Risk sharing for mortgage finance through default insurance for low-income households in South Africa

Abstract

The study explores the business of mortgage default insurance for residential property finance as a potential innovation in the South African housing finance system. The commercial viability (in terms of post-tax earnings) of such an insurance programme, as targeted at the low-income households, is investigated, with a focus on the so-called gap market in the country’s housing market ladder. One highlight of the study is the difficulty of determining an appropriate price for the premium, given no prior historical record of default behaviour in the target market. This leads to a less than ideal resort to a claims pattern (and earnings pattern) from a mature and yet arguably different market in Canada. These so-called international patterns of default behaviour, although perhaps not representative of the local South African situation, have been used in successful first-time MI implementation elsewhere in emerging economies. The study finds in favour of a profitable, sustainable programme under assumed economic conditions of relatively high mortgage interest rates of 13% pa and higher. Premium under-pricing, however, appears to occur at mortgage rates of 10% pa and lower, rendering the business unworkable over a 9-year forecast period, with persistent annual reported negative earnings for the period.