Author Topic: Insuring loans.  (Read 11152 times)

Ryanlenea

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Insuring loans.
« on: March 13, 2015, 04:57:53 PM »
Hello!

I'm new to P2P and was hoping to start with a small initial investment of $1,000 or so just to see how it worked, but soon discovered that wouldn't be enough to properly diversify and ensure I didn't lose money, even if I invested in all A grade notes. My second thought was, "there must be somewhere where tiny investors like myself can insure their loans to protect against default, right?" - essentially perform a credit default swap. Apparently not. Peter Renton confirmed that while some insurance startups are "in the works," none exist(although the UK uses provision funds), and from talking to a number of other P2P bloggers it seems that those new startups may be focused on larger institutional investors, not small ones.

Because I'm an entrepreneur and have some connections in the insurance industry I was considering looking into the possibility of creating an investor P2P insurance startup myself to offer small peer to peer lenders, who do not have enough capital to diversify across a ďsafeĒ number of loans, insurance to protect against defaults, which have a greater impact on the returns of a small portfolio than a large one(as well all know).

Does anyone have an opinion on if there would be any widespread interest in a product like this? Is it worth looking into? I understand that there are some hurdles to get over, like the fact that investors are going to want to re-deploy any capital that comes in into new notes, and not wait until they get all their money back and can insure an entirely new portfolio again; that insuring every new note you invest in individually would be far too cumbersome. Or the problem of actually confirming that an investor invested in what he said he did when he files a claim. I've thought about it a little and I'm confident I could smooth over those problems, but I'd love to hear any other roadblocks you think I might encounter if I moved forward on this.

Thanks so much!
 

Fee

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Re: Insuring loans.
« Reply #1 on: March 13, 2015, 05:53:48 PM »
I like the idea. How would you minimize counterparty risk?

Ryanlenea

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Re: Insuring loans.
« Reply #2 on: March 13, 2015, 09:32:07 PM »
I think most things I could do to reduce risk would make the product less attractive, and I think I would rather bump the price up slightly than put on onerous requirements. Iíd probably require that they invest no more than $50 per note, which I donít think would be a point of contention for any competent investor and would protect me against large fraud. Maybe if we grew really quickly I would require some best practice settings - from what I understand credit inquires = 0 and Public records = 0 fall into that category. What do you think?

brycemason

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Re: Insuring loans.
« Reply #3 on: March 13, 2015, 10:35:22 PM »
There isn't enough money to be made selling insurance for $1000 portfolios. If you can't stomach the risk of 40 $25 A notes, then maybe go on Folio and buy 100 A notes that are halfway or more repaid.

bobeubanks

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Re: Insuring loans.
« Reply #4 on: March 13, 2015, 10:46:48 PM »
I would think this type of insurance would only be interesting to most people in order to protect against a wide spread economic meltdown leading to a higher than "normal" percentage of defaults.

Fred

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Re: Insuring loans.
« Reply #5 on: March 14, 2015, 03:02:03 AM »
Does anyone have an opinion on if there would be any widespread interest in a product like this?

I would be interested, if the price is right.

Ryanlenea

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Re: Insuring loans.
« Reply #6 on: March 14, 2015, 05:15:40 AM »
Brycemason : I'm sure we could make a profit, although you would need a large customer base. I haven't used Folio so I defer to you on this, but Peter R. has pointed out that "If you buy the highest-grade A notes, you may well end up with a mere 1-2% annual return, which could be easily wiped out with a few defaults and taxes (if youíre not investing within an IRA)." That's in comparison to the returns you would get on a $1,000 portfolio of A grade notes if you bought insurance(see Fred) for $15 - about a 4% return. So it seems to me that it would be possible to further minimize your risk by buying on Folio, but not the best choice if insurance existed at the price I calculated. It also seems like a lot of work for someone who doesn't know what they're doing and is new to P2P like myself.

bobeubanks: Okay, well how many people do you think are concerned about a wide spread economic meltdown? More than a few? I'm not but I imagine some people are. You don't think it would attract new/conservative investors as well? Just doomsdayers?

Fred: Doing some very rough calculations with data from 07-14, I think a portfolio of A grade loans could be insured for about 1.5% of the total value of the portfolio. So on a $1,000 portfolio of A loans it would be around $15. Is that price right?

rawraw

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Re: Insuring loans.
« Reply #7 on: March 14, 2015, 07:54:13 AM »
Brycemason : I'm sure we could make a profit, although you would need a large customer base. I haven't used Folio so I defer to you on this, but Peter R. has pointed out that "If you buy the highest-grade A notes, you may well end up with a mere 1-2% annual return, which could be easily wiped out with a few defaults and taxes (if youíre not investing within an IRA)." That's in comparison to the returns you would get on a $1,000 portfolio of A grade notes if you bought insurance(see Fred) for $15 - about a 4% return. So it seems to me that it would be possible to further minimize your risk by buying on Folio, but not the best choice if insurance existed at the price I calculated. It also seems like a lot of work for someone who doesn't know what they're doing and is new to P2P like myself.

bobeubanks: Okay, well how many people do you think are concerned about a wide spread economic meltdown? More than a few? I'm not but I imagine some people are. You don't think it would attract new/conservative investors as well? Just doomsdayers?

Fred: Doing some very rough calculations with data from 07-14, I think a portfolio of A grade loans could be insured for about 1.5% of the total value of the portfolio. So on a $1,000 portfolio of A loans it would be around $15. Is that price right?
I don't see a large market for ensuring A notes. I also don't see a large market 1000 Portfolios. But I'd be interested in insurance if I felt the entity would still be solvent in a financial crisis and the price was right relative to my return based on some scenarios I'd run.

Fred

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Re: Insuring loans.
« Reply #8 on: March 14, 2015, 09:12:35 AM »
Fred: Doing some very rough calculations with data from 07-14, I think a portfolio of A grade loans could be insured for about 1.5% of the total value of the portfolio. So on a $1,000 portfolio of A loans it would be around $15. Is that price right?

I am intrigued.

Just to confirm, is it 1.5% per year?  Any premium for 60-month vs. 36-month loans?

What are the prices for C, D, E grade loans?

Fee

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Re: Insuring loans.
« Reply #9 on: March 14, 2015, 03:09:55 PM »
I think most things I could do to reduce risk would make the product less attractive, and I think I would rather bump the price up slightly than put on onerous requirements. Iíd probably require that they invest no more than $50 per note, which I donít think would be a point of contention for any competent investor and would protect me against large fraud. Maybe if we grew really quickly I would require some best practice settings - from what I understand credit inquires = 0 and Public records = 0 fall into that category. What do you think?

I think you might have misunderstood my question. Counterparty risk is the risk that the insurance provider fails to pay when the time comes. How will you ensure that they will remain solvent and/or voluntarily pay out when required? This seems difficult with a fragmented market and no exchange backing.

rawraw

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Re: Insuring loans.
« Reply #10 on: March 14, 2015, 04:41:33 PM »
Fred: Doing some very rough calculations with data from 07-14, I think a portfolio of A grade loans could be insured for about 1.5% of the total value of the portfolio. So on a $1,000 portfolio of A loans it would be around $15. Is that price right?

I am intrigued.

Just to confirm, is it 1.5% per year?  Any premium for 60-month vs. 36-month loans?

What are the prices for C, D, E grade loans?
Is this insurance against all defaults or defaults exceeding a certain threshold?

bobeubanks

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Re: Insuring loans.
« Reply #11 on: March 14, 2015, 06:28:40 PM »
bobeubanks: Okay, well how many people do you think are concerned about a wide spread economic meltdown? More than a few? I'm not but I imagine some people are. You don't think it would attract new/conservative investors as well? Just doomsdayers?

To clarify,Since there is enough information on default rates in a normal economic environment, I don't think people will be interested in normal default insurance priced at a level that would be profitable to you. I certainly wouldn't pay $15/$1000/year for A notes. I do think you could set pricing at a profitable level for you against widespread meltdown that people would be willing to pay.

Ryanlenea

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Re: Insuring loans.
« Reply #12 on: March 14, 2015, 07:07:40 PM »
Fred: Assuming the it worked like I had originally thought, the insurance would cover the life of the notes in the portfolio, however long that may be. In my calculations I assumed that all the notes were brand new and you had an equal split of 36 and 60 duration notes. From what I see the 36 month notes do better than the 60 month notes, at least in the A grade. So yes, A grade 36 month notes would be less to insure. If you wanted to insure your portfolio for an entire year so that when you bought new notes they were automatically insured, I think I could swing that too, although you would have to tell us what kind of notes you were going to buy. For example, you could tell the algorithm that for a term of one year you would have a portfolio of A and B notes, no more than say, 50% B notes, and only notes with zero credit inquiries. The more information you gave us the better a rate we could give you, obviously, but the more restricted youíd be in your future investing.  If you just said you were going to buy A and B notes, but werenít willing to limit yourself to specific percentage cap on the B notes, then we would have to give you a policy that assumed you would create a portfolio of 100% B grade loans. Same goes for the filters.

HOWEVER, if we were simply ensuring you against a portfolio loss, like rawraw brought up, not reimbursing you for every loan you had that defaulted, it would be completely different(see rawraw below). In this form, we would be looking at your likely profit, and so D and E grade loans, which yield the best returns after defaults, would be the least expensive, and A loans would be the most expensive. Insuring against defaults for D, E and F notes would be many times more expensive. Conversely, as I said, insuring against a portfolio loss made up of D, E and F notes would be less expensive.

Iíll get you some better numbers soon - I enlisted my uncle whoís a quant, and Iím asking around to try to find someone in actuarial science whoís willing to help.

Fee: I hear yu. I think that limiting note contributions to $25 or $50 like I said would make it less likely that a few giant notes defaulting would make us insolvent. In terms of weathering a an economic downturn, we just have to be large enough that the government considers us to big to fail and can bail us out :). If we couldnít get a bank to underwrite us I guess we would have to keep a large enough cash reserve that we wouldnít get burned. In terms of simply refusing to pay, I hadnít considered that - Iím sure the regulatory agency we registered with would force us to, and it would be the same process youíd go through if the fire insurance company didnít pay out when your house burned down.

rawraw: Iím imagining that it would simply cover all defaulted notes, even if those defaulted notes didnít push your entire portfolio into a negative ROI. Thatís what I was assuming when I got my very rough 1.5% calculation to cover A grade notes. I suppose we could offer to cover you only if the defaults you experienced gave you a negative portfolio ROI as well. It would cost less to insure it that way. Iím not sure which way would be more attractive. Mentioned above.

Bobubanks: so closer to the second kind of insurance I mentioned above?
« Last Edit: March 14, 2015, 07:10:07 PM by Ryanlenea »

rawraw

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Re: Insuring loans.
« Reply #13 on: March 14, 2015, 08:03:13 PM »
So I guess there are three ways to insure.  I was actually thinking of a way differently than what you described.

1) Insure all losses
2) Prevent Negative income
3) Insure losses exceeding certain thresholds

I was curious about 3.  For example, say the expected default rate on B notes is 5%.  I was asking if you were offering insurance for defaults that exceed 7%, basically putting a floor for the investor that they know ahead of time.  It is similar to preventing negative income, but the floor could be establishing a minimum net return which could be 0%, 1%, etc.

I'm not sure about financial insurance, but regular insurance companies are regulated at the state level at least and are very disciplined in how they invest the money they'll be using for payouts.

Ryanlenea

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Re: Insuring loans.
« Reply #14 on: March 14, 2015, 08:47:37 PM »
So I guess there are three ways to insure.  I was actually thinking of a way differently than what you described.

1) Insure all losses
2) Prevent Negative income
3) Insure losses exceeding certain thresholds

I was curious about 3.  For example, say the expected default rate on B notes is 5%.  I was asking if you were offering insurance for defaults that exceed 7%, basically putting a floor for the investor that they know ahead of time.  It is similar to preventing negative income, but the floor could be establishing a minimum net return which could be 0%, 1%, etc.

I'm not sure about financial insurance, but regular insurance companies are regulated at the state level at least and are very disciplined in how they invest the money they'll be using for payouts.

I don't have a clear plan on what to do yet. That's interesting though - I don't see why we couldn't insure them up to a certain point, if there was interest. You think that would be more popular than the other ways? I could see doing them all.