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HMRC internal manual

General Insurance Manual

Technical provisions: background: Unexpired Risks Provision: mortgage indemnity business


Mortgage indemnity insurance covers the risk that a bank, building society or other mortgagee will be unable to recover the full amount of a mortgage advance out of the sale proceeds of the mortgaged property when the mortgagee has taken possession of the property following a default by the borrower. The contract is between the lender and the insurer; and the insurance is paid for by means of a single premium at the time when the loan advance is made. Although the cost of this is often passed on by the lender to the borrower as a condition of making the loan, the borrower is not a party to the insurance contract.

Cover is provided for as long as the loan is outstanding. Where, as is usual, the business is accounted for on an annual accident year basis the single premium needs to be spread forward on a basis that reflects the pattern of the underlying risk (see GIM2110). Strictly, the associated acquisition costs should be spread on a similar basis. In practice the same result is often achieved by allocating a large proportion of the premium (perhaps 50%) to the first year of the insurance to cover both the acquisition costs and the small risk of loss in that year, leaving the balance to be spread. The pattern of claims over time in this type of business is fairly well established, and the insurer should be able to justify the spreading basis that is used by reference to its own experience, or failing that the experience of the industry in general. Historically, most losses arise between three and five years after the loan is advanced. This applies whether the overall level of claims is high or low.

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Mortgage indemnity insurance covers losses that may arise on the sale of repossessed property. This business is highly cyclical: in times of economic recession insurers tend to suffer heavy losses on it because the number of people who cannot service their mortgages rises at the same time as house prices fall. During such periods the balance of the unearned premiums is unlikely to be sufficient to meet future claims and the insurer will, in principle, be required to set up an additional provision for unexpired risks (URP). In quantifying the amount of this it may be appropriate to look at the current level of repossessions, or at the number of borrowers who are in arrear to the extent that, statistically, a loss following a repossession can be expected. Such methods are acceptable provided they are soundly based on the relevant facts. The URP should not exceed the additional amount that is likely to be needed to meet claims over and above the balance of the UPP, and care is needed that double counting is avoided.