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Mortgage Loans

*Mortgages provide a steady earnings stream that support insurance liabilities well. Mortgages meet the primary objective of maintaining a tight asset/liability match with a well-diversified core of investments.

Is an amount of money, loaned at interest for a specified term, secured by real estate and by its improvements such as buildings and infrastructure.

Real estate lending by insurance companies is primarily concentrated on commercial property, where as residential loans, those on homes for four families and fewer, are largely the province of banks.

Promissory Note: represents the promise to pay and is secured by the mortgage on the real estate.
*Mortgagor = Borrower
*Mortgagee = Lender


subordinated lien-holder

*is paid out of such proceeds only after the first lien-holder and all other superior lien-holders are paid. If there are insufficient proceeds to pay the subordinated lien-holder, the remaining balance may only be collected when additional collateral or personal recourse is specifically included in the loan documentation.


Conventional Commercial Loans

*The majority of commercial mortgage loans made are conventional whole loans, where the lender provides the entire loan amount at a specified interest rate for a determined period of time.

* The lender’s ability to recover in the event of a default will be limited to the value of the mortgaged real estate. Only in circumstances where the lender has negotiated additional credit support, can you seek to recover losses incurred, which exceed the value of the property. Typical types of credit support include letters of credit and personal guarantees from the borrower. LTV no more than 80%.

Prepayment of a conventional mortgage loan is discouraged through prepayment penalties. When prevailing market interest rates are lower than the rate on the loan being repaid the borrower has to make up the interest rate differential and the lender is essentially “made whole” for a potential loss of interest.


Subordinated Loans

A mortgage that ranks after the first in priority is a subordinated loan. Properties may have two or more mortgages as liens at the same time. The first mortgagee generally requires that its approval is obtained before additional financing can be put in place.

*Wrap-around Loan: Is a special variation on a second mortgage. In this form, the new lender assumes the original or first mortgage and has the responsibility of collecting all payments and remitting a portion of these payments to the first lender.


Conventional Residential Loans

Most residential mortgage loans are conventional mortgage loans, which allow the lien-holder to look only to the value of the mortgaged property and the net worth of the borrower for repayment in the event of default. No prepayment penalty. LTV should not exceed 80%.


FAH Loans

*This agency does not make loans; it only insures them. For this protection the borrower must pay an annual insurance premium to the FHA of 0.5 percent of the outstanding principal amount of the loan. Upon default, the lender has the option either

1. of assigning the mortgage to the FHA and receiving cash and/or securities equal to the loan amount at the date of the default or
2. of foreclosing on the mortgaged property.

The FHA establishes standards for property that can be insured and maximum terms, interest rates, and amounts for the insured loans.


VA Loans

*VA loans are partially guaranteed by the VA, and the VA in turn imposes certain qualifications for property that may secure the loan and restrictions on the terms of the loan.


Privately Insured Loans

in recent year, Private insurance companies have sold insurance that guarantees a part or the entire principal of a conventional loan.


Residential Loans

Loans are secured by single-family houses or by one-to-four family residential properties.

*Loans that exceed 80 percent of market value generally require the borrower to purchase mortgage insurance


Commercial Loans

Loans are secured by shopping centers, office buildings, industrial buildings and *multifamily residential properties.


Construction Loans

Loans are made to finance the construction of residential or commercial property. Security for these loans is the structure being built and the land
on which it is situated.

*In some cases, the construction loan lender will agree in advance to provide long term or intermediate financing when the structure is completed and in service. However, if this is not the case, the construction loan lender will usually require evidence that the borrower has arranged for long term financing from another lending institution. *This arrangement is commonly called a commitment.

*Construction funds are advanced as the work progresses. The borrower must submit evidence of costs incurred and demonstrate that there are adequate funds not yet disbursed in the loan to complete the project.

* When the structure is completed and put in service, the construction loan is paid off from the proceeds of the long term financing, whatever its source.


Development Loans

*Loans on developed building lots and loans to finance the acquisition and development of unimproved land. Development loans are secured by unimproved land and the improvements made to the land.

Land development usually refers to the installation of improvements necessary to make unimproved building sites ready for the construction of structures.

development loans are funded periodically and are paid off either when construction loans for the structures are funded or after building is completed and long term residential or commer- cial loans are obtained on the properties.


Undeveloped Land Loans

*Loans on secondary undeveloped land that is not to be developed in the foreseeable future


Farm Loans

Loans that are secured by farmland including produce farms, standing timber, vineyards, orchards and dairy farms. The standing crop and the chattel, as well as the improvements on the land are usually part of the security for the loan.


Purchase Money Loans

*Loans that result when life insurance companies purchase real estate or, as lenders, may acquire real estate through foreclosure on mortgage loans.

When such property is sold by the life insurance company, part or all of the consideration that the company receives may be a mortgage loan on the property. * A mortgage loan received as part or all of the purchase price for real estate owned previously by a life insurance company, is called a purchase money loan.


Mezzanine Real Estate Loans (MRELs)

* Are secured by a pledge of direct or indirect equity interests in an entity that owns real estate. MRELs do not include a security. MRELs is a nonadmitted asset.(unless specifically identified as an admitted asset in the Manual)


Governmental Regulations Affecting Mortgage Loans

*Require life insurance companies to invest only in first lien mortgage loans and in some cases, only certain types of first lien mortgage loans.

*Regulations limit the loan to market value ratio of new and existing mortgage loans from 66 2/3 to 80 percent, unless the mortgage loans are insured or guaranteed by the FHA or VA.

Some jurisdictions prohibit a concentration of investments in mortgage loans with any one borrower or in any one property. Some jurisdictions prohibit or limit investments in mortgage loans when a person or entity affiliated with the insurer is the borrower.


Basket clauses

*Allow investments to be made, up to a certain percent of invested or total admitted assets, in assets that do not otherwise meet regulatory requirements. If their domiciliary jurisdiction regulations have a basket
clause, a life insurer with a business purpose for doing so can make a limited amount of mortgage loans that do not meet regulatory requirements without a reduction in surplus.


Normal Documentation for Mortgage Loans

The Investment Department and the company’s Investment Committee are responsible for assessing opportunities to make mortgage loans, for making commitments for investments in new mortgage loans, for disbursing mortgage loan proceeds, and for monitoring the status of previously paid-out mortgage loans.

The assessment process (commonly called underwriting) helps to ensure the safety of mortgage loan principal. The underwriting process generates certain important documentation, which should be preserved. When the loan is funded, normally at a closing, other documentation is generated. Certain important documentation is also accumulated over the life of the loan.

The Accounting Department or a separate control function of the Investment Department or the Treasurers Department should be responsible for receiving all cash, issuing all checks, and accounting for all cash receipts and disbursements and other transactions related to a company’s investment in mortgage loans.


Documentation Generated During the Underwriting Process

* Required documents are:
• Loan application
• Credit report: *A report that provides the borrower’s past credit history and current credit standing. *If the loan is on commercial income-producing property, the company usually also obtains credit reports on the principal tenants and copies of the leases.
• Borrower’s financial statements,
• Verification of the borrower’s employment
• Verification of Deposit
• An appraisal
• Environmental report: *An environmental review of the property which the company would order depending on the age, history of usage, location, and other factors.



The appraisal value is used to determine that the loan to market value ratio is in compliance with regulatory requirements. *It also is used to determine any nonadmitted mortgage loan amount.

*Even if a company maintains its own appraisers, independent appraisals are obtained as a check on the quality of company appraisals. Some jurisdictions require independent and certified appraisals. Appraisers use three approaches to determine the property’s value:
• Cost - *determines a value that represents the current cost of reproducing a property less depreciation.
• Income - determines a value that represents the property’s net earning power. *It is based upon capitalization of net income.
• Market Data - determines a value from the recent sales of comparable properties in the same market as the property being appraised.


Generated when loan funds are distributed

• original promissory note
• the mortgage: * those most commonly encountered are regular mortgages, deeds of trust, equitable mortgages, deed absolute given as security for debt, and deed to secure a debt.
• evidence of its first lien on the property used as security: * lender’s title insurance policy offers greater protection to the company than an attorney’s title search and opinion.
• survey of the property: A survey from an approved engineer or surveyor ensures there are not encroachments related to the mortgage property.
• closing statement
• property insurance policy
• assignment of rent if appropriate for income-producing property

• any participation agreement agreed to between the borrower and lender:

• and others: * These include the assignment of mortgage or deed of trust where loans are purchased, assignments or liens on life insurance policies, escrow agreements, lot release agreements, partial release agreements, construction loan funding schedules, and releases of mechanics liens in the case of construction and land development loans.


Evidence of its first lien on the property used as security

*An attorney’s opinion and an abstract of title, a lender’s title insurance policy, or an owner’s title insurance policy is obtained to protect the company against having an imperfect lien against the mortgaged property.Therefore, a lender’s title insurance policy offers greater protection to the company than an attorney’s title search and opinion.


Participation Agreement

*An agreement the company receives part of the gross or net income being generated by income-producing property upon which the company has granted a mortgage.


Acquiring Mortgage Loans Through
Secondary Markets

Buying participation in a block of existing loans or buying existing loans from another life insurance company or another financial institution.


Acquiring Mortgage Loans Through
Block of Loans During Acquisition or Mergers.

Obtaining a block of loans when it acquires or merges with another life insurance company.


Acquiring Mortgage Loans Through
In Lieu of cash in a reinsurance transaction

Receiving loans in lieu of cash from ceding insurance companies to fund policy reserves on policies acquired by the reinsurer in a reinsurance transaction.


Acquiring Mortgage Loans Through

Historically, mortgage bankers and direct placements were primary sources of new mortgage loans. However, with the advent of secondary market activities, bond brokerage houses and investment bankers have entered the field of selling and placing


Acquiring Mortgage Loans Through
Participation or Joint Venture Loans

Life insurers have increased sharing loans with other life insurers to take part in larger projected loans while spreading risks and diversifying types of loans (i.e., shopping centers, office towers, etc.).


Acquiring Mortgage Loans Through
Participation Certificates

Essentially these are pass-through certificates whereby a trustee holds all mortgage documents in trust, sells off interests in the underlying mortgages, collects the mortgage payments, and remits its portion to each holder. The GNMA is probably the most widely recognized issuer of this type of mortgage interest. Another kind of instrument is the CMO.


Accounting for the Initial Investment in a loan
Original Recorded Amount

The amount recorded as the initial investment in a loan is the consideration given for the loan.

* This consideration is the principal amount of the loan, net of deferred loan origination and commitment fees.

This difference in rates generates either a premium or a discount. A premium occurs when the amount paid for the loan is more than the principal of the existing loan. A discount occurs when the principal of the existing loan is more than the amount paid for the loan.This premium is amortized or the discount is accrued over the remaining life of the loan, the period of time until total principal proceeds of the loan are received in cash.


Accounting for the Initial Investment in a loan
Expense of Initial Investment

The major costs to a company that originates its loans directly are the salaries and expenses of personnel in the Investment Department who underwrite the loan and represent the company in the loan transaction. These salaries and expenses are treated as period costs and are expensed as incurred.

When loans are obtained from a mortgage banker, the mortgage banker will usually charge a fee, expressed as a percent of the loan principal amount, for underwriting and originating the loan. This


Accounting for the Initial Investment in a loan
Income from Initial Investment

The only income generated through an initial
investment in mortgage loans, is the commitment fee that the company might receive for issuing the commitment letter obligating the company to make the loan. Such a fee reimburses the company for its expenses in originating the loan.

* Loan origination fees represent fees charged the borrower for originating, refinancing or restructuring a loan. Loan origination fees may include charges for points, management, arrangement, placement, application, and underwriting, to name a few.


Servicing the Investment in Mortgage Loans
Loans Serviced Directly

Functions are split into?

functions are split between the
1. Accounting Department and
2. the Investment Department.


Servicing the Investment in Mortgage Loans
Loans Serviced Directly

Functions of the accounting department?

• processes and records all receipts of commitment fees, principal, interest, equity participations, late fees, prepayment penalties, extension fees, other income, and escrow funds.

• reviews, approves, and makes disbursements for and records all expenses, escrow funds (principally payments of real estate taxes and insurance premiums), and loan principal related to the investment in loans and foreclosed property.

Accounting department is responsible for:
• Supplying the Investment Department with correct data and reports that summarize all loan transactions.

• Alerting the Investment Department promptly whenever an exception to the normal processing routine occurs.

• Design, maintenance, and accuracy of accounting records, for periodic management and exception reports, and for statutory statement preparation.


Servicing the Investment in Mortgage Loans
Loans Serviced Directly

Functions of the Investment department?

The Investment Department is responsible for promptly supplying the Accounting Department with:

• Accounting data on new loans
• Data related to changes in existing loans, which affects the accounting function.
• Resolving all exceptions reported to it by the Accounting Department, i.e., when a borrower defaults on a loan payment.


Servicing the Investment in Mortgage Loans
Loans Serviced by Others

Control over the servicer: The contract between the company and servicer should provide?

The contract between the company and servicer should provide that the:
• Company can periodically audit the servicer’s records and files pertaining to the loans owned by the company. In lieu of making the audit, the company can agree to receive an annual audit report pertaining to its loans from the servicer’s independent certified public accountants. * This is the single audit concept.

• Servicer must have a fidelity bond and an errors and omission policy of stipulated minimum amounts.

• Servicer must have an annual independent audit, with a copy of the audited financial statements sent to the company within a certain period of time after the end of the servicer’s fiscal year.


Accounting for Loans During the Servicing Period

Accounting transactions that occur during the period the loan is being serviced fall into two broad categories:

• processing transactions: which are recurring and similar in nature for all mortgage loans

• special transactions.


Accounting for Loans During the Servicing Period
Processing Transactions

Recording Principal Receipts?

Recording Principal Receipts - Mortgage loan balances are usually amortized on a monthly basis over the term of the loan.


Accounting for Loans During the Servicing Period
Processing Transactions

Recording Interest Income?

Interest income is recorded as earned. Interest due but not received at the end of the accounting period is accrued into income. Interest received before it is due is not reflected as income until earned and is recorded as unearned investment income.


Accounting for Loans During the Servicing Period
Processing Transactions

Earned Interest Income?

includes interest income accrued collected, change in interest due and accrued, change in unearned investment income plus amortization of premiums, deferred fees and accrual of discounts.

When a loan is in default, interest should be accrued if deemed collectible. If a loan in default has interest income due and accrued 180 days past due and collectible, investment income continues to accrue but interest is reported as non-admitted. Interest continues to be accrued until deemed uncollectible, at which time the accrued interest is written off against investment income and no longer accrued.


Accounting for Loans During the Servicing Period
Processing Transactions

Escrow Accounts?

Escrow accounts constitute funds collected monthly from the borrower and held for ultimate payment of taxes and insurance.

*Separate bank account or a trust bank account may be opened. with all escrow receipts deposited into it to prevent commingling of escrow funds with a company’s operating funds.

* Tust bank : If escrow funds are deposited in a segregated trust bank account are recoded as separate assets in the statutory statement (not recorded as cash on deposit)

Separate Nontrust bank : Escrow funds deposited in separate nontrust bank accounts are recorded as cash on deposit.

The liability for such escrow funds, whether credited as cash or a separate account, is recorded as an amount withheld or retained by the company as agent or trustee liability.


Accounting for Loans During the Servicing Period
Special Transactions

Modified Mortgages

Trouble Debt restructuring - is defined as a debt restructuring whereby the insurer for economic or legal reasons related to borrower financial difficulties, grants a concession to the debtor that it would not otherwise grant.

Fair value for a non-collateral dependent loan is determined in accordance with the NAIC Purposes and Procedures of the Securities Valuation Office or the present value of future cash flows.

If a loss is recorded the amount of the interest accrued included in the loss is reversed and recorded as a charge to interest income.


Environmental report

*An environmental review of the property which the company would order depending on the age, history of usage, location, and other factors.


Sources of Mortgage Loans for Life Insurers

Secondary Markets
Participating or Joint Venture Loans
Participation Certificates


Accounting Systems for Mortgage Loans

Exhibit of Net Investment Income
Earned income consists of collected income, change in due and accrued income, change in unearned income including amortization or accretion. Uncollectible investment income due and accrued is written off and charged to investment income.

Exhibit of Capital Gains and Losses
• Realized capital gains and (losses): Realized gains and losses from the sale, foreclosure, or write downs for other than temporary impairments to the recorded investment of mortgage loans are reported in realized capital gains and (losses).
• Unrealized gains and losses relating to the adjustments to the statement value for recognizing an impairment of a mortgage loan by creating or adjusting a valuation allowance for an impaired loan are reported in unrealized gains and (losses). Expenses related to mortgage loans are reported in general expenses.


Schedule B

Summaries of all transactions that affect the principal balance of mortgage loans during the year are broken out by type of loan in Schedule B, which also provides analyses, by type, of the number and of the recorded investment of mortgage loans by location (state or foreign country) of the mortgaged property.

Other sections of this schedule give detailed information on the following: loans with interest overdue more than 3 months not in the process of foreclosure at the end of the year; and mortgages in the process of foreclosure at the end of the year.

Schedule B, Part 2, provides analyses of mortgage loans sold, transferred or paid in full by loan, the recorded investment at disposition, consideration received and profit/loss on sale.

Schedule B also presents information related to the appraised values of mortgaged property held as security for loans, to loans on which property taxes are delinquent, and to certain mortgage loans where the borrower is an officer, director, parent, subsidiary, or affiliate of the reporting life insurance company.

The information contained in Schedule B is also used in computing a company’s Risk-Based Capital (RBC).

Additionally, Investment Risk Interrogatories are required as a supplement to the Annual Statement to be filed by April 1. These Investment Risk Interrogatories require mortgage information for amount and percentage of the total admitted assets held of each of the ten largest aggregate mortgage interests, loan to value ratio categories, and types of mortgages.



* These are securities whose underlying assets consist of commercial mortgage loans. The commercial loans are pooled, which brings diversification and liquidity to the asset class.

* There are many different sources of CMBS. Conduits and aggregate pools generally consist of loans newly originated, purchased or held by investment bankers until the pool is large enough for an efficient execution. Government agencies such as the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corp. (FHLMC) are important sources of residential financing.


Commitment Letter

* Indicates the lender’s commitment to make a loan in accordance with the terms specified either in the borrower’s loan application or in the terms the company approves for the loan.

The letter and loan application together represent the contract.

In many cases, companies receive a fee for issuing commitment letters.Nonrefundable commitment fees are deferred. If the commitment is exercised, the fees are deferred and amortized over the life of the loan. If the commitment is not exercised, the fees are credited to income on the commitment expiration date.


Documentation Accumulated During the Life of the Loan

* Subsequent to the funding of a loan, the three most common documents obtained are:
1) new or updated appraisals as evidence of the current value of the property;

2) current financial statements on the borrower or the property, if the property is income producing, as evidence of the borrower’s continuing financial strength and of the property’s continuing ability to produce income; and

3) periodic inspection reports as evidence of the physical condition of the property.


Loans Serviced Directly

Expenses and Income Related to Direct Servicing

* Generally, a company earns a servicing fee when it retains the servicing of a block of loans in which it has sold all or part of the block. Service fees received from sales of participations are recorded as gross income and not netted against interest income remitted to the acquiring party.


Servicing the Investment in Mortgage Loans
Loans Serviced by Others

*Expenses Related to Serviced Loans.

A company that has its loan serviced is usually charged a servicer's fee.

* The servicer’s fee is usually expressed as an annual fraction of a percent of the principal balance of the loans or based on a percentage of each interest payment. Fee is collected periodically and deducted from the amount of principal and interest collections remitted by the servicer.

If the servicing agent reports interest income net of servicing costs, interest due and accrued is reported net of servicing costs. If the servicing agent reports interest gross, interest due and accrued is reported gross, with a liability recorded to reflect the servicing cost accrual.


Accounting for Loans During the Servicing Period
Processing Transactions

Recording Participation Income?

this type of income does not relate directly to the unpaid principal balance.

*Generally, it is an income stream due the company and is based upon the financial results of the borrower and/or borrowing business entity. Although it can take several forms, two of the more prominent ones are:

• *Participation in revenue generated by the mortgaged property above a specified sum, such as a percentage of gross sales in excess of a specified dollar volume.

• *Participation in profits from the mortgaged property, such as a percentage of gross income less defined expenses.

* ADC are lending agreements in which the lender participates in expected residual profits. Expected residual profit (called interest or another name such as equity kicker) is the profit above the reasonable amount of interest and fees expected to be earned by the lender.
• >50% of the expected residual profits the ADC arrangement is classified and accounted for as investment real estate
• 50% or less of the expected residual profits, the ADC arrangement is classified as a loan or a real estate joint venture.


Accounting for Loans During the Servicing Period
Processing Transactions

Recording Expenses?

* Expenses, other than those related to foreclosure of loans, are normally considered overhead whether the company is servicing the loan directly or having the loan serviced by others. They are expensed as incurred.


Accounting for Loans During the Servicing Period
Special Transactions

Recording Foreclosures?

When foreclosed, the cost of the property is transferred from the mortgage loan account to the real estate account.

Foreclosure costs can include legal fees, payments of unpaid real estate taxes, other direct expenses incurred to protect the investment or obtain clear title to the property, and accrued interest receivable at foreclosure.

*The company does not capitalize all foreclosure expenses. These costs are only capitalized to the extent deemed recoverable from the ultimate disposition of the property, otherwise these costs are expensed as incurred.

If the fair value of the real estate is less than the carrying value, a write down is recognized as a mortgage realized capital loss. If a loss is recognized at foreclosure, the amount of interest accrued included in the loss is reversed, and recorded as a charge to interest income.


Accounting for Loans During the Servicing Period
Special Transactions

Recoding Foreclosures?

* accrued interest is nonadmitted if a mortgage in default has investment income due and accrued 180 days past due and collectible.


Accounting for Loans During the Servicing Period
Special Transactions


* SSAP No. 33 “Securitization” (“SSAP No. 33”) provides statutory accounting guidance for securitizations of financial assets. An asset securitization converts assets which would normally serve as collateral for a loan into securities. A securitization is accounted for as a sale when the transferor surrenders control over the financial assets transferred. Gain or loss is recognized only to the extent that consideration, other than beneficial interests in the transferred assets, is received in exchange. A sale is not recognized for the portion of the securitization for which beneficial interests in the transferred assets are received. This transaction is treated as an exchange of assets with no measurement of a gain or loss.


Statutory Reporting of Mortgage Loans

* Notes To Financial Statements provide additional valuable information on the loans. Some of the more significant information provided includes

1) The valuation of the mortgage loan portfolio, including a description of the valuation basis for mortgage loans and income recognition.

2) The recorded investment and interest past due on mortgages with interest more than 180 days past due.

3) The recorded investment and number of mortgages on which interest has been reduced, and the percent the interest was reduced.

4) Disclosures of impaired loans: The total recorded investment in impaired loans at the end of each period
a) For each period for which results of operations are presented, the average recorded investment in the impaired loans during each period, the related amount of interest income recognized on impaired loans.
b) For each period for which results of operations are presented, the activity in the allowance for credit losses account