Mortgage underwriting by insurers: New guidelines and processes
The Financial Services Commission (the FSC) issued on 13 May 2021 the ‘Guidelines for Mortgage Underwriting Practices and Procedures ’ (the Guidelines) under sections 7(1) (a) of the Financial Services Act and 130(2) of the Insurance Act 2005. These Guidelines came into effect on the 1 July 2021.
The objectives of these Guidelines were brought in place to anticipate and prevent any problems like the famous Subprime Mortgage Crisis in the US and the UK1, which led to mortgage delinquencies, foreclosures, and the devaluation of housing-related securities. The crisis had severe, long-lasting consequences for the U.S. and European economies, and the U.S. entered a deep recession, with nearly 9 million jobs lost during 2008 and 2009. In the longer run, as the crisis passed, it became important to focus on sustainable policies for the financial system and to put in place a system to stem the tide of toxic mortgages and systemic breaches in accountability and ethics at all levels.
Mortgages underwritten by insurance companies have become significant, and the aim of the Guidelines is to provide a regulatory framework in order to supervise mortgages underwritten by insurers. The Guidelines are applicable to all insurers that are engaged in mortgage underwriting and will further the FSC’s objects and functions in:
(a) ensuring the orderly administration and sound conduct of business in the financial services sector;
(b) taking measures for the better protection of consumers of financial services including their premiums; and
(c) establishing proper market conduct and a level playing field with regard to mortgage underwriting by insurance companies.
What our law says
Under the Code Civil Mauricien, the term “mortgage” has the same meaning as “hypothèque”2 and includes any loan or syndicated loan that is secured by residential and/or commercial property for the purpose of acquisition or refinancing of land and/or construction of building.
The process of “mortgage underwriting” can be described as the process that an underwriter goes through to evaluate the borrowing capacity and collateral of the applicant for a mortgage loan. It is applicable to all insurers that are engaged in mortgage underwriting and/or the acquisition of mortgage loan assets and should be distinguished from the provision of mortgages at a retail level.
The Guidelines require all insurers to adopt prudent and sound mortgage underwriting by virtue of the following five principles:
The first principle
The first principle relates to insurers’ governance and the elaboration of overarching business objectives, strategies and the development of oversight mechanisms in respect of mortgage underwriting and/or the acquisition of mortgage loan assets. It is a requirement for insurers that are engaged in mortgage underwriting and/or the acquisition of mortgage loan assets, to have a comprehensive Mortgage Underwriting Policy (MUP) approved by the Board of Directors (the Board). Mortgage practices and procedures of insurers should comply with their established MUP.
Under the MUP, insurers would have to provide for a general policy in terms of the risk management that the management would be willing to accept, maximum debt-to-income (“DTI”) ration (i.e. the percentage of a borrower's monthly gross income that goes towards paying his monthly total debt obligations), maximum amortization period for mortgages underwritten and the maximum Loan-To- Value (LTV) ratio.
Furthermore, the Board will need to ensure that the auditor, appointed under section 40 of the Insurance Act 2005 , reviews and reports to the Board on compliance with these Guidelines at least once a year.
Morgage underwriting declaration
The Guidelines further require the Chief Executive Officer or other delegated senior officer of an insurer to make an annual declaration in writing to the Board confirming that the insurer’s mortgage underwriting and acquisition practices and associated risk management practices and procedures meet, except as otherwise disclosed in the declaration, the standards set out in these Guidelines.
In the event of a deviation from these Guidelines, the nature and extent of the deviation, and the remedial measures taken or proposed to be taken to mitigate the risk associated with the deviation, should be documented and disclosed to the Board and to the Commission3 in full.
The other principles
The next three principles focus on the mortgage credit decision and the underwriting process, specifically the assessment of:
Under Principle 2, insurers should ensure that reasonable enquiries (from the MCIB, the Conservator and any other credit enquiries) are made into the borrower’s identity, background, credit history and borrowing behaviour of a prospective mortgage loan borrower as a means to establish the borrower’s reliability to repay a mortgage loan on a timely basis.
Additionally, insurers should also ensure that appropriate borrower’s consent is obtained for this assessment and comply with relevant legislations such as Data Protection Act 2017 governing the use and privacy of personal information.
One of the main measures to be put in place is that the insurers should set out the pre-qualification screening criteria which would act as a guide for their officers to determine the types of mortgages that are acceptable to the insurer. The criteria, for instance, may include rejecting applications from blacklisted customers. These criteria would help institutions avoid processing and screening applications that would be later rejected.
Insurers should design a comprehensive mortgage application form and checklist that are sufficiently detailed to ensure that all relevant information needed for the initial assessment are readily available. Consequently, insurers should maintain complete documentation of the information that led to a mortgage approval. Some examples are as follows:
(a) A description of the purpose of the loan;
(b) Employment status and verification of income (see Principle 3);
(c) DTI ratio calculations including verification documentation for key inputs (e.g., taxes and other debt obligations);
(d) LTV ratio, property valuation and appraisal documentation (see Principle 4);
(e) Report from the MCIB, the Conservator and any other credit enquiries;
(f) Documentation verifying the source of the down payment;
When an application is made by a corporation, insurers should review up-to-date information on the borrower encompassing:
(a) latest audited financial statements and management accounts;
(b) details of customers’ business plans and any changes brought thereto;
(c) financial budgets and cash flow projections;
(d) any relevant board resolutions for corporate customers; and
(e) particulars of promoters, beneficial owners, controllers and directors.
The above documentation should be obtained at the origination of the mortgage and for any subsequent refinancing of the mortgage. Insurers should update the borrower and property analysis periodically (not necessarily at renewal) in order to effectively evaluate credit risk. In particular, insurers should review some of the aforementioned factors if the borrower’s condition or property risk changes materially.
Insurers should maintain a checklist which can demonstrate that all their policies and procedures ranging from receiving the mortgage application to the disbursement of funds have been complied with. The checklist should also include the identity of individual(s) and/or committee(s) involved in the decision-making process.
Anti-money laundering/combating the financing of terrorism (AML/CFT)
As part of an insurer’s assessment of the borrower, if the insurer is aware, or there are reasonable grounds to suspect that the mortgage loan transaction is being used for illicit purposes, then the insurer should decline to disburse the loan and consider filing a suspicious transaction report to the Financial Intelligence Unit in line with sections 3(2) and 3(3) of the Financial Intelligence and Anti-Money Laundering Regulations 2018 (FIAML Regulations 2018).
In order to detect and deter the possible use of a mortgage to launder the proceeds of crime or assist in terrorist financing, insurers should ensure that mortgage loans are subject to the requirements of:
(a) the Financial Intelligence and Anti-Money Laundering Act 2002 (FIAMLA); and
(b) FIAML Regulations 2018.
In particular, insurers should comply with the AML/CFT obligations under the FIAMLA, the FIAML Regulations 2018, including but not limited to, customer due diligence process and record keeping requirements, and also ensure that they obtain sufficient information about the borrower to determine whether the latter is a high-risk customer.
Under principle 3, it is the duty of the insurers to adequately assess the borrower’s capacity to service its debt obligations on a timely basis. Insurers should demonstrate rigour in the verification of a borrower’s income. This includes substantiation of a borrower’s:
(a) Employment status; and
(b) Income history (e.g. through bank statements).
With respect to the borrower’s down payment for mortgages, insurers should determine if it is sourced from the borrower’s own resources or savings. Where part or all of the down payment is gifted to a borrower, it should be accompanied by a letter from those providing the gift confirming no recourse will be made from the gift provider to the borrower. Where non-traditional sources of down payment (e.g. borrowed funds) are being used, further consideration should be given for greater risk mitigation. Incentive and rebate payments (i.e. cash back) should not be considered part of the down payment.
For borrowers who are self-employed, insurers should also be guided by the sound principles listed above. In particular, insurers should obtain proof of income and relevant business documentation.
Insurers should also exercise rigorous due diligence in underwriting loans that are materially dependent on income derived from the property to repay the loan (e.g. rental income derived from an investment property). Income that cannot be verified by reliable and well-documented sources should be treated cautiously when assessing the ability of a borrower to service debt obligations.
Guarantors and co-signors of mortgages
Where an insurer obtains a guarantee or when a co-signor is supporting the mortgage, it should also undertake a sufficiently rigorous mortgage assessment of the guarantor/co-signor. This assessment should be commensurate with the degree to which the guarantor/co-signor’s support is relied upon.
The Commission expects the DTI ratio for all mortgages underwritten and/or acquired to be less than the insurer’s stated maximum6, as articulated in its MUP, and reflects a reasonable distribution across the portfolio. The DTI ratio should be calculated conservatively (i.e. appropriately stressed for varied financial and economic conditions and/or higher interest rates).
Additional assessment criteria
In addition to income and debt service coverage, insurers should take into consideration, as appropriate, other factors that are relevant for assessing credit risk such as the borrower’s assets and liabilities (net worth), other living expenses, recurring payment obligations (for example through searches from the Conservator of Mortgages, Mauritius Revenue Authority, etc…), and alternate sources for loan repayment.
To the extent possible, income assessments should also reflect the stability of the borrower’s income, including possible negative outcomes (e.g., variability in the salary/wages of the borrower). Conversely, temporarily high incomes (e.g., overtime wages, irregular commissions and bonuses) should be suitably normalised or discounted.
The Commission expects the average amortization period for mortgages underwritten to be less than the insurer’s stated maximum, as articulated in its MUP.
Under Principle 48, insurers should use various methods to assess the value of the property including on-site inspections, third-party appraisals and/or automated valuation tools.
These above-mentioned four principles should be evaluated by lenders through a holistic and risk-based approach unless otherwise specified in these Guidelines. The borrower’s willingness and capacity to service its debt obligations on a timely basis should be established and should be an important element of a lender’s mortgage decision. Undue reliance on collateral can pose challenges as the process to obtain title to the underlying mortgaged property can be costly to the lender.
Under Principle 510, insurers should have effective credit and counterparty risk management procedures that support mortgage underwriting including, as appropriate, mortgage insurance. This includes using sound underwriting practises by insurers, updating each insurance mortgage insurance contract throughout the life of the insurance contract, independent validation process including a regular review and recalibration of the of risk parameters with respect to their mortgage portfolio. Further, insurers should have a stress-testing regime that considers unlikely but plausible scenarios and their potential impact on the mortgage portfolio.
The Guidelines also impose internal control, monitoring and reporting mechanism by spelling out the role and responsibilities of the Board and of Senior Management of insurers. It is expected of insurers to demonstrate compliance with these Guidelines to the Commission and they should expect verification from the Commission that their mortgage operations are well supported by prudent underwriting practices, and that they have sound risk management and internal controls that are commensurate with these operations.
In line with the terms and conditions of these Guidelines, insurers have quite onerous obligations, which are ultimately necessary to suppress malpractices and ensure protection of the market and members of the public as well. Furthermore, it will be fundamental to have a “compliance culture” given that FSC will conduct on-site inspections and constantly monitor the conduct of business activities of licensees, to ensure that they comply with legislations at all times. This system of surveillance is expected to maintain the sound repute of the Mauritius jurisdiction and a stable financial system; a precondition for a healthy and successful economy.
2See Article 2163 et suiv. of the Code Civil Mauricien
3“Commission” has the same meaning as in the Financial Services Act
6The insurer’s stated maximum is the maximum amount an insurer will pay under a policy for a covered loss. Maximums may be set per period (e.g., annual or policy term), per loss or injury, or over the life of the policy, also known as the lifetime maximum.