GMA worth up to $3.60 in run offShould CBA not continue its long...

GMA worth up to $3.60 in run off

Should CBA not continue its long term relationship with GMA, a run off situation would be financially beneficial to GMA shareholders, with expected capital returns of ~$3.15 to $3.60 over 7-10 years.

A Lenders’ Mortgage Insurance (LMI) policy is highly capital intensive in its early years. Assuming no recession, in full run-off GMA’s Probable Maximum Loss (PML) would reduce quickly as capital intensity reduces steadily with cancellations and seasoning.

Upwards of 75% or more of GMA’s PML could be gone within 4-5 years - with surplus capital subsequently building.

This is in addition to the current $340m of excess capital above target (at the 30 September 2021 Prescribed Capital Amount (PCA) of 1.87x).

However, risks (eg concentration risk) would increase within the run off portfolio. That said, high levels of recent house price appreciation have likely created significant buffers which could offset if not outweigh risks in the in-force portfolio.

Regardless, in a run off situation, APRA would be expected to tighten capital controls on GMA. For example, increasing the PCA to over 2x and further lengthening the unearned premium recognition trajectory.

In terms of operating performance, GMA’s 30 June 2021 unearned premiums of $1,546m would continue to accrue through the Net Earned Premium (NEP) line for a number of years after new business ceased being written (as the delayed earning pattern for LMI premiums would continue to feed revenues).

Expense management would be a challenge in the face of declining Gross Written Premiums (GWP), as GMA would need to maintain headcount and systems to handle claims and administration services.

Eliminating other costs (listing costs, sales/marketing, premises, etc) would likely prove more difficult than shareholders would like, as ongoing non-claims expenses likely have large portions that are fixed and/or embedded into GMA’s operations.

As a proxy, in 2015 when GMA lost WBC as a customer, the insurance analyst James Coghill (a great guy and a very good analyst) assumed “acquisition expenses reduce at 2/3rds the rate of NEP and administration costs contract at half the rate. The implication is negative jaws and a rising expense ratio.”

Bringing this all together, a run off situation would be financially beneficial to GMA shareholders with expected capital returns of ~$3.15-$3.60 per share, but with expectations the time frame for these returns more likely to be over 7-10 years (and weighted to the back end).