FHA and Private Insurers Follow Distinct Reserving Practices and Capital Requirements

Reserving practices and capital requirements for FHA’s Fund differ in key  respects from those for PMIs. These differences stem from the distinct  environments in which FHA and PMIs operate, including the particular  accounting principles and statutory provisions that they must follow. For  both FHA and PMIs, capital requirements are expressed as ratios that  compare risk and capital, but these terms have different meanings in the  PMI and FHA contexts. It is calculated by estimating the  net present value of expected future cash flows for all outstanding loans  (anticipated losses less anticipated future revenue). FHA has not met its capital requirement for the last 4 years (see fig. As shown in figure 4, PMIs also have struggled to meet their capital  requirements in recent years, and regulators forced three large PMIs to  cease writing new business for failing to meet these requirements. However, certain  consequences PMIs face for not meeting capital requirements— remediation plans and additional reporting—could be applied to FHA to  enhance agency accountability. For  example, two of the liabilities that PMIs record under statutory accounting  principles—unearned premium reserves and contingency reserves—are  intended, in part, to protect policyholders by limiting payment of excessive  dividends to stockholders, which reduce capital. Industry Practice of Separately Disclosing Reserve Components Could Increase Transparency of Risks Facing FHA’s Fund

Although specific PMI reserving practices have limited applicability to  FHA, the concept of separately disclosing reserve components as PMIs  do could be applied to the Fund. For example, the PMI loss reserve and  unearned premium reserve focus on the timing of specific cash flows— the loss reserve on claims that are likely to be paid on delinquent loans in  the near-term and the unearned premium reserve on premiums as they  are earned over time. In contrast, FHA has a single reserve from a  financial accounting perspective, the liability for loan guarantees, which  combines estimates of future claims payments with estimates of future  premiums and recoveries over a 30-year period into a single number. Disclosing the timing of  specific cash flows would help illustrate the extent to which estimates of  claims payments, premiums, and recoveries in the liability for loan  guarantees are concentrated in the near term or longer term and  therefore more or less certain. Disclosing this  information could enhance congressional oversight of FHA’s financial  condition and would be consistent with reporting practices of other federal  programs and federal internal control guidance. In 2012, FHA provided Congress with a  set of planned actions to address its capital shortfall, but had not done so  in prior years. A capital restoration plan requirement triggered by  noncompliance with the Fund’s statutory capital requirements could help  ensure prompt action by FHA and focus Congress’s monitoring efforts  should this situation arise in the future. This type of requirement is  contained in legislative proposals currently before Congress and would be  consistent with prior congressional actions for certain financial institutions  and government entities. Matter for Congressional Consideration

To strengthen FHA accountability for complying with the Fund’s statutory  capital requirement, Congress should consider requiring that FHA submit  a capital restoration plan and regular updates on plan implementation  whenever the capital ratio falls below 2 percent as calculated in the  annual actuarial review of the Fund, or the Fund’s financial condition does  not meet other congressionally-defined requirements. Recommendation for Executive Action

To provide additional perspective on the Fund’s financial status, FHA  should disclose estimates of the individual cash flows associated with the  liability for loan guarantees (premiums, claims, and recoveries), including  their value for each year of the 30-year estimation period. Appendix I: Objectives, Scope, and Methodology

We examined the Federal Housing Administration’s (FHA) financial  condition requirements for the Mutual Mortgage Insurance Fund (Fund)  and compared them with those used by private mortgage insurers (PMI). Specifically, we discuss (1) how the reserving practices and capital  requirements of FHA’s Fund compare with those for the PMI industry and  (2) how, if at all, applicable PMI reserving practices and capital  requirements could enhance oversight of FHA’s Fund. We  reviewed generally accepted accounting principles for federal entities and  federal statutes that apply to FHA’s Fund. We analyzed data from FHA on the volume and  performance of the mortgages it has insured through the end of fiscal  year 2012 to calculate a loss reserve for FHA in the manner of a PMI.
Why GAO Did This Study

FHA insures private lenders against losses from defaults on single-family mortgages that meet FHA criteria. FHA's insured portfolio was more than $1 trillion at the end of fiscal year 2012. The mortgage insurance market also includes PMIs regulated by the states. Since 2009, FHA's Fund (under which FHA insures almost all its single-family mortgages) has not met its statutory 2 percent capital requirement. GAO was asked to examine the financial condition requirements that apply to FHA and PMIs. This report examines (1) how reserving practices and capital requirements for FHA's Fund compare with those for PMIs, and (2) how applicable PMI practices and requirements could enhance Fund oversight.
To address these objectives, GAO reviewed accounting standards, federal and state laws, regulations, and policies; analyzed FHA data; and interviewed federal officials and PMI industry officials and analysts.

What GAO Found

Reserving practices and capital requirements for the Mutual Mortgage Insurance Fund (Fund) of the Federal Housing Administration (FHA) differ in key respects from those for private mortgage insurers (PMI). These differences stem from the distinct environments in which FHA and PMIs operate, including the particular accounting principles and statutory provisions that they must follow. For example, statutory accounting principles (developed to meet the needs of insurance regulators in assessing financial condition) require PMIs to establish several reserve components, including a reserve for estimated losses expected in the near term on loans that are delinquent (loss reserve). In contrast, generally accepted accounting principles for federal entities (developed to align financial statement reporting with federal budget requirements) require FHA to reserve for the present value of estimated losses for all outstanding loans net of anticipated revenues (liability for loan guarantees). For both FHA and PMIs, capital requirements are expressed as comparisons of risk to capital, but the calculations measure risk and capital differently. Like FHA, PMIs have struggled to meet their capital requirements in recent years.
The PMI regulatory framework has limited applicability to FHA's Fund, but it has certain features that could enhance Fund oversight. Some of the purposes and concepts underlying PMI reserving practices and capital requirements are not pertinent to FHA. For example, two of the PMI reserve components (the unearned premium reserve and the contingency reserve) are intended, in part, to prevent PMIs from reducing capital through payment of excessive dividends to stockholders. However, the concept of separately disclosing reserve components as PMIs do could be applied to the Fund. The PMI loss reserve and unearned premium reserve focus on the timing of specific cash flows--the loss reserve on near-term insurance claims for delinquent loans and the unearned premium reserve on insurance premiums as they are earned over time. In contrast, FHA's liability for loan guarantees combines 30-year estimates of future claims, premiums, and recoveries into a single number, as required, and does not disclose the timing of each type of cash flow. Disclosing the timing of specific cash flows would help illustrate the extent to which estimates of claims payments, premiums, and recoveries in the liability for loan guarantees are concentrated in the near term or longer term and therefore more or less certain. Such disclosure could enhance congressional oversight of FHA and would be consistent with reporting practices of other federal programs and federal internal control guidance for communicating externally about an agency's risks. Accountability features of the PMI regulatory framework also could be applied to FHA. Unlike FHA, PMIs must take certain actions for noncompliance with their capital requirements. These actions may include remediation plans to restore capital to required levels and additional reporting. In 2012, FHA provided Congress with a set of planned actions to address its capital shortfall, but had not done so in prior years. Producing a capital restoration plan when the capital ratio fell below the required level could help ensure prompt action by FHA. This type of requirement is contained in legislative proposals currently before Congress and would be consistent with requirements Congress has enacted for the Federal Deposit Insurance Corporation and certain financial institutions.

What GAO Recommends

Congress should consider requiring FHA to submit a capital restoration plan and regular updates on implementation whenever the Fund's capital ratio does not meet required levels. Also, FHA should disclose estimates of specific cash flows (premiums, claims, and recoveries) over time to provide additional perspective on the Fund's financial status. FHA generally agreed with GAO's recommendation.