A couple of weeks ago a Seeking Alpha article was published that highlighted some problems on the horizon for Radian Group (RDN). The article was excellent and it introduced me to the idea of liquidity risk at a mortgage insurance subsidiary. That led me into a much more detailed investigation of the Radian Guaranty insurance subsidiary, which I will discuss below.
The liquidity of an insurance sub
Before getting into the issues specific to Radian, let’s talk a bit about liquidity risk. For some reason liquidity is not at the forefront of discussion during conference calls and in brokerage reports on mortgage insurance companies. Questions and comments focus on risk to capital ratios and loan loss reserve methodologies, which, while providing important clues, do not in themselves allow you to conclude whether a company will have the cash available to pay the claims. The author of the SeekingAlpha article, Darren Oliver, suggested that this was because the mortgage insurance industry is not very well understood. This could be the case, I don’t know. I just find it surprising.
As a mortgage insurer, the bottom line is that you have the cash available to pay claims and that the regulator who watches over you believes that this is the case. Over time, the cash and short term investments on hand plus the premiums paid need to be enough to pay out claims made as well as operating expenses incurred. If there is a concern that the cash and future premiums will not be enough to cover the expected claims, the insurer will either be taken over by the regulator or put into run off.
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