New financial product: Home Value Insurance

5 years too late, but it’s here.

Kathleen Kelly, 47, might be able to sell her Visalia, California, house today if she had bought insurance against falling home prices when she purchased the place four years ago.

The policies, designed to reimburse homeowners who suffer a loss on a sale due to declining local prices, hit the market in September. That’s about five years too late for U.S. homeowners who bought at or near the peak in 2006, as prices have dropped about 31 percent since then. It doesn’t cover the fall prices have already taken.

“It’s a fear factor sale,” Kelly, a bank branch manager, said in a telephone interview. “From the insurance industry’s standpoint, now would be the best time because home prices have nowhere to go but up. But from the buyer’s point of view, I don’t think you’d use it.”

U.S. home prices are unlikely to take another big drop, which may be why companies are selling these contracts now, saidStan Humphries, chief economist for Zillow Inc., which tracks home values.

“I think they’re calculating we’re closer to the bottom than the top,” said Humphries, who expects prices to fall about 5 percent before leveling off in 2012 or later.

The insurance is designed to protect homebuyers concerned they may be forced to sell for a loss in the event of a job transfer, income loss or family change, said Scott Ryles, chief executive officer of Home Value Insurance Co.

“Most people don’t sell their house because prices have gone up or they think they’re going to go down,” he said in a telephone interview. “Most people sell their home because they need to move.”

Licensed in Ohio

Home Value Insurance was licensed in September by the Ohio Department of Insurance to sell its policies to homeowners in that state. The insurance, which costs about $20 a month per $100,000 in value, pays out only if the insured home sells for a loss and if local prices, as measured by S&P/Case-Shiller home-price indexes, have declined.

EquityLock Solutions LLC, another provider, has sold more than 250 contracts since it started offering them in May, said T.J. Agresti, chief executive officer of the Denver-based company. EquityLock contracts, which are not insurance policies, may pay if local home prices, as measured by Federal Housing Finance Agency price indexes, fall in value, even if the owner sells for a profit.

The home-value contracts could help provide a price floor by restoring buyer confidence, even in the hardest-hit markets, said Agresti.

Investment or Home?

“If enough people do that in a market like Las Vegas, then the natural side effect is market stabilization,” he said in a telephone interview.

The high cost of the premiums and the untested nature of the contracts make them a bad choice for most consumers, said Bob Hunter, director of insurance for the Consumer Federation of America, a Washington-based consumer-advocacy group.

“Is your house an investment, or is it a home?” said Hunter, a former insurance commissioner of Texas. “In the long run, the market will be all right.”

Prospective buyers should be sure they understand the contracts’ structures and exclusions, said Scott Simmonds, an insurance consultant based in Saco, Maine.

Home Value Insurance won’t pay if an insured home has declined in value due to a natural disaster, physical damage to the home, or has been sold under eminent domain or in a foreclosure, according to terms reviewed by Bloomberg News.

10-Year Term

The policies generally last up to 10 years and have deductibles for the first two years. In the event of a claim, they’ll pay the lowest of the home’s price decline, the percentage decline of the local home-price index multiplied by the home’s value, or 25 percent of the home’s value. The company may raise the monthly premiums by as much as 5 percent each year.

EquityLock’s contracts may last for 15 years and won’t pay out during the first two years. They’ll pay a maximum of 20 percent, based on the underlying index value.

EquityLock isn’t an insurance company. It purchases insurance to cover its own financial risk through a so-called captive insurer licensed in Washington. Captive insurance companies are more loosely regulated than conventional insurance companies that sell policies to the public, Hunter said.

‘Risky Situation’

“It’s a much more risky situation,” Hunter said. If the company failed, contract holders wouldn’t be covered by an insurance guaranty fund. “If you have a bank account, you have the FDIC; if you have an insurance company, you have the guaranty fund; here you’ve got nothing,” he said.

EquityLock’s outside insurer is “actuarially defined, regulatory approved and supervised,” Ted Rusinoff, EquityLock’s president, said in an e-mail. “That level of oversight is exactly why all of our contract holders feel comfortable that our ability to pay a market downturn payment is secure.”

The potential U.S. market for the insurance policies is $25 billion a year, said Chi-Hua Chien, a partner at venture capital firm Kleiner Perkins Caufield & Byers, which was an early backer of Silicon Valley startups such as Google Inc. (GOOG) Home Value Insurance may claim about 1 percent of the market over the next five years, for projected revenue of about $250 million a year, Chien said.

Kleiner Perkins, other venture-capital firms and university endowments have together invested more than $10 million in Home Value Insurance, said Chien, who declined to disclose an exact amount because the company is closely held.

Value Proposition

There was $10.4 trillion of home mortgages outstanding on June 30, down 6.93 percent from the $11.2 trillion in 2007, theFederal Reserve reported Sept. 16.

“Home equity represents the majority of the average American’s net worth,” Chien said in a telephone interview from his office in Menlo Park, California. “In my mind, it’s a compelling, if not mind-blowing, value proposition.”

Kelly bought her home for $479,000 with a 20 percent down payment in 2007, when she needed room for her ailing parents, husband and four children. Her parents have since died, the marriage ended in divorce and she’d like a smaller place with lower utility bills, even after Bank of America Corp. (BAC) agreed to a loan modification that cut her mortgage payments by 38 percent to $1,435 a month.

“I did all the right things and it didn’t make a difference,” she said. The home, which has two mortgages totaling $380,000, is worth about $300,000 now, Kelly said.

Home-Value Hedge

Products that hedge against home-value gyrations aren’t a new idea. MacroMarkets LLC in 2009 issued two exchange-traded trusts that allowed investors to bet on the direction of the Case-Shiller 10-city index. The funds liquidated in January 2010 because they never gathered more than $50 million in assets, said Terry Loebs, managing director at MacroMarkets.

Grant Davis, president of GDI Insurance in Turlock,California, said he has lined up six California homebuilders who want to offer home-equity insurance policies to prospective buyers. The trouble has been finding an insurance company to back the plan, he said.

“It has to be a highly rated company,” Davis said in a telephone interview. “That’s what we’ve been pursuing and that’s the hard part.”

Not Rated

Home Value Insurance is not rated by any credit analysts because the company is new and is closely held, Ryles said. The firm had to demonstrate financial strength and capital to the satisfaction of Ohio’s insurance regulators, including the ability to back all claims in the event of another plunge in real-estate values, in order to become licensed, he said. Licenses in other states are pending, according to Ryles.

As of July, the most recent month for which data is available, home values in 20 U.S. cities were down 31 percent from their July 2006 peak, according to the Case-Shiller index of repeat sales. The drops ranged from 59 percent in Las Vegas to 7.5 percent in Dallas.

In 2005, EquityLock CEO Agresti, an attorney, was suspended from practicing law by a Colorado judge for one year and one day after exercising “unauthorized dominion and control” over a client’s funds, according to court documents. Agresti “did not scheme to defraud his client,” the order said.

Agresti said an office manager he employed misappropriated about $187,000 from his law firm from 2002 to 2003, including client funds.

Consumers should be wary of new insurance products in general, since it often takes time for policies’ loopholes to become apparent and for companies to work out appropriate pricing, Hunter said.

“It’s like Texas hold ‘em,” Hunter said. “Except you don’t see any of the cards.”

To contact the reporters on this story: John Gittelsohn in L

I read only the first paragraph, so I can’t claim to be any wiser than before I opened this thread. But really, talk about the horse, the barn, bolting and all of that.

I also only read the first paragraph, but these policies will probably be gold mines over the long-term.

Agreed. I can’t believe that I didn’t know about this. All WFC, BAC or other companies have to do is offer an OTM put on real estate with every mortgage that they originate. They can charge 1-2% spread and make a shitton of money. Of course, this would mean that the biggest mortgage originators will be long real estate - even more than they are now. So there might be some systematic risk issues if these products become mainstream. I can’t think of any natural terminal buyer of the long real estate positions. Maybe the banks can introduce a collar structure (customers buy OTM put, sell OTM call). This way, home owners are guaranteed a price for their homes within a narrow band. This would also alleviate the systematic long real estate problem.

A lot of basis risk wrt Case/Shiller - still probably room to grow in this area, though this product is probably more BS than anything imo.

Well, we don’t need to be bogged down by the specifics of past approaches. The fact is that there is probably close to $1 trillion of mortgage origination notional per year in the US. If banks manage to attach an additional financial product to even a fraction of this, there is a lot of money to be made. The details - like how to value the homes - can always be changed.

…How in the h*ll does an insurance company significantly/profitably hedge the downside risk of real estate prices falling. Don’t say CaseSchiller futures because the open interest is simply too low. I would venture to guess that insurance companies are probably not hedging for downside risk; kind of like AIG. I’m just saying…if the housing markets crashes, they will be h*ll to pay for these insurance companies that wrote these contracts…Lord knows this housing market is being artificially propped up by the Fannie, Freddie, and the Fed…

It’s funny how we so quickly forget the lessons of yesterday!

I can’t imagine anything going wrong with a product like this. Also, now that we can link directly to articles, how about we don’t post the whole thing in the text box?

@sweep the leg, “I can’t imagine anything going wrong with a product like this.”; Are you being sarcastic?

You need to broaden your thinking a bit. First of all, although this product is a form of insurance, it does not need to be offered by insurance companies. The natural issuer of this product is mortgage originators themselves. It’s much easier to sell an additional financial product if you already have a customer base. This is why banks are is obsessed with “cross selling” - in some cases resulting in great profit, I might add. As for the long real estate position, yes, I acknowledged this in my previous post. However, I don’t buy the argument that financial services companies should not stay in business if the result is a long real estate position. If this is the case, then all mortgage originators should immediately close down. There must be a way to manage this risk, or else JPM or WFC would have gone the same way as Wachovia or CitiGroup. This sort of insurance is just an extension of existing mortgage businesses.

Actually, once you think about it, it’s dubious to argue that insurance should not be offered against any event that does not have a liquid futures market. Where is the futures market for car crashes or heart disease? Once you think about it, declining home prices are much more quantifiable.

Zesty - I’m kind of with ohai on this one…it’s not that the product doesn’t make sense from a seller’s perspective (even if they can’t hedge), it’s that in it’s current form it doesn’t make sense for the buyer. Besides if it’s actually issued as an Insurance Policy, reserves will be strictly regulated and will act as a ‘hedge’ against losses. Once they figure out how to address the issue of providing usable value to the buyer, then imo, it becomes a much more viable market. Until then, I’m not sold on this (not sure if the pun is intended).

@LPoulin133, Three words…American International Group…aka AIG. Different story but the moral remains the same. Unlike life or auto insurance, when there is a recession housing prices fall across the board, in pretty much every state. So unlike Life or Auto insurance, where claims come in streams, when the next recession hits there will be a wild torrent of claims.

Therefore, if I saw that an insurance company was issuing these insurance policies. I would steer clear as an investor…I’m just saying.

AIG is not a very good example. Some firms failed due to poor risk management. This does not mean that all firms cannot be risk managed effectively. Take WFC for example.

…fwiw, Chartis, the actual “Insurance” part of AIG regulated by the states/NAIC did and continues to do pretty well (though even that is a cyclical business). It was the AIGFP division that was responsible for all hell breaking loose - and agreed, they is be morons.