

definition under Dodd-Frank, thereby eliminating any additional down payment 

requirement. 

• Basel III. The U.S. banking regulators have proposed rules to implement Basel 

III in the United States. The proposed rule would significantly raise minimum 

capital requirements for banks and, for residential mortgages, the proposed rule 

would assign risk-weightings based on LTV. FHA loans retain a risk weighting 

of zero. However, the banking regulators do not recognize private MI as a risk 

mitigant when assigning residential mortgage credit asset risk-weightings based 

on a mortgage's LTV ratio. This means that, as proposed, a loan with a 5% down 

payment that lli insured by private MI would be treated the same as a loan with a 

95% LTV without private MI in terms of the amount of capital that a bank must 

hold for that loan. Therefore, the proposed rule would favor high down payment 

loans by making low down payment loans more costly and also further tilt the 

playing field for low down payment loans to FHA. 
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Recommendations for the Future 

Reforms are nccessary to scale back FHA to its stated historical mission of 

supporting underservcd borrowers and to improve the agency's financial position whilc 

enabling private MI, with its reliance on private capital, to be uscd by borrowers in the 

conventional market. I provide several recommendations below: 

Share the risk with the private sector. Changes are needcd both to protect the 

FHA and the U.S. taxpayer and, just as importantly, to protcct future FHA borrowers who 

should not be put into homes thcy cannot afford to keep. FHA should be authorized to 

cnter into a modem risk-share agreement with private mortgage insurers. Undcr this riskshare, the private mortgage insurer will conduct an independent underwriting of the FHA 

borrower and the mortgage being sought. If the borrower and the mortgage undcrwriting 

terms meet the conditions mutually agrced upon bctween FHA and the private mortgage 

insurer, then the private mortgage insurer will take the first loss on the FHA loan with the 

deeper loss covered by FHA. In this way, FHA and the U.S. taxpaycr will be protected 

by an indepcndent underwriting at thc front end of the loan origination and private capital 

will be placed at a position of first loss risk on any future claim arising from the mutually 

insured loan. In this way, the potential FHA borrower also will be protected by the 

upfront private MI underwriting from entcring into a mortgage that places him or her at 

risk of foreclosure. 

Focus FHA on low and moderate income borrowers. FHA's loan limits have 

been set at very high levels, which make the program attractive to borrowers with 

comparatively high incomes. In high cost areas, FHA insures mortgages up to $729,750. 

Even at interest rates as low as 3.5%, a borrower needs an annual income of no less than 

$175,000 to qualifY for a loan of this size. Nationwide, the FHA has a base loan limit of 

$271,050, which is now almost $100,000 higher than the average existing horne sold in 

2012 according to NAR. 

Additionally, the concept of a government program targeted to house prices and 

loan amounts, rather than the income of the borrower, no longer makes sense. What we 

have seen over the years is that the FHA loan amounts continue to increase while the 

average American's income stagnates. Even when house prices fall in an area, the FHA 

loan limits remain frozen. Thus, through FHA, the U.S. taxpayer is being asked to 

subsidize larger and larger mortgages for those people who can afford them without 

taxpayer assistance. 

In this time of budgetary struggles, asking taxpayers to subsidize higher income 

and wealthy borrowers through government mortgage insurance seems likc curious 

public policy. Rather, the FHA program should be targeted to the median income of the 

household in an area. In fact, the Administration's February 2011 white paper to 

Congress on housing financc reform specifically called for limiting FHA eligibility to 

borrowers that have incomes below the mcdian lcvel for their area. In this way, FHA will 

be targeted to serve only the moderate and middle-income borrowers who need their help. 

FHA should not be used by higher income borrowers who can afford the highest priced 
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homes in an area even where the average family in that same area eould not dream of 

affording the same high-prieed home. 

Reduce the level of the government guarantee. Congress should also reduce 

the FHA's guarantee below its current 100% level similar to the VA mortgage program. 

An essential feature of private MI is the concept of coinsurance on the part of all parties 

to the transaetion. Private MI stands in a first loss position behind the borrower's equity 

and generally is 25% to 35% of the loan amount, whieh covers most, but not all, of the 

losses that the parties to the mortgage transaction experience so there remains an 

incentive for all parties to avoid foreelosure. FHA, on the other hand, insures 100% of 

the loan amount if the home goes into foreelosure so that the loan originator lacks any 

meaningful risk ofloss. This 100% guarantee does not properly align incentives 

between originators and the FHA. Reducing the 100% coverage amount will provide 

lenders with an incentive to conduct prudent underwriting. It will also reduee taxpayer 

exposure to losses resulting from borrower default, and this will reduee the budgetary 

eost of FHA's program. 

Provide more flexibility for FHA premiums. One major reason FHA is in such 

financial distress is that it historically did not charge prcmiums that were appropriate for 

the risk. In order to adequately protect the FHA fund and the taxpayer and to avoid an 

unfair government price advantage compared to the private sector, Congress should 

provide FHA with additional authority to adjust its premiums to levels that reflect the true 

risk of the loans that it insures. Doing so will help FHA to prevent a costly taxpayer 

bailout. 

Avoid government actions that unintentionally drive borrowers to FHA. It 

is important that the government not take actions that unfairly tilt the playing field to 

government insured programs like FHA rather than private MI, thereby discouraging 

reliance on private capital in the housing market. As policy makers scale back the GSEs, 

they have also reduced opportunities for private MI, which means that low down payment 

loans will be insured by the FHA. For example, Fannie Mae and Freddie Mac, at the 

behest of Congress and the Federal Housing Finance Agency, continue to increase the 

fees that they charge to borrowers, such as GSE gnarantee fees and LLP As beyond what 

is actuarially sound, thereby making privately-insured loans purchased by the GSEs more 

expensive than FHA-insured loans. As a result, increasing GSE pricing steers borrowers 

with low down payments away from privately-insured loans that are sold to Fannie Mae 

and Freddie Mae and towards government-backed FHA-insured loans. Policy makers 

should discontinue the practice of increasing GSE g-fees and LLPAs unless there is 

demonstrated additional risk and GAO should publish and submit to Congress an annual, 

independent, actuarial review of GSE pricing. 

Regulations that Could Potentially Advantage FHA 

QRM. As discussed previously, regulators are today considering the appropriate 

mortgages to inelude within the QRM exemption to the Dodd-Frank risk retention 

requirements. The proposed rule would limit the QRM exemption to loans with 20% 

down payments. Additionally, regulators have proposed to automatically exempt FHA-
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insured loans from the risk retention requirements, and loans guaranteed by the GSEs are 

also exempt from the risk retention requirements while the GSEs are in conservatorship. 

Low down payment loans that are privately insured are not included in the QRM 

exemption. This means that, after the GSEs' conservatorship ends, the only low down 

payment loans that would be exempt from the risk retention requirements would be those 

insured by FHA. 

As proposed, the rule would inerease FHA's market share while decreasing the 

private MI industry's ability to compete, significantly and unnecessarily impeding the 

availability of private capital to serve low down payment borrowers. Ultimately, the U.S. 

taxpayer will be asked to bear even more of the risk associated with low down payment 

borrowers. 

Synchronizing the QRM definition with Qualified Mortgage definition under 

Dodd-Frank would eliminate any additional down payment requirement. There is much 

support for this outcome. With the elimination of risky mortgage terms through the final 

Qualified Mortgage rule, the low down payment borrower is proteeted from entering into 

a risky mortgage. 

However, if a down payment requirement is included in the QRM exemption, 

then the QRM exemption should include loans with down payments of 5% to 20% 

provided that they have first loss loan level insurance coverage by an adequately 

capitalized private mortgage insurer. The presence of private MI ensures that the private 

sector has "skin in the game," thereby achieving the primary goal of the risk retention 

requirements. Additionally, a 5% down payment loan insured by private MI has 

historically provided more protection to lenders and investors from the risk of default 

than would a 20% down payment. This is because when adequate private MI coverage is 

required on a low down payment mortgage, the combination of the private MI coverage 

and the borrower's down payment will typically cover 25-35% of the loan amountmeaning lenders and investors are at risk for only the remaining 65-75% of the loan 

amount instead of 80% for a loan with 20% down without private MJ. 

BasellII. Currently, the U.S. risk-based capital rules (generally referred to as 

Basel I when they apply to community banks and Basel II wben applicable to the largest 

banks) provide a zero risk weight for obligations backed by the full faith and credit of the 

United States Government ("USG"), including mortgages insured by FHA or mortgage 

backed seeurities guaranteed by Ginnie Mac comprised of FHA-insured loans. The Basel 

I rules also have allowed the U.S. banking agencies to provide a reduced risk weight for 

high LTV mortgages when these are backed by private MI. This means that loans with 

LTVs that are greater than 80% carry a 100% risk weight, while those loans with LTVs 

that are greater than 80% and insured by private MI have a 50% risk weight. For Basel II 

banks, the internal models that determine risk weightings also may take private MI into 

account to reduce risk weightings for all insured loans. 

The proposed Basel III rules that would govern all U.S. insured depositories and 

their holding companies maintain the zero risk weighting for USG-backed obligations. 

This means that the banks could still hold no risk-based capital related to FHA-insured 
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loans. However, the proposal would eliminate any reduced risk weighting when private 

MI is used, thus making it equally costly under the capital rules to hold a high LTV 

mortgage with or without private ML For example, as proposed, a loan with 5% down 

that & insured by private MI would be treated the same as a loan with a 95% LTV 

without private MI in terms of the amount of capital that a bank must hold for that loan. 

The practical effect of this proposed treatment is two-fold. First, it creates a 

strong regulatory incentive for U.S. banking organizations to hold only USG-backed 

mortgage obligations, significantly increasing taxpayer risk. Secondly, it makes high 

LTV mortgages that are privately insured unnecessarily costly for lenders because the 

value of private MI as a proven form of credit risk mitigation is not reflected in the 

applicable risk-based capital requirement Given the need for high LTV mortgages to be 

insured outside of FHA, the proposed Basel III rule will sharPly reduce credit availability 

to borrowers like first-time homeowners. Instead, the final rule should continue the 

current treatment of private MI and permit banks to offset some of their capital with that 

of qualified private mortgage insurers, as this will significantly increase credit availability 

for first-time homebuyers without putting either the bank or taxpayer at risk. 

Conclusion 

FHA has served and should continue to serve a critical role in the housing finance 

system by providing access to homeownership to those low and moderate income 

borrowers who are unable to obtain loans via the conventional market However, the 

recent crisis has identified issues that should be addressed in order for FHA to continue to 

play this important role. For example, in the report it released last month, the Bipartisan 

Policy Center recommended that Congress lower FHA loan limits and increase FHA 

premiums to return FHA to its traditional role. 

Indeed, FHA reform should be undertaken with a view toward reducing the role 

of the federal government in the mortgage market, increasing the role of private sector 

capital, and preventing future taxpayer bailouts. This necessarily includes scaling back 

FHA to its traditional role of supporting underserved borrowers and discontinuing 

housing policies and practices that provide a competitive advantage to FHA over private 

MI. 

In examining the range ofrefonns before the Subcommittee, I urge you to: 

• Authorize risk-sharing between private mortgage insurers and FHA. This will 

introduce private-sector discipline to FHA underwriting and place private capital 

in a first loss position ahead of the taxpayer; 

• Alter FHA-borrower eligibility standards to target them to low- to moderateincome levels, not house prices. This will allocate taxpayer resources to serve the 

FHA's rightful mission; 
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• Consider additional reforms, induding reducing the FHA's guarantee below its 

current 100% level, much the same as the VA mortgage program. This will 

properly align incentives between originators and the FHA; 

• Require FHA to establish premiums that accurately reflect the true risk of thc 

loans that it insures. This will help to ensure that FHA avoids a eostly taxpayer 

bailout; 

• A void government actions, such as GSE price increases, that steer borrowers with 

low down payments away from privately-insured loans purchased by the GSEs 

and toward federally-insured FHA loans. This will bring more private capital into 

the housing market; 

• Encourage regulators to exdude prudently underwritten, privately-insured loans 

from the Dodd-Frank risk retention requirements; and 

• Encourage regulators to continue the current treatment of private MI in the final 

Basel III rule and permit banks to offset some of their eapital with that of a 

qualified private mortgage insurers. 
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, TESTIMONY 

Milliman 

TESTIMONY 

Mortgage Insurance: 

Comparing Private Sector and Government-Subsidized Approaches 

Prepared by: 

Milliman. Inc. 

Kenneth A. Bjurstrom 

Before The 

The Subcommittee on Housing and Insurance 

United States House of Representatives 

Wednesday, March 13, 2013 at 10:00 a.m. 

Room 2128 Rayburn House Office Building 

Principal and Financial ConSUltant 

March 12. 2013 

Milliman 

15800 W. B!uemound Road, Suite 100 

Brookfield, W! 53005-6043 

TEL +12627842250 

FAX +12629233686 

Mi!liman.com 
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TESTIMONY 

Mortgage Insurance: 

Comparing Private Sector and Government-Subsidized Approaches 

OPENING REMARKS 

Before The 

The Subcommittee on Housing and Insurance 

United States House of Representatives 

Chairman Neugebauer, Ranking Member Capuano, Members of the Subcommittee: Thank you for the 

privilege of appearing before you today. 

My name is Ken Bjurstrom. I am a Principal at Milliman, Inc., where my practice focuses on mortgage 

credit risk analysis for the mortgage insurance and mortgage banking industry. In association with 

Milliman, I have conducted analyses of the private mortgage insurance industry at the request of 

individual companies and their trade association. At the request of the U.S. Department of Housing and 

Urban Development's Inspector General, I have conducted several reviews of the actuarial report for the 

Federal Housing Administration's (FHA) Mutual Mortgage Insurance Fund (MMIF). 

You have asked me to discuss and compare the mechanics of the private mortgage insurance business 

and the FHA, including its operational, structural and regulatory components and include any other 

legislative and regulatory suggestions that I believe will enhance FHA, protect taxpayers and facilitate the 

return of private capital. To that end, in my testimony I will recommend that the FHA evaluate and adopt 

many of the private mortgage insurance statutory accounting provisions, better understand and modify 

their exposures to those that specifically support their mission and retain the necessary capital that is 

required to protect the Mutual Mortgage Insurance Fund currently and for the next economic downturn 

that will most definitely occur again, at some point in the future. 

Milliman 
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2 

MORTGAGE INSURANCE 

Mortgage insurance makes home ownership possible for first time home-buyers with limited credit history 

and underserved borrowers with limited resources. Without such insurance coverage, mortgage lenders 

would generally require a borrower to have a downpayment equal to at least 20% of the home's value. 

With mortgage insurance coverage, mortgage lenders are able to originate loans to borrowers with 

downpayments of as little as 3%. 

To the extent that the losses associated with mortgage defaults tend to vary based on macroeconomic 

conditions, a mortgage insurer, whether it is a private mortgage insurer or the FHA, is in the business of 

"insuring the economy." During periods of economic expansion, the credit environment is generally 

healthy and mortgage default losses tend to moderate or diminish, enabling insurers to realize and retain 

underwriting earnings to cover potential losses that inevitably arise in the economic contractions that 

follow. During recessions, the credit environment deteriorates and defauH-related losses tend to mount, 

potentially causing mortgage insurers to draw down their stockpiles of retained underwriting earnings to 

cover claims. 

Exhibit 1 illustrates the annual rate of change in the FHFA All Transactions historical and forecasted 

home price Index and unemployment rate developed by Moody's Analytics as of September 30, 2012. 

During the early 1980s and again in the early 1990's, as well as over the last few years, the economy has 

suffered declines in home prices or increases in unemployment resulting in mortgage insurance claims. 

Subsequent to each of these periods of economic stress the FHA's MMIF experienced substantial losses. 

Exhibit 2 illustrates the actual and ultimate forecasted claim rates by endorsement year of the MMIF 

according to the most recent FHA actuarial review ,. Both the actual and forecasted claim rates in this 

exhibit were produced by the FHA's independent actuary. For endorsement year 1981, roughly 22 out of 

every 100 FHA borrowers defauHed and lost their home resutting in a mortgage insurance claim to the 

FHA. For endorsement years 1990 through 2003, approximately 8 out of 100 FHA borrowers resulted in 

a claim to the FHA. For 2007 endorsements, over 30 out of every 100 FHA borrowers are estimated to 

result in an FHA claim demonstrating the volatility of the mortgage insurance business. 

Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund Forward Loans for 

Fiscal Year 2012, November 5,2012, Integrated Financial Engineering. 

Milliman 
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- 3-

MORTGAGE INSURANCE OPERATIONS 

As Illustrated, this unique line of insurance exposes mortgage insurers like the FHA to considerable risks. 

The non-cancelable contracts for extended durations of coverage coupled with the economically 

correlated individual risks lead to extreme volatility of losses. This, in turn, necessitates mortgage 

insurers such as the FHA to maintain basic disciplines that govern the financial operations including 

underwriting and ratemaking, loss reserving and high capital commitments as directed by counter parties, 

regulators and rating agency requirements. 

Underwriting and Rate Making 

According to the Statement of Principles Regarding Property and Casualty Ratemaking (SOPRatemaking) as adopted by the Board of Directors of the Casualty Actuarial Society (CAS), Ratemaking is 

defined as "the process of establishing rates used in insurance or other risk transfer mechanisms." 

The following four ratemaking principles are specified in SOP-Ratemaking and can be applied to 

mortgage insurance ratemaking: 

Principle 1: a rate is an estimate of the expected value of future costs; 

Principle 2: a rate provides for all costs associated with the transfer of risk; 

Principle 3: a rate provides for the costs associated with an individual risk transfer; 

Principle 4: a rate is reasonable and not excessive, inadequate or unfairly discriminatory if it is an 

actuarially sound estimate of the expected value of all future costs associated with an individual 

risk transfer. 

The key objective of the ratemaking process is therefore the estimation of the costs associated with the 

transfer of risk effected by issuing mortgage insurance policies. Historically, mortgage insurers have 

generally used the size of the down payment or loan-to-value, product type such as fixed rate or 

adjustable rate and the amount of coverage in their underwriting and rate making approach. Relatively 

recently, private mortgage insurers have expanded their premium rate programs to recognize the 

importance of borrower FICO Scores and other factors. 

In contrast, the FHA currently utilizes fewer tools available to them to financially manage mortgage 

insurance exposures. The FHA insures 100% of the potential claim loss, compared to generally 25% to 

35% for private mortgage insurers, and the FHA charges the same premium rates for all loan product 

types and borrower FICO Scores. Wtthout a more granular approach to ratemaking the FHA may be 

encouraging adverse selection with respect to obtaining FHA mortgage insurance protection. 

Ratemaking for mortgage insurance should take these factors into account and take a long-term view of 

pricing while also considering the important roles of adverse selection and changes in the underlying 

insured risks. The adverse selection effects of alternatives to mortgage insurance coupled with the 

potential for future boom and busts in the housing market add to the operational challenges of mortgage 

insurance industry. 

Statutory Reserve Requirements 

Mortgage insurance losses represent the costs of claims arising from defaulting loans insured under 

mortgage insurance policies. Such losses are incurred when a loan becomes delinquent and ultimately 

gives rise to a claim by an insured lender or investor. A private mortgage insurer must be licensed in each 

state where it writes business and insurance laws generally require private mortgage insurers to 

adequately maintain the following reserves: 

Milliman 
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4-

Unearned Premium Reserve: 

./ A reserve on an annual or on a monthly pro rata basis on all unexpired coverage, except that in 

the case of premiums paid more than one year in advance, the premium shall be earned 

proportionally with the expiration of exposure; 

Loss Reserve (both a case and incurred but not reported reserves) and Loss Adjustment Reserves: 

./ Case basis loss reserves are based on an estimate of the liability for claims on individual insured 

loans in various stages of default; 

./ An incurred but not reported reserve is based on an estimate of the liability for future claims on 

insured loans that are in defautt but of which the insurer has yet to be notified by the servicer; and 

./ A loss adjustment expense reserve is based on an estimate of the cost of adjusting and settling 

claims on insured loans in default; 

Contingency Reserve: 

./ A reserve, which consists of fifty percent (50%) of the insurers earned premium and is maintained 

for ten years. Subject to the approval of the commissioner, withdrawals may be made from the 

contingency reserve in any year in which the actual incurred losses exceed 35% of the earned 

premiums. 

Additionally, general insurance requirements may also require a premium deficiency reserve. A statutory 

premium deficiency exists if future paid losses and expenses on unexpired business as of an evaluation 

date exceed the related premium revenue for such business (on a present value basis), along with the 

current loss reserves, unearned premium reserve and contingency reserve. 

The reserve requirements for private mortgage insurance require the company to account for near-tem 

expected losses, restrict shorter-term dividends and measure the company's ability to write new business. 

The FHA in contrast does not have a comparable reserving methodology. 

Statutory and Industry Capital Commitment 

Private mortgage insurers are generally subject to a maximum risk-to-capital ratio of 25:1 (Le., the ratio of 

insured loan risk exposure [coverage times original loan balance] to the sum of policyholders' surplus and 

contingency reserves). Taken together, the contingency reserve and risk-to-capital ratio requirements 

have the effect of requiring the private mortgage insurer to build reserves and surplus during periods of 

economic growth and stability so that they are in position to cover substantial levels of claims during 

periods of economic downturn. 

In addition, Fannie Mae and Freddie Mac (the GSEs) have developed a rigorous set of eligibility 

requirements for their approved private mortgage insurers. Private mortgage insurers must comply with 

these requirements in order to maintain approval to insure mortgage loan business purchased or 

securitized by the GSEs. The requirements have been periodically updated over time as the mortgage 

lending environment has evolved and the GSEs' needs have changed. 

The three major credit rating agencies also monitor the financial safety and soundness of the mortgage 

insurers. In part, the agencies have assumed this role in conjunction with GSE private mortgage insurer 

eligibility requirements. 

The FHA MMIF is not subject to the statutory reserve requirements or comparable capital requirements 

as those that apply to private mortgage insurers. 

Milliman 
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-5 

The 1990 Cranston-Gonzalez National Affordable Housing Act requires an independent actuarial analysis 

of the economic net worth and financial soundness of the FHA MMIF. The primary purpose of this 

actuarial review is to estimate (excluding Home Equity Conversion Mortgages): 

The economic value of the MMIF, defined as the sum of existing capital resources, total assets less 

total liabilities of the MMIF, plus the net present value of the current books of business; and 

The total insurance-in-force (IIF) of the MMIF. 

The FHA is required to maintain a 2 percent ratio of the economic value of the MMIF to IIF (capital ratio). 

This ratio requirement and the economic valuation from which it is derived is the FHA's only gauge of its 

ability to withstand losses 

The economic value calculation for the FHA has several inherent weaknesses. The calculation is based 

on a 30-year time horizon and is subject to a forecast of the United Sates economy. Exhibit 1 attached to 

my testimony highlights the actual and forecasted rates of home prices and unemployment since 1979 

and the assumptions currently used by the FHA in assessing its actuarial soundness. Although the 

current financial crisis is generally reflected beginning in 2007 and recovering in 2013, the longer-term 

forecasts generally assume a return to a 6% unemployment rate and home prices appreciating at greater 

than 3%. This long-term forecast results in significant positive economic value for the most recent 

endorsement years as if these economic forecasts were certain. Because the more recent endorsement 

years have the potential for significant variability over the long-term the calculation should consider the 

risk associated with economic outcomes and insurance liabilities, particularly given the size of the more 

recent endorsement years. In contrast, the private mortgage insurers do not take credit for the economic 

value reflected in future premiums in terms of their statutory capital requirements. 

If we relook at the history and forecasted FHA claim rates (Exhibit 2) and the economic environments 

(Exhibit 1) that caused them, it is clear that the FHA should establish a capital threshold that reflects a 

more risk-based probability of stressed losses in the future. Exhibit 3 illustrates the number of 

endorsement years that are estimated to experience the indicated ultimate claim rate. Over roughly a 

thirty-year period 13 of the endorsement years have an ultimate claim rate greater than 10%. A simple 

probability distribution calculation would suggest that FHA should expect an ultimate claim rate greater 

than 15% more than 20% of the time. 

In addition to reflecting the risk of more adverse economic outcomes, the FHA should be allowed to 

establish loss reserves and account for estimated loss liabilities prior to determining its capital ratio or 

other assessment of its financial strength. The establishment of loss reserves for currently delinquent 

borrowers for example is more transparent to estimate because these reserves are calculated using 

current market and economic conditions. Loss reserves are a critical part of determining the actuarial 

health of any insurance fund and should be part of the MMIF capital assessment to give Congress a more 

accurate view as to the capital adequacy of the FHA's single family operations. 

Milliman 
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6-

RECOMMENDATIONS AND CONCLUSIONS 

The mortgage insurance industry has weathered many storms since 1934 when the National Housing Act 

was passed in 1934 to create the FHA and make better housing available to low- and moderate-income 

families and 1957 when the private mortgage insurance industry was established to supplement the 

financing of affordable housing with private capital put at risk. Since the early 1980s when I began 

working in this industry I have witnessed muttiple economic downturns which created tremendous losses 

for both private mortgage insurance companies and government run funds at both the state and federal 

level. It is therefore important to continue to work diligently in protecting this very important housing 

program. To that end I recommend that the FHA evaluate and adopt rnany of the private mortgage 

insurance statutory accounting provisions described above, better understand and modify their exposures 

to those that specifically support their mission and retain the necessary capital that is required to protect 

the program now and for the next economic downturn that will most definitely occur again. 

Milliman 
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-7-

QUALIFICATIONS AND LIMITATIONS 

For this testimony, I have relied on data and other information provided in the public domain. I have not 

audited or verified this data and information. If the underlying data or information is inaccurate or 

incomplete, my testimony may likewise be inaccurate or incomplete. I have significant expertise in the 

evaluation of mortgage credit risk and mortgage insurance and I have been assisted with my testimony by 

staff and peer reviewers who are Members of the American Academy of Actuaries, Fellows of the 

Casualty Actuarial Society and/or also have significant expertise in the evaluation of mortgage insurance. 

Additionally, Milliman has not performed an exhaustive review of the FHA's MMIF ultimate claims paying 

ability and therefore are not expressing an opinion on the MMIF's financial condition. 

Any reader of this report must possess a certain level of expertise in areas relevant to this testimony to 

appreciate the significance of the assumptions and the impact of these assumptions on the illustrated 

results. The reader should be advised by, among other experts, actuaries or other professionals 

competent in the area of actuarial projections of the type in this testimony, so as to properly interpret. 

• • • • • 

Thank you for inviting me and for your consideration of my views. I would be pleased to answer any 

questions from the Subcommittee membership. 

Respectfully submitted, 

Kenneth A. Bjurstrom 

Principal and Financial Consultant 

Milliman, Inc. 

KAB/sbs 

March 12, 2013 

Milliman 

80872.030

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Home Price Index Value and National Unemployment Rate 

Moody's Analytics Historical and Forecast 

FHFA All Transactions Home Price Index, (Index 1980Q1 = 100, NSA) 

,.; Actual Data _Actual Forecast _Actual Unemployment Rate •••• Forecast Unemployment Rate 

Calendar Year 

Source Moody's AnalytJcs 

Milliman 

80872.031

35% 30% 

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U.S. Department of Housing and Urban Development 

Federal Housing Administration Mutual Mortgage Insurance Fund 

Ultimate Claim Rate Estimates by Endorsement Year 

Source: FY 2012 Actuarial Review 

Endorsement Year 

Source Actuanal Rev,ew ot the FedSfal iiouslog Adm)(HS!J"a(,on'$ Mutua! Mortgage Insurance Funo FOfWafd Loans for F,acal Year 2012 

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U.S. Department of Housing and Urban Development 

i'ederal Housing Administration Mutual Mortgage Insurance Fund 

Ultimate Claim Rate Frequency Distribution 

Source: FY 2012 Actuarial Review 

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Ultimate Claim Rate 

Source Aclul!rlaJ R .. ",ew 01 the F .. deral hwsrng Adm,n'stratlQr)'s Mutual Mortgage losu'a!1ce Fund Forward Loans for Fiscal Year 2012 

MlHiman 
76 


80872.033

POTOMAC PARTNERS LtC 

The Power of Partnership in Washi1lgto11 

Testimony of 

Brian Chappelle 

Partner, Potomac Partners llC 

Washington D.C. 

Hearing before the U.s. House of Representatives 

Committee on Financial Services 

Subcommittee on Housing and Insurance 

on 

"Mortgage Insurance: Comparing Private Sector and Government-Subsidized Approaches" 

Wednesday, March 13, 2013 

Chairman Neugebauer, Ranking Member Capuano, and Members of the Subcommittee, thank 

you for the opportunity to testify on the role of the Federal Housing Administration. 

In my testimony, I will address the three issues outlined in your letter. They are: 

Mechanics of the mortgage insurance business and FHA 

• Discussion of whether FHA's policies and practices thwart efforts by the private sector 

to revive and strengthen the free enterprise system 

• legislative and regulatory suggestions to enhance FHA, protect taxpayers and facilitate 

the return of private capital 

I believe that a strong and viable private mortgage insurance (MI) industry is an integral part of 

the mortgage market. However, I also believe that the Mis' current problems have little do with 

the Federal Housing Administration. 

Before addressing the specific issues listed above, I would like to discuss, what I believe, is a 

more pressing problem for the mortgage market and the broader economy: the over-all 

weakness of the purchase mortgage market. This problem affects policy considerations for FHA, 

the Mis and the Government Sponsored Enterprises (GSEs). Just last Friday, in a speech to the 

Mortgage Bankers Association of America, Federal Reserve Board Governor Elizabeth Duke 

highlighted the severity of this problem, noting that "purchase mortgage originations hit their 

lowest level since the early 1990s". 

Younger, lower income and minority homebuyers are being particularly hard-hit by these 

troubling purchase numbers. According to Governor Duke, "from late 2009 to 2011, the fraction 

of individuals under 40 years of age getting a mortgage for the first time was half of what it was 

in the early 2000s". She added that since 2007, there has been "a fall of about 90% (in purchase 

originations) for borrowers with credit scores between 620 and 680". The Federal Reserve's 

Bulletin: Mortgage Market in 2011, which analyzed Home Mortgage Disclosure Act (HMDA) 

data, also indicates that lower income and minority homebuyers saw the steepest declines in 

homeownership activity. link: 

http:Uwww.federalreserve.gov/pubs/bulietin/2012/articies/HMDA/default.htm 

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80872.034

At the same time, "all cash" sales approached 30% of all purchase transactions in 2012 

according to the National Association of Realtors. DataQuick, a mortgage and real estate 

information firm, found that 32% of all purchase transactions in California were "all cash" in 

2012. In other words, the private sector has returned to the housing market, just not to the 

mortgage market. 

The disappointing purchase activity (which is also seen in FHA and GSE purchase volumes) and 

the explosive growth in "all cash" sales raise serious concerns about the mortgage market. 

Unless policymakers address these concerns, I am worried that we may well be moving 

backwards towards a housing market where homeowners hip is limited to those who are 

wealthy (or have wealthy parents) and a dwindling few whose credit is stellar enough to qualify 

for a mortgage. At the same time, there will be an increasing number of renters who, while 

creditworthy, lack the resources to purchase a home. I believe that we must first solve this 

challenge before worrying about carving up a depressed purchase mortgage market. 

The main pOints of my testimony are: 

1. The fundamental problem with the current mortgage market is not that FHA is doing 

too many purchase loans but that combined (FHA, the GSEs and the private mortgage 

insurers) are not backing enough purchase mortgage originations. 

Despite the fact that the government is reportedly 90% of the mortgage market, FHA and 

Government Sponsored Enterprise (GSE) purchase activity is running well behind historical 

levels. FHA's FY 2012 purchase volume was 13 percent below FHA purchase activity in FY 2000 

when FHA's share was in line with historical norms. FHA purchase activity has fallen steadily 

since FY 2010 and its FY 2012 volume was 34 percent below FY 2010 levels. 

Fannie Mae and Freddie Mac's purchase activity is even more disappointing. The GSEs together 

have barely backed more purchase loans than FHA since 2009 and that only occurred because of 

recent FHA's declines as part of its effort to assist the recovery of the private mortgage insurers. 

They historically acquired multiples of FHA's purchase activity. It is estimated that the GSEs' 

combined purchase volume is roughly 50% of pre-bubble levels. 

Home Mortgage Disclosure Act (HMDA) data corroborates this problem for the broader 

mortgage market. U.S. total purchase transactions have declined almost 50 percent from 4.79 

million loans in 2000 to 2.42 million loans in 2011 (latest year available) and based on Governor 

Duke's speech, there is little optimism for improvement in 2012. 

2. FHA's performance has improved significantly since the housing crisis. 

The Committee was rightly concerned about the FY 2012 Actuarial Review's headline number of 

negative $13.5 billion for the forward mortgage program. However, a closer look at the 

independent actuary's analysis confirms that FHA's problems are concentrated in older books 

(FY 2005 - FY 2008), which are 13% of FHA's portfolio. Recent books (FY 2010 - FY 2012), which 

are 58% of FHA's portfolio, are projected to perform better than any three-year period of FHA 

underwritten loans in more than 30 years. Despite the $28 billion of negative adjustments in 

the audit, the projected cumulative claim rate of the FY 2010 - 2012 books actually improved in 

the FY 2012 audit to a combined cumulative claim rate of 6.3% (1 in 16 loans). Each of the FY 

2011- FY 2019 books are projected to have cumulative claim rates below 5.7%. No earlier 

books in over 30 years have projected claim rates below 5.7%. 

2 
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80872.035

Also encouraging is the fact that there has been improvement in the economic factors on which 

the actuarial review was based and they should have a positive impact on future projections. In 

particular, home price estimates have improved significantly since the FY 2012 Actuarial Review 

was completed. 

The Actuarial Review was based on an estimate of a less than 1% increase in home prices in 

2012. This estimate has turned out to be very conservative. S&P/Case-Shiller Home Price 

Indices released on February 26th stated: "The national composite posted an increase of 7.3% 

for 2012." Core logic's Home Price Index also found that home prices increased 9.7% in January 

2013 on a year-over-year basis. 

3. FHA mortgage and borrower income data show that FHA remains focused on its 

mission of primarily serving lower income homebuyers. 

For all the attention given FHA's maximum mortgage amounts, the data shows that FHA activity 

is concentrated in lower priced homes. FHA's median loan amount for purchase transactions 

was $147,000 in 2011 according to the Federal Reserve Bulletin mentioned earlier. Seventy-one 

percent of FHA loans insured in 2012 were below $200,000, which is also below the FHA base 

limit of $200,160 that was in effect prior to the enactment of the Economic Stimulus Act (ESA) of 

2008. 

At least 80% of FHA loans insured in 2012 had mortgage amounts below the maximum 

mortgage amount that was in effect prior to ESA. (The FHA maximum mortgage limit in high 

cost areas was up to $362,790.) 

FHA's median borrower income was $56,000 in 2011 according to the Federal Reserve's HMDA 

analysis. FHA's median income was closer to the U.S. median household income in 2011 than it 

was in 1971. In 2011, FHA's median income was 12% higher than the U.S. median household 

income ($50,050). In 1971, FHA's median income was 22% higher than the national median 

income according to a Government Accountability Office (GAO) report published in 1994. link: 

http://www.gao.gov/assets/80/78805.pdf 

4. FHA has taken reasonable steps to facilitate an increase of private mortgage insurance 

activity. 

As the above data shows, FHA's current higher mortgage limits are a very small part of its 

business or the Mis' problem. In addition, since FHA has raised mortgage insurance premiums 

five times in recent years (with a sixth increase is coming in April 2013), any pricing disparities 

have already been addressed. 

The private mortgage insurers recognize FHA's efforts to assist them. Here is what one MI 

executive said in a public filing last year. 

"the FHA's current premium pricing, when compared to our current credit-tiered 

premium pricing (and considering the effects of GSE pricing changes), may allow us to 

be more competitive with the FHA than in the recent past for loans with high FICO credit 

scores." 

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80872.036

This statement was made prior to the announcement of the FHA premium increase that takes 

effect next month. 

There are others factors affecting MI business over which FHA has no control. Foremost among 

those are the pricing policies of the Federal Housing Finance Agency (FHFA), Fannie Mae and 

Freddie Mac. In particular, Fannie Mae and Freddie Mac's charging of loan level pricing 

adjustments (LLPAs) on loans with credit scores below 700 has severely curtailed MI purchase 

activity. To address this problem, the Mis must demonstrate to the GSEs that these fees are no 

longer necessary on loans backed by the private mortgage insurers. The net effect of LLPAs is 

the double charging of fees to homebuyers (MI premium and LLPAs). 

In addition, if FHFA continues to increase guaranty fees as part of its effort to "contract" the role 

of the GSEs, this policy will have a direct impact on the MI purchase activity since Mlloans are 

primarily purchased by the GSEs. 

In the current environment, FHA cannot be expected to keep raising its own fees (beyond what 

is necessary to maintain actuarial soundness of the Fund) in light of the alarming problem in the 

purchase mortgage market articulated by Governor Duke. FHA must balance its efforts to assist 

the private Mis while addreSSing the current market reality that not enough purchase mortgages 

of any kind are being made. 

5. Mortgage lenders have significant risk in the FHA program. 

Mortgage lenders have taken the unprecedented step of adding their own underwriting 

restrictions (called credit overlays) on top of FHA lending requirements to protect their firms 

from liability. 

This point can be boiled down to the following question: 

Why would FHA lenders add credit overlays (additional underwriting criteria) on top of FHA's 

requirements when the loan is 100% insured by the government? 

Much like doctors practice defensive medicine (i.e. requiring more tests to avoid lawsuits), 

mortgage lenders have adopted defensive lending (i.e. raising eligibility requirements on new 

originations to protect their companies from risk). 

In her testimony before this Committee last month, FHA Commissioner Carol Galante 

acknowledged the impact of this problem on FHA's ability to serve many lower income families. 

With this information as a backdrop, I will now address your three specific questions. 

I. Mechanics of the Mortgage Insurance Business and FHA 

As a former FHA official, I will address this issue from FHA's perspective. In this regard, it is first 

important to remember that FHA is an insurance program and like any successful insurance 

program, it needs to spread its risk. Just like an auto insurer could not be limited to drivers 

under the age of 25, FHA cannot be targeted only to higher risk borrowers. 

4 
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FHA has an even more daunting task than your typical insurer. Its mission is two-fold: 

To serve borrowers not adequately served by the private sector 

• To operate at no expense to the American taxpayer 

If those goals were not enough, FHA is asked to accomplish them without encroaching on the 

private sector. 

FHA loons have a Government guarantee 

The principal difference between FHA and private mortgage insurance industry, of course, is 

that FHA loans have the backing of the full faith and credit of United States government. This 

difference has existed since the modern day private mortgage insurance industry reemerged in 

the 1950's. 

To achieve the delicate balance between FHA's mission and fiscal responsibility and minimize 

overlap with the private insurers, there are three long-standing features of the FHA program. 

FHA's premium structure reduces overlap with the private mortgage insurers 

Instead of using risk-based pricing that is an integral part of private insurance and would make 

FHA insurance more competitive for borrowers with better credit characteristics, FHA has 

always charged all borrowers the same premium regardless of credit characteristics. Charging 

the same premium to all borrowers produces a type of cross-subsidization in which lower risk 

loans help to offset the losses associated with loans having higher risk characteristics. 

More important for the deliberations of the Committee, a uniform premium structure also 

discourages borrowers with lower risk factors from using the program. Many have encouraged 

FHA to implement risk-based pricing. However, risk-based pricing would increase FHA's 

competitiveness on higher quality loans thereby exacerbating the concerns of the Committee 

about FHA's role. 

At the same time, however, if these loans with higher credit characteristics were completely 

removed from the program, FHA would either have to charge even higher premiums to the 

families that need FHA financing the most to offset the lost revenue or require taxpayer 

assistance. Neither is an acceptable alternative. 

FHA uses reasonable mortgage limits to target activity 

The Economic Stimulus Act (ESA) of 2008 temporarily increased FHA's base limit to $271,050 

and the maximum mortgage limits in high cost areas up to $729,750 to ensure liquidity in the 

mortgage market. Despite the increase in eligible mortgage limits, FHA data shows that the 

higher mortgage limits are used very infrequently. In 2012, at least 80% of FHA loans were 

made below the limits that were in place prior to the enactment of ESA in 2008. (The base limit 

was $200,160 and the high cost area limit could go up to $362,790.) 

5 
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Here are some other statistics that demonstrate the minimal impact of the higher loan amounts. 

o 1.6% of FHA 2012 originations are above $500,000 (link: 

https:/Ientp.hud.gov/sfnw/public/ 

Over 50% are in California. 

3.5% of FHA 2012 originations are above $400,000 

9% of FHA 2012 originations are above $300,000 

o The vast majority of FHA originations are below $200,000 

71% of FHA 2012 originations were below $200,000 

o FHA insured more loans under $50,000 in 2012 than it insured over $500,000. 

o FHA insured twice as many loans under $100,000 in 2012 than it insured over 

$300,000. 

FHA's median loan amount for purchase loans was $147,000 in 2011 according to the Federal 

Reserve Bulletin. 

To provide some historical context about FHA mortgage limits, they were four times the median 

sales price at FHA's inception in 1934. While no one would expect FHA's limits to remain that 

high today, it is noteworthy that FHA mortgage limits were 150% of the median sale price for 

existing homes well into the 1970's. Accordingly, the base loan limit in effect today ($271,050) 

is comparable to the mortgage limit in the 1970's. 

Why are having some higher balance loans important to the financial soundness of the 

program? 

Higher balance loans perform better than smaller loans. 

• FHA loans over $400,000 have a 33% lower early default and claim rate than loans under 

$200,000 (Neighborhood Watch data). 

o loans over $500,000 perform even better. 

• FHA actuarial reviews confirm these findings. 

Every recent FHA audit has included a statement similar to this one 

from the FY 2011 audit: 

"FHA experience indicates that more expensive houses tend to perform 

better compared with smaller houses in the same geographical area, all 

else being equal. larger loans incur claims at a lower rate and in those 

cases where a claim occurs loss severity tends to be lower." 

The data shows that having some larger balance loans benefits the Fund and reduces risk for the 

taxpayer. The data also shows FHA made a very small percentage of high balance loans. I 

believe FHA's uniform premium structure discourages borrowers purchasing more expensive 

homes from using the FHA program. 

FHA provides 100% insurance coverage 

Some are recommending that FHA reduce its insurance coverage to promote "skin in the game". 

This issue has been raised many times in the past. In fact, the Government Accountability Office 

6 
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(GAO) prepared a 1997 report entitled "Potential Effects of Reducing FHA's Insurance Coverage 

for Home Mortgages". Link: http://www.gao.gov/archive/1997/rc97093.pdf 

The GAO Report concludes: 

"If FHA's insurance is reduced and lenders become responsible for the risk associated 

with the uninsured portion of loans, lenders will likely make fewer and more costly 

FHA loans." 

As I noted earlier, lenders are already adding "overlays" (additional underwriting requirements) 

on top of FHA requirements. lenders would only add more overlays if the insurance coverage is 

reduced making it even more difficult for many creditworthy families to qualify for a mortgage. 

The VA program has also been mentioned as a possible model since it has reduced coverage 

(generally around 25%) and lower delinquency rates. However, the lower delinquency rates 

likely have more to do with the better borrower characteristics than the reduced coverage. 

o VA loans have much higher credit scores. 

In 2004 2007, VA had median credit scores of about 680 when FHA's 

were around 630-640. 

• As both FHA's and VA's credit scores have improved in recent 

years, the difference has declined. 

o In FY 2011 and FY 2012, the VA's median score was 719 

and FHA's was close to 700. 

o Veterans have much higher incomes than FHA borrowers. 

in 2011, according to 2011 HMDA data, veteran income is more than 

25% higher than the income of FHA borrowers. 

o Veteran borrowers, because of their military backgrounds, have always been 

seen as more experienced in handling their financial obligations than FHA 

borrowers. 

With the purchase mortgage market already depressed, changing FHA's insurance coverage 

would exacerbate the program. 

Mortgage lenders have significant risk in the FHA program 

There are three key reasons why lenders added credit overlays (additional underwriting 

requirements on top of FHA rules) in the FHA program. They are: 

• Enforcement risk 

o FHA, the HUD inspector General (I.G.) and the Department of Justice (DOJ) have 

increased scrutiny of FHA lenders. When FHA terminated one of its largest 

lenders in August 2009, that action reverberated throughout the industry. 

o Public display of early default and claim rates in Neighborhood Watch deters 

bad behavior. 

In addition to potential FHA suspension for high early default rates, 

business partners (warehouse banks and purchasers of servicing) make 

business decisions based on this performance data. 

7 
83 


80872.040

Indemnification risk 

o Mortgage lenders are held accountable for making loans that do not meet FHA 

standards. When FHA determines that a loan was not originated properly, it can 

require the lender to absorb FHA's loss. 

• Reputation or "headline" risk 

o In addition to any penalties imposed by HUD, the I.G. or the DOJ, the public 

announcement of sanctions can have a severe impact on a firm, particularly 

large financial institutions when articles appear on the front page of the major 

newspapers in America. 

• Financial risk 

o The ultimate economic value of an FHA loan is in the monthly servicing fee (an 

annuity-like payment) on a performing loan. This is in contrast to subprime and 

Alt-A loans in which the revenue was in the origination of the loans. 

Accordingly, if an FHA loan doesn't perform, the lender loses significant 

revenue. This is particularly true in transactions in which large servicers buy 

originations from smaller originators by paying an upfront fee (approximately 

2% of the loan) to the originator shortly after closing. 

Mortgage lenders began imposing credit overlays in early 2008. See the attached chart 

documenting the shift in the distribution of FHA credit scores starting in early 2008. In 2007 4Q, 

47% of FHA loans had credit scores below 620. That percentage dropped steadily in every 

quarter until it bottomed out below 5% where it remains today. On the other hand, the 

percentage of borrowers with credit scores above 680 has increased every quarter since 2007 

4Q. The percentage of FHA loans with high credit scores exceeded 55% in 2009 3Q and is still 

there today. 

This data and the imposition of lender credit overlays categorically refute the allegation that 

FHA has replaced subprime lending and that FHA lenders do not have significant liability in the 

program. 

FHA is burdened with administrative requirements, inflexibility and uncertainty that discouroge 

participation 

Here is what GAO said in 2007 about processing FHA loans. 

"According to mortgage industry officials we interviewed, processing FHA- insured loans 

was more time consuming, labor intensive, and costly than processing conventional 

mortgages." 

The GAO report also noted that FHA has limited flexibility in hiring and compensating staff or 

investing in technology: 

"Although FHA has taken actions to enhance key tools and resources, it operates in a 

highly competitive environment in which other market participants have greater 

flexibility to hire and compensate staff and invest in information technology, which 

enhances their ability to adapt to market changes." 

FHA has also been saddled with other requirements that make it more complicated than 

conventional lending. For example, by law, FHA is required to have lenders provide homebuyers 

with a disclosure (Informed Consumer Choice) stating that loans with private mortgage 

8 
84 


80872.041

insurance may be cheaper than FHA insurance. FHA transactions also have a tiered pricing 

restriction. Mortgage lenders cannot charge more than a two discount point differential on any 

FHA loan regardless of the cost of originating a particular loan. 

Throw in uncertainty about the availability of FHA lending in times like sequestration or the 

expiration of Continuing Resolutions (e.g. March 27th) and there are plenty of reasons why 

mortgage lenders avoid FHA lending when they have a choice. 

To sum up, FHA's "competitive advantage" (i.e. government backing) has existed since 1934. 

However, there are certainly other factors that discourage FHA lending particularly to borrowers 

with better credit characteristics. 

II. Discussion of whether FHA's policies and practices thwart efforts by the private sector to 

revive and strengthen the free enterprise system 

I do not believe that FHA's policies "thwart efforts by the private sector". However, there are 

factors affecting MI business over which FHA has no control. 

In the aftermath of the housing crisis, concerns about FHA's advantages have centered on FHA's 

"pricing ". Of course, FHA has increased mortgage insurance premiums five times. FHA also 

assisted the Mis' competitiveness by primarily raising the annual premium (almost 1%), which 

effectively raises the interest rate on an FHA loan by that amount. 

The concern about pricing should be directed at the policies of the Federal Housing Finance 

Agency, Fannie Mae and Freddie Mac. In particular, the charging of loan level pricing 

adjustments has severely curtailed MI purchase activity. The Mis must demonstrate to the GSEs 

that these fees are no longer necessary on loans backed by the private mortgage insurers. 

In addition, while the Mis believe they pay all legitimate claims, mortgage lenders are upset by 

the significant increase in rescissions (i.e. claim denials). Rescissions increased from 5% -10% to 

over 20% in 2008 -2010. While many rescissions may have been justified, mortgage lenders 

believe some were not. Just like loan repurchases have damaged lender relationships with the 

GSEs, rescissions have soured the relationship with the private mortgage insurers. 

Finally, the Mis made necessary business decisions in pulling back from the mortgage market, 

particularly in the hardest-hit areas. Once these markets stabilized with the help of FHA 

financing, the Mis gradually returned to the marketplace. However, the Mis should not expect 

their market share to return immediately to pre-bubble levels. 

III. legislative and Regulatory Suggestions 

I submit the following recommendations for the Committee's consideration. 

The cause of credit overlays must be addressed 

The mortgage industry, rightly or wrongly, believes that the government is no longer taking the 

credit risk but instead, is transferring a portion of this risk to mortgage lenders through 

repurchases, indemnifications, lawsuits, settlements, etc. The reputation or "headline" risk 

associated with public disclosure of legal settlements only exacerbates the impact. 

9 
85 


80872.042

As I noted earlier, the mortgage industry has taken the unprecedented step of adding their own 

underwriting restrictions (called credit overlays) on top of government lending requirements to 

protect their firms from this liability. Much like doctors practice defensive medicine (i.e. 

requiring more tests to avoid lawsuits), mortgage lenders have adopted defensive lending (i.e. 

raising eligibility requirements on new originations to protect their companies from risk). 

FHA leadership is acutely aware of this problem and has been trying to address the industry's 

concern about risk without undermining the safety and soundness of the program. FHA has 

made changes to the Neighborhood Watch program and is updating program handbooks to 

provide more transparent guidance in an effort to encourage lenders to reduce overlays in the 

FHA program. (It is recognized that FHFA has also taken steps to address this problem in GSE 

lending.) 

Unfortunately, lender reluctance to follow FHA's underwriting criteria is more complicated than 

reaching an understanding between FHA officials and the industry. The Department of Justice 

and the HUD Inspector General have also been active participants in the enforcement of FHA 

rules. While the full weight of the law should be brought against lenders that knowingly commit 

fraud or abuse, there is growing concern in the industry that procedural errors in the processing 

of groups of cases can lead to settlements of hundreds of millions of dollars and even more 

importantly reputation risk through front page articles in the major newspapers of the country. 

The mortgage industry increasingly believes that the only way to protect their companies from 

this procedural liability in the current environment is to tighten up on new originations (hence 

overlays). 

No one expects or wants the government to stop penalizing lenders that knowingly commit 

fraud or serious violations of program and underwriting requirements. These abusive lenders 

damage the marketplace in addition to inflicting financial cost to the program. 

I offer the following ideas as part of the discussion on this critical subject. I would recommend 

that a special meeting be convened with the Executive Branch and the industry to address this 

issue. 

One issue that could be considered is the type of errors that precipitate a False Claims Act 

violation. It would also be helpful if the government provided detailed explanations of specific 

violations that precipitated these penalties. The impression in the industry is that procedural 

mistakes (i.e. "process fouls" or "foot faults") are the cause of these penalties. 

In addition, it would also be helpful if auditors would update lenders on the status of 

investigations to the extent practical. Obviously, in cases involving widespread fraud, such 

updates are inappropriate. However, I am aware of instances where lenders received 

subpoenas a year ago or longer and have not heard any word. In the interim, lenders have 

added overlays to protect their firms going forward. 

Finally, it should be understood that the marketplace makes a judgment about the fairness of 

actions and penalties. If they believe the government actions are excessive, the industry would 

step-up overlays to protect their companies. 

10 
86 


80872.043

Expand Neighborhood Watch to include information on individual loan originators 

The public display of early default and claim performance system in the Neighborhoqd Watch 

system has been an invaluable tool for self-policing in the industry. Business partners 

(warehouse banks and aggregators) have used this information to encourage FHA loan quality. 

I believe expanding this tool to individual loan originators will have an even more profound 

impact on loan quality. If loan originators know that their company as well as others in the 

industry can see how well their originations perform, they will be much less willing to take 

improper actions. 

When a lender terminates a loan originator for improper conduct, the loan officer can simply 

move to another lender. Their former employer would be unwilling to say anything because of 

legal concerns. However, if this originator's performance were visible to other lenders, I believe 

and many lenders have told me that it would have a dramatic impact on fraud and abuse. 

Conclusion 

The fundamental problem with the mortgage market today is not that FHA (or Fannie Mae and 

Freddie Mac) are making too many purchase loans, but that the total purchase mortgage market 

is not making enough loans. 

The performance of FHA loans insured since the private mortgage market collapsed shows that 

FHA ha officials have acted responsibly in balancing FHA's dual mission of serving those not able 

to find financing from other sources and avoiding risk for the American taxpayer. 

FHA has also taken the appropriate steps to facilitate the return of private capital. However, 

FHA is also rightly concerned about making additional changes in light of the weak purchase 

mortgage market. 

The Mis benefited from FHA's efforts to provide liquidity to the mortgage market at the height 

of the crisis in 2008 and early 2009. By helping to stabilize home prices, FHA reduced the size of 

Mllosses. However, as the FHA Actuarial Review shows, FHA did incur significant losses on 

these loans. Like any insurance company, FHA must be able to spread its risk within reasonable 

limitations to perform this role in the future without requiring taxpayer assistance. 

There is still more work to be done to ensure that all creditworthy Americans are able to buy a 

home. Placing more restrictions on FHA at this time will only make it more difficult for many 

families to qualify for a mortgage. Equally important, they could increase financial risk for the 

FHA program and the American taxpayer. 

11 
87 


80872.044

20nx 

2009 

2010 

Above 2011 

680 ... 

" E.,dudc< f;1r"",mhnc refinance]"""" 

FHA Single-Family Mortgage Insurance 

Borrower Credit Score" Distribution on New Endorsement.,b 

By Fiscal Year (FY) and Quarter 

l.5 

49 1.0 

40 07 

)5 05 

2.7 0.4 

30 0.4 

25 03 

2.2 OJ 

0.2 

'Sorruw"", WitnooIC ... ,.h! "',(ooes eM be1!ndeNnll"" fOT FHA !n,uta""" uSing .l!cmltl,,'e enter", 

Source: Data from FHA, Mortgage Bankers Association, and CoreLogic: January 2012 

Below 620 

3.9 

36 

31 

07 2.2 

02 1.4 

00 07 

OU 0.7 

00 07 

00 OC> 

00 06 

on 06 

0.0 0.6 

00 05 

00 04 

n.o 0.4 

There has been a dramatic shift in the distribution of FHA credit scores since 2007 

12 
88 


80872.045

Written Testimony of Nat Shapo, Katten Muchin Rosenman LLP 

House Financial Services Committee 

Subcommittee on Housing and Insurance 

Honorable Randy Neugebauer, Chairman 

March 13,2013 

Chairman Neugebauer, Ranking Member Capuano, Members of the 

Subcommittee. Thank you for the privilege of appearing before you today 

regarding "Mortgage Insurance: Comparing Private Sector and GovernmentSubidized Approaches." 

My name is Nat Shapo. I am a partner at Katten Muchin Rosenman LLP, where 

my practice is in litigation and insurance regulatory matters, and I am a lecturer in 

insurance law at the University of Chicago Law School. I had the honor of serving 

as the Illinois insurance commissioner from 1999-2003. 

You have asked me to analyze the FHA mortgage programs from a regulatory 

perspective. Such analysis yields the unambiguous conclusion that FHA's 

operations and oversight ignore basic regulatory principles. Most importantly, the 

Mutual Mortgage Insurance Fund (MMIF) does not meet its very forgiving risk to 

capital legal standard, and the program has continued to write, and even expanded, 

its business at a time when it is impaired, insolvent, and extraordinarily undercapitalized. These are cardinal violations for any risk bearer and for the oversight 

thereof. 

Background On Insurance Regulation 

While there has been debate for centuries about its proper location (Federal or 

State), it is well settled in U.S. law and public policy that insurance regulation is a 

fundamental governmental responsibility. In its landmark ruling that insurance is 

interstate commerce and Constitutionally subject to Congressional oversight, the 

Supreme Court explained that "Perhaps no modem commercial enterprise directly 

affects so many persons in all walks of life as does the insurance business. 

1 
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Insurance touches the home, the family, and the occupation of almost every person 

in the United States."} 

Such a business requires significant regulation, the Court has recognized. "[T]he 

business of insurance has ... a reach of influence and consequence beyond and 

different from that of the ordinary businesses of the commercial world. . .. The 

contracts of insurance may be said to be interdependent. ... It is .. , essentially 

different from ordinary commercial transactions and ... is of the greatest public 

concem.,,2 

Insurance is a common fund. Public confidence in that common fund's financial 

stability is a paramount policy consideration. "[T]he effect of [contracts of 

insurance's] relation is to create a fund of assurance and credit, the companies 

becoming the depositories of the money of the insured, possessing great power 

thereby, and charged with great responsibility. How necessary their solvency is, is 

manifest.,,3 

Indeed, supervising the solvency of risk bearing insurers is the single most 

important function of the State insurance departments, vested with primary 

regulatory oversight of most lines of insurance under the McCarran-Ferguson Act 

of 1945. Financial stress is the greatest calamity to threaten policyholders since 

the potential inability to pay claims directly calls into question the promise to pay 

at the heart of the insurance contract. 

Solvency Regulation In The States 

State regulation of insurer solvency is rigorous and complex, both with respect to 

standards and remedies. "[S]olvency regulation polices a number of aspects of 

1 Us. v. Southeastern Underwriters, 322 U.S. 533 (1944). 

2 German Alliance Ins. Co. v. Lewis, 233 U.S. 389 (1914). 

3 Id. Lewis featured a closely divided Court on the Constitutionality of a State rate 

regulatory statute. The one thing that the majority and dissent agreed upon was the 

fundamental importance of solvency regulation. See id. (Lamar, J., in dissent) 

("Regulatory statutes were, from time to time, adopted to protect the public against 

conditions and practices which were subject to regulation. The public had no 

means of knowing whether these corporations were solvent or not, and statutes 

were passed to require a publication of the financial condition."). 

2 
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80872.047

insurers' operations, including: 1) capitalization; 2) pncmg and products; 3) 

investments; 4) reinsurance; 5) reserves; 6) asset-liability matching; 7) transactions 

with affiliates; and 8) management. Regulators police these areas by setting 

financial standards, monitoring insurers' compliance and financial condition, and 

intervening when necessary to enforce these standards and protect policyholders' 

interests.,,4 

Much of the basic framework for tools and practices in State solvency regulation is 

established in a series of widely adopted National Association of Insurance 

Commissioners (NAIC) Model Acts and Regulations. 

Risk To Capital Ratio 

Capitalization is rightly listed first in any list of the priorities of an insurance 

solvency regulator. All States require insurers to establish and maintain a base 

level of minimum capital, usually in the low seven figures, but the rigor in the 

system devolves from risk to capital analyses and requirements. 

The NAIC Mortgage Guaranty Insurance Model Act ("Model Act") provides a 

common template in the area at issue before the Subcommittee today. Section 12, 

Outstanding Total Liability, instructs that "A mortgage guaranty insurance 

company shall not at any time have outstanding a total liability, net of reinsurance, 

under its aggregate mortgage guaranty insurance policies exceeding twenty five 

(25) times its capital, surplus and contingency reserve." This is a commonly 

adopted measure. 5 

Risk to capital ratio requirements are a cornerstone of the solvency regulation of 

mortgage insurers. They provide an objective standard linked to the size of the 

insurer and its exposure to risk, and they at all times require that risk to be 

supported by presently ascertainable funds. If a company does not meet the 25: 1 

4 Robert W. Klein, "The Growing Sophistication of Solvency Policing Tools," 

Journal of Insurance Regulation, National Association of Insurance 

Commissioners, Winter 2000. 

5 See, e.g., N.C. Stat. 58-10-125(a) ("a mortgage guaranty insurer shall maintain at 

all times a minimum policyholders position of not less than one twenty-fifth of the 

insurer's aggregate insured risk outstanding"). 

3 
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80872.048

ratio--capital of at least 4% of its calculated outstanding liability-then it cannot 

be understood to possess an adequate base to support its exposure. 

From a public policy perspective, it is essential to prevent troubled carriers from 

taking on yet more risk, in jeopardy of both existing and future consumers. Thus 

the Model Act requires that, "In the event that any mortgage guaranty insurance 

company has outstanding total liability exceeding twenty-five (25) times its capital, 

surplus and contingency reserve, it shall cease transacting new mortgage guaranty 

business until such time as its total liability no longer exceeds twenty-five (25) 

times its capital, surplus and contingency reserve." 

The risk-to-capital ratio, a hallmark of solvency regulation generally, has been a 

key component of regulators' response to the financial crisis during the last five 

years. The prohibition on writing new business-a hallmark for regulation of 

insurers who have become stretched too thin-has been enforced against multiple 

mortgage insurers 6 and has ensured that companies' troubles do not become 

catastrophic. 7 

By contrast, as well documented by a series of GAO audits, the FHA has far less 

stringent standards, and they have not been materially enforced in regulatory 

fashion. 

See, e.g., http://www.pmi-us.comJ; 

http://www.rmic.com/ratesguides/releasenotes/DocumentsIRMIC-CustomerAnnouncement_ 8%203%2011.pdf 

7 Even the exceptions made in deference to the literally historically bad market 

demonstrate the rigors of the State regulatory system. For instance, North 

Carolina's statute now allows the Commissioner to "waive the requirement," but 

requires a written request "at least 90 days in advance of the date" the insurer 

expects to fall below the required ratio, spells out a dozen factors to be considered, 

cannot be waived for more than two years, and is subject to any conditions the 

Commissioner might impose. In other words, it is a closely supervised process on 

paper-and has been in practice as well, as the Commissioner has tightly 

monitored, and then cut off, courses of writing new business outside the statutory 

baseline. 

4 
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80872.049

The baseline requirement is a 50: 1 ratio of risk to capital, meaning that the 

program is only required to keep 2 cents on hand for every dollar of risk. 8 This 2% 

requirement is half that found in the States. 

Loose as it is, though,9 the restriction is unambiguous-and the biggest problem 

from a regulatory perspective is that there is the statutory standard has not been 

enforced in a meaningful way. As detailed by the GAO, "According to annual 

actuarial reviews of the insurance fund, the capital ratio fell from about 7 percent 

in 2006, to 3 percent in 2008, and below 2 percent in 2009.,,10 Rather than halt 

new business in 2009, though, FHA only continued to write substantial amounts of 

new business. "[S]ince 2008, the economic value has fallen as the insurance-inforce has risen, dramatically lowering the capital ratio."ll The amount of new risk 

assumed has been dramatic. "In 2006, FHA insured approximately 4.5 percent of 

purchase mortgages. At its peak in 2009, it insured 32.6 percent of purchase 

mortgages." 12 

The results have been predictable-and exactly what insurance regulation is 

designed to prevent: the deepening of a crisis, and a full-blown negative balance 

8 GAO-13-400R at 7. "The Omnibus Budget Reconciliation Act of 1990 required 

the HUD Secretary to ensure that FHA's Mutual Mortgage Insurance Fund attained 

a capital ratio (the ratio of the insurance fund's economic value to insurance 

obligations) of at least 2 percent by November 2000 and maintain[ ] at least that 

ratio at all times thereafter." 

9 My analysis focuses on MMIF's failure to meet its own standard and the 

implications of that from a regulatory perspective. I could, but do not at this time, 

belabor the (substantial) extent to which the FHA's standards are weaker than 

those observed by private insurers. Not only are the risk to capital numbers far less 

stringent, but FHA· immediately books its premiums up front as assets instead of 

liabilities while private carriers start analogous premium as liabilities, only to be 

amortized into income over the life of the risk. And FHA counts as capital the 

present value of future revenue, a speculative practice not followed by private 

regulated carriers whose capital only includes the value of present tangible assets. 

10 GAO-13-400R at 7. 

11 Id. 

12 Id. at 3. 

5 
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80872.050

sheet position. As explained by the GAO, "In 2012, the capital ratio fell below 

zero to negative 1.44 percent."]} 

Perhaps most telling is the fact that "The 2012 actuarial analysis projects that the 

capital ratio will be positive by 2014,,14-an extended period of insolvency. And 

the Fund will not meet its required risk-to-capital ratio for the better part of a 

decade. It fell below 2% in 2009, remains so impaired, "and will go above 2.0 

percent in 2017.,,15 

Operating In A Hazardous Condition 

One of the most powerful tools in State regulators' kit is the widely adopted NAIC 

Model Regulation to Define Standards and Commissioner's Authority for 

Companies Deemed to be in Hazardous Financial Condition. 

The Hazardous Financial Condition Regulation wields a powerful remedies 

section, "Commissioner's Authority." The regulator may require the insurer to 

take a dozen different steps, including "Reduce, suspend or limit the volume of 

business being accepted or renewed"; "Increase the insurers' capital and surplus"; 

"Limit or withdraw from certain investments"; "Correct corporate governance 

deficiencies"; etc. 

The triggers for application of these remedies are instructive. Found in the 

"Standards" section, they are the types of the most basic red flags which alert the 

financially savvy observer to solvency dangers in a risk bearing insurer. The 

MMIF's operations trigger several of these, including: 

• "Adverse findings reported in financial condition and market conduct 

examination reports, audit reports, and actuarial opinions, reports or 

summaries." A slew of authoritative audits have published a litany of such 

adverse findings. 16 

• "Whether the insurer's operating loss in the last twelve-month period or any 

shorter period of time ... is greater than ... 50% ... of the insurer's 

]} Id. at 7. 

14 Id. at 8. 

15 rd. 

16 See, e.g., id. 

6 
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80872.051

remaining surplus." The Fund has a negative economic value, no remaining 

surplus, and thus an operating loss greater than half its surplus. 

• "Whether the insurer's operating loss in the last twelve-month period or any 

shorter period of time ... is greater than ... 20% ... of the insurer's 

remaining surplus." Same as above; the Fund has negative economic value 

and no surplus. 

• "Whether the insurer has grown so rapidly and to such an extent that it lacks 

adequate financial and administrative capacity to meet its obligations in a 

timely manner." The Fund increased its market share by 700% precisely as 

its risk to capital ratio plunged below its statutorily required leveL 17 

• "Whether management has established reserves that do not comply with 

minimum standards established by state insurance laws, ... sound actuarial 

principles and standards of practice." For four years, and four more 

projected, the Fund has not met its statutory capital reserve requirements. 

These are all bread and butter regulatory standards, and the Fund's non-compliance 

is unambiguous. 

FHA Fails The Most Fundamental Regulatory Benchmarks 

Certainly FHA is not a private insurer and is not subject to State insurance 

department regulatory oversight. But it is operating in competition with such 

private insurers, and it is doing so in an insurance marketplace designed by 

Congress, under the McCarran-Ferguson Act, to be primarily overseen by State 

regulators. IS 

And the program itself since 1990 has been statutorily required to meet a minimum 

risk to capital ratio, subject since 2008 to an annual requirement to obtain an 

independent actuarial review of the economic net worth and soundness of the 

17 rd. at 5. "FHA's market share of all purchase mortgages increased from 4.5 

percent in 2006 to a high of32.6 percent in 2009." 

18 McCarran-Ferguson Act, 15 USC 1011 et seq. "Congress hereby declares that 

the continued regulation and taxation by the several States of the business of 

insurance is in the public interest." 

7 
95 


80872.052

Fund. 19 Thus the Subcommittee's desire to seek an analysis of the Fund's 

operations under a regulatory framework seems well founded. 

Such a regulatory analysis, in my opinion, demonstrates deep and fundamental 

problems. The MMIF is an insurance fund that has exceeded its statutory 

maximum risk-to-capital ratio for four years and is expected to continue to do so 

for another four; which is insolvent, and which is projected to remain so for at least 

two years; which has no surplus to compare to its operating loss; which increased 

its market share from 4.5% to 32.6% in three years; and which has been subject to 

numerous actuarial findings of inadequate capital. 

It is operating in fundamental disregard for the basic principles of insurance 

solvency regulation, despite the clear suggestion to the public, created by the 

statutory requirements of minimum capital requirements and annual audits, that it 

follows such tenets. 

FHA's explanations of its situation are further inconsistent with basic notions of 

insurance, proper risk analysis, and solvency regulation. Its presentations heavily 

rely upon treating the poorest, financial crisis years as essentially a quarantined 

anomaly which should not be allowed to control review of the MMIF balance 

sheet.2o But the essence of insurance is that sometimes results are good, sometimes 

they are bad. That is particularly true of mortgage insurance, which is subject to 

extraordinary swings in losses. 

To ask to be reviewed in a way that explains away a negative balance sheet and a 

projected eight year violation of a very forgiving risk-to-capital ratio requirement 

is something that a regulated company could never do. And that is not a 

technicality: A core mission of solvency regulation is to prevent risk bearers from 

expanding their exposure at the very time that their financial position is decaying. 

FHA, of course, enjoys a key advantage which allows it to in a sense write its own 

rules. It explicitly relies on its limitless u.S. Treasury backstop to prop up 

19 GAO-13-400R at 7. 

20 See Assistant Secretary Galante testimony of Feb. 13 ("Books of business 

originated from 2007-2009 continue to be the prime source of stress to the Fund . 

. .. In contrast, the actuary attests once again to the high quality and profitability of 

books insured since 2010."). 

8 
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80872.053

confidence in the program. 21 This seeming protection, however, may well have the 

effect of worsening a bad situation. State insurance regulations prevent insurers 

from attempting to write their way out of a crisis. The purpose of that is to prevent 

a total collapse. 

The fact that such a calamity could ultimately be borne by the taxpayers clearly is a 

fiscal concern of Congress's. And its effect on an important market-and the 

consumers served therein-is a matter of substantial public policy concern now 

that MMIF's market share stands at more than one quarter of purchase mortgages. 

Thoughts On Policy Implications Of FHA's Financial Results 

As recognized by the Supreme Court and Congress, insurers maintain solvency by 

properly evaluating and classifYing risk, correlating premiums to the likelihood and 

amount of claims. "[T]he legislative history of the McCarran-Ferguson Act 

strongly suggest[s] that Congress understood the business of insurance to be the 

underwriting and spreading of risk. Thus, one of the early House Reports stated: 

'The theory of insurance is the distribution of risk according to hazard, experience, 

and the laws of averages. ",22 

FHA has not run MMIF according to the basic principles of insurance. It has not 

evaluated hazards according to actuarial principles and correlated premiums to 

risk. It has not spread risk in a manner supported by financial wherewithal. And it 

21 Id. at 2. "While the actuary's finding regarding the economic net worth of 

FHA's portfolio is obviously of very serious concern, it is not the determining 

factor for whether FHA will need to draw on permanent and indefinite budget 

authority from the Treasury. Any determination that such a draw is necessary will 

not be made until the end of FY 2013, and in any event, does not affect the full 

faith and credit of the Federal Government to pay any claims." 

22 Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205 (1979). "The 

primary elements of an insurance contract are the spreading and underwriting of a 

policyholder's risk. 'It is characteristic of insurance that a number of risks are 

accepted, some of which involve losses, and that such losses are spread over all the 

risks so as to enable the insurer to accept each risk at a slight fraction of the 

possible liability upon it.' 'Insurance is an arrangement for transferring and 

distributing risk. '" !d. 

9 
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80872.054

plainly states that it does not live by the most basic rules that private insurers 

must-or die. 

If MMIF was a private insurer, it would have been stopped from writing new 

business and in fact would have been placed in receivership. Instead, the program 

stands with a market share of over a quarter, and is reaping the benefits of an 

improving market denied to its competitors who have been placed in receivership, 

stopped from writing new business, and/or struggled to raise capital in a market 

distorted by the presence of a government-backed behemoth. 

Ultimately, the policy determinations that the Subcommittee must make with 

respect to the Fund rest at the proverbial higher pay grade than mine. Proponents 

of FHA can certainly advocate for the social benefits purportedly derived from 

FHA's role in the marketplace both generally and during the financial crisis. 

But to the extent that my thoughts are relevant, I think that this discussion must 

start from the basic insurance doctrine articulated by the Supreme Court. 

Insurance must be rooted in actuarial principles. Solvency must be paramount. 

This is not just an ideological viewpoint. Insurance markets are no different than 

any others. While there is an essential social role to be played by this product, in a 

market which is designed to be primarily serviced by private providers, substantial 

government interference will yield the same results as it will in any other 

marketplace. Capital formation will be impaired. Competition will be distorted. 

Incentives will not align with healthy markets and the public good. 

Most importantly, the very people whom government intervention is designed to 

help may be hurt. I have seen this many times in the insurance marketplace, when 

government programs like residual risk pools, put in place to try to help hard 

markets, have ballooned in market share and only ultimately distorted the market 

and destroyed any chance it had of pulling out of a crisis. New Jersey's 

automobile insurance marketplace, the subject of testimony in front of this 

committee in the past by me and others, provides such a cautionary tale. 23 

23 See, e.g., http://archives.financialservices.house.gov/medialpdf/061605ns.pdf; 

http://www.texaspolicy.comlcenter/economic-freedomlreports/shopping-solution; 

http:// archives. financialservices.house.gov /medialpdf/03 31 04 po.pdf 

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While each line of insurance is different, the basic laws of economics and 

insurance are the same. In my view, the FHA mortgage insurance program is 

operating in a manner at odds with these immutable rules. It is taking substantial 

market share from private carriers at the same time when, if it were a true 

competitor playing by the same rules, it would be prohibited from writing new 

business. In doing so, it makes both obtaining business and attracting capital more 

difficult for regulated insurers, distorts the market as a whole, and deepens the 

spirals already in place both at the FHA and with private carriers. 

It may be the choice of policy makers that the social benefits reaped in the process 

outweigh the financial risks, but that decision should be a considered one with an 

awareness of its consequences. 

Thank you for inviting me and for your consideration of my testimony. I would be 

pleased to answer any questions from the Subcommittee membership. 

Respectfully submitted, 

Nat Shapo 

Katten Muchin Rosenman LLP 

nat.shapo@kattenlaw.com 

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Testimony of Stephen Stelmach 

Senior Vice President and Research Analyst 

FBR Capital Markets & Co. 

House Financial Services Subcommittee on Housing and Insurance Hearing on 

"Private Mortgage Insurance: Comparing Private Sector and Government-Subsidized Approaches" 

2168 Rayburn House Office Building 

March 13, 2013 

10:00 AM 

Good morning, 

My name is Steve Stelmach. I am a senior vice president at FBR Capital Markets & Co., an investment 

bank headquartered in Arlington, Virginia. 

I would like to thank Chairman Neugebauer and Ranking Member Capuano for my invitation today. 

Among the issues that the Subcommittee asked to be addressed today is the impact of the FHA's 

policies and practices on investments in private mortgage insurance. 

This is a topic on which I can offer a unique perspective. In my role at FBR Capital Markets, I have 10 

years of experience in advising our clients on the merits and risks of investing in particular industries and 

companies. My particular area of expertise is United States housing, mortgage finance and, relevant to 

this Subcommittee, private mortgage insurance. 

FBR's clients are pension funds, endowments, mutual funds, and asset managers throughout the U.S. 

and Europe. Collectively, these investors manage assets in the trillions of dollars. 

Having partiCipated in countless conversations with these institutional investors over many years, I can 

attest that the actions ofthe FHA have a direct influence on investors' decisions to allocate or not to 

allocate capital to the private mortgage insurance industry. 

Today, I would like to address three main topics on which investors tend to (ocus: 

1) How the FHA has historically crowded out private capital. 

2) How recent changes at the FHA have encouraged new capital into the market. 

3) How FHA premium increases can have the impact of expanding mortgage availability. 

How the FHA Has Historically Crowded Out Private Capital 

First, on the issue of crowding out private capital: 

The FHA has a fixed insurance premium structure, which means that borrowers are all charged the same 

insurance premium on each FHA-insured loan, regardless of creditworthiness. Until recently, this 

premium was at or below the rates charged by private mortgage insurers. Prior to the passage of the 

FHA Reform Act of 2010, the maximum premium the FHA could charge was just above one-half of a 

percent, or 0.55%. This premium, combined with down payment requirements less than those 
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necessary on loans with private mortgage insurance, higher FHA seller concessions, lower perceived 

repurchase risk for defaulted loans, and higher gain-on-sale margins, pushed lenders and borrowers into 

the FHA product. At its peak, FHA loans represented 90% of the market of insured mortgages. 

With capacity constraints among mortgage originators and uncertainty over future liabilities, the 

creditworthiness of the average FHA borrower is much higher than historical levels. Currently, the 

average credit score for FHA-insured loans hovers around 700. This is safely in "prime" credit territory 

and well above the average FICO score for many low- and moderate-income households that the FHA 

has traditionally served. When the FHA premium was capped at 0.55%, the FHA charged a lower 

insurance premium for this prime-quality borrower than the premium charged by private mortgage 

insurers, making it exceedingly difficult for private mortgage insurers to compete for that business. As 

this trend persisted, private capital was hesitant to invest in mortgage insurers, who were at a 

competitive disadvantage relative to their government competition. As a result, the private mortgage 

insurance market share continued to shrink. 

How Recent Changes at the FHA Have Encouraged New Capital to Enter the Market 

Secondly, touching on the issue of the private mortgage insurance industry attracting additional capital, 

we see investor interest as very strong. 

Following passage of the FHA Reform Act of 2010, the FHA was given the authority to raise annual 

premiums to 1.55% and, following a series of premium increases, the current FHA premium is 1.35%. 

Additionally, the FHA has taken steps to shore-up its finances, making FHA loans less attractive to higher 

creditworthy borrowers, expanding the market share for private mortgage insurance-backed loans. 

Since the FHA began to institute premium increases in 2012, FBR has helped raise $550 million in capital 

for a new mortgage insurance company and recently participated in raising over $1 billion in capital for 

an existing mortgage insurance company. In total, the mortgage insurance industry has attracted nearly 

$3 billion in new capital in the last 12 months. 

Notably, investors chose to invest this capital only after the FHA instituted premium increases. 

Despite the sums raised in the past 12 months, they are a far cry from the roughly $20 billion of capital 

that the industry enjoyed only a few years ago before paying out billions of dollars of claims. 

While much of the decline in industry capital was the result of these extraordinary claims that the 

industry has paid in recent years, investors have been hesitant to provide the industry capital due to 

persistent regulatory uncertainty-including GSE reform, FHA reforms, and implementation ofthe 

qualified mortgage (QM) definition and the qualified residential mortgage (QRM) standard, both 

required by the Dodd-Frank Act. 

We believe that, as the market receives greater clarity on all of these regulatory issues, this clarity can 

facilitate an even greater investment in the private mortgage insurance industry. 

As a public policy, it could been seen as self-defeating for the FHA to allocate precious dollars toward 

borrowers who would otherwise qualify for private mortgage insurance while other borrowers struggle 

to get financing. As a means of expanding mortgage availability to those less served segments of our 

country, the FHA has a critical role to play. 
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And this dynamic leads to my final point: 

How FHA Premium Increases Can Have the Impact of Expanding Mortgage Availability 

Higher FHA premiums can actually increase mortgage availability. Now this may sound inconsistent with 

policymakers' objectives, but in fact, we expect FHA premium increases to widen mortgage availability 

to less served communities. 

As premium increases at the FHA take hold, the FHA will price itself out of the "prime" credit market 

that I mentioned earlier. Private mortgage insurers are willing to serve this prime market and, as the 

government backs away, investors are more willing to invest in the private industry. 

In fact, we have started to see this play out, as I mentioned earlier. The FHA's market share of the 

insured mortgage space is down to 42% and decreasing while private mortgage insurance has seen its 

market share increase, and the average credit score among FHA borrowers is slowly declining. 

Importantly, however, now that FHA capacity is not being allocated toward higher-credit-quality 

borrowers, the FHA's precious resources can be directed to qualified, but less creditworthy, households 

that have not had access to credit in recent years, hence widening mortgage availability. 

Under this scenario, we see the FHA fulfilling an important policy objective of providing mortgage credit 

to underserved borrowers while private capital becomes increaSingly available to meet growing 

mortgage market demand. 

Again, I thank the Committee for inviting me today, and I am happy to answer any questions that you 

may have. 

o