Mortgage impairment coverage remains a unique traditional insurance product applicable mainly to banks, mortgage administrators, lenders, servicers, or insurers. Traditional insurance, by definition, is a promise for an insurer to indemnify an insured against losses from specific perils – it is a means to protect the insured from uncertainty, which could result in financial loss. But what if there are other ways to transfer risk for these types of financial institutions? Over the last several years, specific industry sectors have been utilizing parametric insurance solutions to de-risk their portfolios from various risk factors, such as flood, earthquake and other catastrophic perils.
Historically, parametric solutions have been used predominantly as a solution in the agricultural industry because of the devastating impact of severe weather events. Parametric solutions have since evolved and can be used in place of traditional insurance policies for catastrophic risks such as earthquakes, storms and floods. This can be meaningful for financial institutions with aggregation risk in catastrophe-prone geographies given the significant volume of collateral at risk.
The main benefit of parametric insurance policies is that they offer faster payouts than traditional insurance. In a traditional insurance scenario, the insured is indemnified for the total value of the loss or the limit, whichever is less, minus the applicable deductible or retention. When the loss occurs under a traditional insurance policy, a claim is submitted by the insured and the claim is then quantified by the insurer’s adjuster and can often take months or years to settle. With a parametric insurance policy, there is greater certainty around quantum and timeliness of payment. The insurer validates that the loss event exceeded the pre-agreed trigger event, and that is enough to warrant a payout under the policy. For example, a parametric policy may stipulate that the trigger event is an earthquake on Vancouver Island that exceeds a magnitude of 6.5. Once the magnitude of the trigger is verified and the insured provides a proof of loss, the policy should pay immediately – often within days. Parametric insurance solutions can provide banks and mortgage lenders with the liquidity needed to quickly recover after a disaster strikes, which can in turn avoid a default scenario or minimize the credit risk.
This type of insurance can also provide coverage for the difficult-to-model losses, which we know is certainly the case for flood exposures in Canada. In most provinces where catastrophe exposure exists, national insurance programs are still not widely available to homeowners, and if they are, they are cost prohibitive for the average homeowner. This leaves a bank’s or mortgage lender’s loan portfolio exposed to catastrophic risk and very few commercial solutions. Mortgage impairment insurance policies can provide coverage for these types of perils, but most will not cover perils that are not required to be purchased within the lending agreement or will heavily sublimit coverage in exposed areas in an effort to avoid adverse selection.
When considering the insurance solution that is most appropriate, it is worth noting that parametric insurance coverage is most valuable when a single event stands to impact a significant portion of a lender’s portfolio, so first assessing aggregation of catastrophe-exposed locations across a portfolio is crucial in determining whether this type of product is a suitable alternative to mortgage impairment insurance.
In the current market, insurers continue to re-evaluate their mortgage impairment product offering by imposing segregation of locations by flood zones and applying different terms and conditions, i.e. different deductibles and limits. The hard market has created space for innovation and reconsideration of risk transfer solutions. Now is the perfect time to evaluate the catastrophe risk present across a lenders’ loan portfolio and to conduct a risk-to-benefit analysis of the traditional and non-traditional products available to financial institutions.
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
