Liability distributions for mortgage insurance

Option models can provide not only the value of an insurance policy, but also more disaggregated information concerning those precise circumstances under which defaults occur and, hence, insurance payouts must be made. The value of the insurance policy serves as a summary statistic describing insurance payouts. However, given the rather highly irregular and skewed character of the entire distribution of insurance payouts, this single value will be a poor estimate of the typical payout. Thus it should be of considerable interest to mortgage insurance issuers to know not only the expected cost of insurance, but also the entire distribution of potential payouts as exhibited in this study. Insurers have not traditionally differentiated prices among different homeowners' mortgage insurance policies as much as rational pricing or even common sense would seem to demand. The option model pricing techniques presented in this study provide the means of assessing differential mortgage insurance values.