The difficulty with mortgage insurance is that claims may result, not merely from the day to day risks associated with foreclosures caused by illness, death, marital or job problems, but also from widespread economic adversity and unemployment. Since the latter conditions are likely to coincide with a depressed stock market, the ability of mortgage insurance companies (MICs) to weather times of economic stress depends heavily on the aggressiveness of their investment portfolios.
In particular, there is little justification for sizable equity positions in MIC portfolios. One of the primary reasons non-life insurance companies hold common stock in their portfolios is to obtain protection against inflation. Unlike fire and casualty companies, however, mortgage insurers benefit from inflation because it increases the collateral value underlying the mortgages they insure.
Liquidity is another important issue. In 1966, 1969-70 and 1973-74, savings flows to thrift institutions were disrupted by high short-term interest rates. Mortgage lending activity decreased sharply, causing sharp reductions in the premium volume and cash flows of mortgage insurers. For this reason, short-term bonds are probably preferable to long-term ones as MIC investments.
About the only regulations constraining portfolio investment by mortgage insurers are prohibitions against participating in the real estate of mortgage markets. These regulations cannot be relied upon to prevent potential problems in MIC investment portfolios.