Investigating captive mortgage reinsurance.

Lenders should do their homework before diving into reinsurance.

Banks and other mortgage lenders have recently begun participating more in the insurance of default risk on their originations. This interest can be attributed to several factors that relate to developments in both mortgage

Among the specific factors driving the trend are:

* Consolidation in banking and mortgage lending producing fewer and larger competitors that are more diverse and thus better suited to retain default risk and negotiate risk-sharing contracts with mortgage insurers;

* Mortgage insurance has recently been a profitable line of business; and

* Such arrangements move lenders further into the insurance industry in a coverage that is incidental to lending activities.

Captive reinsurance arrangements are becoming a popular vehicle for lenders to self-insure mortgage-insurance (MI) risk on mortgages they originate. In such an arrangement, the lender establishes a reinsurance company subsidiary (captive). The captive assumes MI risk written by a direct mortgage insurance company (direct writer) on loans originated by the lender. As consideration for the risk transfer, the direct writer cedes a portion of the MI premium to the captive.

As of late 1997, at least six national banks have received federal approval from the Office of the Comptroller of the Currency (OCC) to form a mortgage reinsurance subsidiary. Additional reinsurance subsidiaries have been established by mortgage lenders that are not subject to OCC oversight. As many as 50 or more of these companies may ultimately be formed by lenders and direct writers, according to Standard & Poor's (S&P), an agency responsible for rating the claims-paying ability of insurance companies.

If you are a sizable player in the mortgage lending market, the chances are good that these opportunities have attracted your attention. However, given the complexity of such arrangements and the variety of options available, the captive mortgage reinsurance arena should not be pursued without a carefully constructed strategy. Attention to the following eight considerations can help chart a course appropriate for a particular lender.

* Volatility of MI losses;

* Lender's appetite for risk;