Triad Guaranty Inc.
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
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(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended
December 31, 2006
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or
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission file number 0-22342
Triad Guaranty Inc.
(Exact name of registrant as
specified in its charter)
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DELAWARE
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56-1838519
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(State or other jurisdiction
of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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101 South Stratford Road
Winston-Salem, North Carolina
(Address of principal
executive offices)
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27104
(Zip Code)
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Registrants telephone number, including area code:
(336) 723-1282
Securities registered pursuant to Section 12(b) of the
Act:
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Title of Each Class
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Name of Each Exchange on Which Registered
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Common Stock, par value
$.01 per share
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The NASDAQ Stock Markets LLC
(NASDAQ Global Select
Market)
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Securities registered pursuant to Section 12(g) of the
Act:
None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act.
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Large accelerated
filer o
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Accelerated
filer þ
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Non-accelerated
filer o
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Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Act)
Yes o No þ
State the aggregate market value of the voting and non-voting
common equity held by non-affiliates of the registrant, computed
by reference to the price at which the common equity was last
sold, or the average bid and asked price of such common equity,
as of the last business day of the registrants most
recently completed second fiscal quarter: $530,001,050 as of
June 30, 2006, which amount excludes the value of all
shares beneficially owned (as defined in
Rule 13d-3
under the Securities Exchange Act of 1934) by officers and
directors of the registrant (however this does not constitute a
representation or acknowledgment that any such individual is an
affiliate of the registrant).
The number of shares of the registrants common stock, par
value $0.01 per share, outstanding as of February 28,
2007, was 14,862,243.
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Portions of the following documents are incorporated by
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Part of this
Form 10-K
into which the document
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reference into this
Form 10-K:
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is incorporated by reference
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Triad Guaranty Inc.
Proxy Statement for 2007 Annual Meeting
of Stockholders
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Part III
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PART I
Overview
Triad Guaranty Inc. is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation
(Triad), provides private mortgage insurance
(MI) coverage in the United States to residential
mortgage lenders and investors as a credit-enhancement vehicle.
Triad Guaranty Inc. and its subsidiaries are collectively
referred to as the Company. The Company
when used within this document refers to the holding company
and/or one
or more of its subsidiaries, as appropriate.
Triad was formed in 1987 as a wholly-owned subsidiary of
Primerica Corporation and began writing private mortgage
insurance in 1988. In September 1989, Triad was acquired by
Collateral Mortgage, Ltd., now called Collateral Holdings, Ltd.
(CHL), a mortgage banking and real estate lending
firm located in Birmingham, Alabama. In 1990, CHL contributed
the outstanding stock of Triad to its affiliate, Collateral
Investment Corp. (CIC), an insurance holding company.
The Company was incorporated by CIC in Delaware in August 1993,
for the purpose of holding all the outstanding stock of Triad
and to undertake the initial public offering of the
Companys common stock, which was completed in November
1993. In November 2005, the Company completed a transaction in
which CIC transferred all of its 2,573,551 shares of the
Companys common stock to the Company in exchange for
2,528,214 newly issued shares of the Companys common
stock. The newly issued shares were then distributed to CIC
shareholders as part of CICs liquidation. Currently, CHL
owns 17.3% of the outstanding common stock of the Company, which
it acquired in 1993 from the Company in exchange for the
cancellation of debt, prior to the initial public offering.
The principal executive offices of the Company are located at
101 South Stratford Road, Winston-Salem, North Carolina 27104.
Its telephone number is (336) 723-1282.
MI is issued in many home purchase and refinance transactions
involving conventional residential first mortgage loans to
borrowers with equity of less than 20%. If the homeowner
defaults on the mortgage, MI reduces, and in some instances
eliminates, any loss to the insured lender. MI also facilitates
the sale of low down payment mortgage loans in the secondary
mortgage market, with the largest percentage to the Federal
National Mortgage Association (Fannie Mae) and the
Federal Home Loan Mortgage Corporation (Freddie
Mac). Investors and lenders also purchase MI to obtain
additional default protection or capital relief on loans with
equity of greater than 20%. Under risk-based capital
regulations applicable to most financial institutions, MI
reduces the capital requirement for such lenders on residential
mortgage loans retained in the lenders portfolio.
Currently, Triad is licensed to do business in all fifty
U.S. states and the District of Columbia. In May 2006, we
submitted an application to incorporate a Canadian subsidiary to
begin operations in Canada. The Canadian company will be a
monoline provider of MI and, pending regulatory approvals, is
expected to start operations sometime in 2007.
Mortgage
Insurance Products
Primary
Insurance
Primary insurance provides mortgage default protection to
lenders on individual loans and covers a percentage of unpaid
loan principal, delinquent interest, and certain expenses
associated with the default and subsequent foreclosure
(collectively, the insured amount or claim
amount). The claim amount, to which the appropriate
coverage percentage is applied, generally ranges from 110% to
115% of the unpaid principal balance of the loan. Our obligation
to an insured lender with respect to a claim is determined by
applying the appropriate coverage percentage to the claim
amount. Under our master policy, we have the option of paying
the entire claim amount and taking title to the mortgaged
property or paying the coverage percentage in full satisfaction
of our obligations under the insurance written. Insurance
written is defined as the entire loan balance for which a
lender has requested mortgage insurance and is generally
utilized as a term to measure sales production. We classify a
policy as Primary insurance when we are in the first loss
position and the
loan-to-value
(LTV) ratio is 80% or greater when the loan
1
is first insured. Primary insurance comprised approximately 60%
and 67% of our total direct insurance in force at
December 31, 2006 and 2005, respectively.
We offer coverage generally from 12% to 37% of the insured
amount. The insured lender selects the coverage percentage that
we provide, subject to our underwriting approval, usually in
order to comply with their investors requirements to
reduce investor loss exposure on loans they purchase.
Fannie Mae and Freddie Mac are the ultimate purchasers of a
large percentage of the loans we insure. Generally they require
a coverage percentage that will reduce their loss exposure on
loans they purchase to 75% or less of the propertys value
at the time the loan is originated. Since 1999, Fannie Mae and
Freddie Mac have accepted lower coverage percentages for certain
categories of mortgages when the loan is approved by their
automated underwriting services. The reduced coverage
percentages limit loss exposure to 80% or less of the
propertys value at the time the loan is originated.
Our premium rates vary depending upon various factors including
the LTV ratio, loan type, mortgage term, coverage amount,
documentation required, credit score and use of property, all of
which may affect the risk of default on the insured mortgage
loan. Usually, premium rates cannot be changed after issuance of
coverage. Consistent with industry practice, we generally
utilize a nationally based, rather than a regional or local,
premium rate structure for those loans originated by lenders and
submitted to us on a
loan-by-loan
basis. However, special risk rates are often utilized as well.
Premiums on Primary insurance generally are paid by either the
borrower (borrower paid) or the lender (lender
paid). Under our borrower paid plan, mortgage insurance
premiums are charged to the mortgage lender or servicer that
collects the premium from the borrower and, in turn, remits the
premiums to us. Under our lender paid plan, mortgage insurance
premiums are charged to the mortgage lender or loan servicer
that pays the premium to us. The lender may recover the premium
through an increase in the borrowers interest rate.
Approximately 57% and 68% of Primary insurance was written under
our borrower paid plans during 2006 and 2005, respectively. The
remainder was written under our lender paid plans (43% and 32%
of Primary insurance during 2006 and 2005, respectively). Our
lender paid volume is concentrated among larger mortgage lender
customers.
Premiums may be remitted monthly, annually, or in one single
payment. The monthly premium payment plan involves the payment
of one or two months premium at the mortgage loan closing.
Thereafter, level monthly premiums are collected by the loan
servicer for monthly remittance to us. We also offer a plan
under which the first monthly mortgage insurance payment is
deferred until the first loan payment is made. This deferred
monthly premium product decreases the amount of cash required
from the borrower at closing, thereby making home ownership more
affordable. Monthly premium plans represented approximately 91%
and 96% of Primary insurance written in 2006 and 2005,
respectively.
The annual premium payment plan requires a first-year premium
paid at mortgage loan closing with annual renewal payments. With
respect to our borrower-paid annual premium plans, renewal
payments are collected monthly from the borrower and held in
escrow by the mortgage lender or servicer for annual remittance
to us in advance of each renewal year. Annual premium plans
represented approximately 8% and 4% of Primary insurance written
in 2006 and 2005, respectively.
The single premium payment plan requires a single payment paid
at loan closing. The single premium payment can be financed by
the borrower by adding it to the principal amount of the
mortgage or can be paid in cash at closing by the borrower.
Single premium plans represented 1% or less of Primary insurance
written in 2006 and 2005.
Modified
Pool Insurance
Modified Pool insurance is written only on structured bulk
transactions through the structured bulk channel. Structured
bulk transactions involve underwriting and insuring a group of
loans with individual coverage for each loan. Structured bulk
transactions are typically initiated by underwriters of
mortgage-backed securities, mortgage lenders, and mortgage
investors such as Fannie Mae and Freddie Mac, who seek
additional default protection (typically secondary
coverage or on loans for which the individual borrower has
greater than 20% equity), capital relief, and credit enhancement
on groups of loans that are sold in the secondary market.
Coverage on structured bulk
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transactions is determined at the individual loan level,
sufficient to reduce the insureds exposure on any loan in
the transaction down to a stated percentage of the loan balance
(down-to coverage), which is typically between
50% and 65%. We are provided loan-level information on the
group of loans, and, based on the risk characteristics of the
entire group of loans, the requirements of the secondary
mortgage market participant and any associated stop loss level
or deductible amount, we submit a price for insuring the entire
group of loans through a bid process. The majority of premiums
for our Modified Pool insurance are remitted monthly. We compete
primarily against other forms of credit enhancement provided by
the capital markets for these transactions as well as other
mortgage insurers.
Structured bulk transactions frequently include an aggregate
stop-loss limit applied to the entire group of insured loans.
Additionally, some of the structured bulk transactions we enter
include deductibles under which we pay no claims until the
losses exceed the deductible amount.
Traditional
Pool Insurance
Traditional pool insurance generally has been offered by private
mortgage insurers to lenders as an additional credit enhancement
for certain mortgage-backed securities and provides coverage for
the full amount of the net loss on each individual loan included
in the pool, subject to an aggregate stop loss limit
and/or a
deductible. We have not offered traditional pool insurance.
Risk-sharing
Products
We offer mortgage insurance structures designed to allow lenders
to share in the risks of mortgage insurance. One such
arrangement is our captive reinsurance program. Under the
captive reinsurance program, a reinsurance company, generally an
affiliate of the lender, assumes a portion of the risk
associated with the lenders insured book of business in
exchange for a percentage of the premium. Typically, the
reinsurance program is an
excess-of-loss
arrangement with defined aggregate layers of coverage and a
maximum exposure limit for the captive reinsurance company.
Captive reinsurance programs may also take the form of a quota
share arrangement, although we had no quota share arrangements
in force under captive reinsurance programs as of
December 31, 2006. Under our
excess-of-loss
programs, with respect to a given book year of business, Triad
retains the first loss position on the first aggregate layer of
risk and reinsures a second defined aggregate layer with the
reinsurer. Triad generally retains the remaining risk above the
layer reinsured. Of the reinsurance agreements in place at
December 31, 2006, the first layer retained by Triad ranged
from the first 3.0% to 6.5% of risk originated and the second
layer ceded to reinsurers ranged from the next 4.0% to 10.0%.
Ceded premiums, net of ceded commissions, under these
arrangements ranged from 20.0% to 40.0% of premiums.
We require the counterparties to all of Triads captive
reinsurance agreements to establish trust accounts to support
the reinsurers obligations under the reinsurance
agreements. The captive reinsurer is the grantor of the trust
and Triad is the beneficiary of the trust. The trust agreement
includes covenants regarding minimum and ongoing capitalization,
required reserves, authorized investments, and withdrawal of
assets and is funded by ceded premium and investment earnings on
trust assets as well as capital contributions by the reinsurer.
The ultimate impact on our financial performance of an
excess-of-loss
captive structure is primarily dependent on the total level of
losses and the persistency rates during the life of the
business. We define persistency as the percentage of insurance
in force remaining from twelve months prior. We believe that our
excess-of-loss
captive reinsurance programs provide valuable reinsurance
protection by limiting the aggregate level of losses, and, under
normal operating environments, potentially reduce the degree of
volatility in our earnings from the development of such losses
over time. At December 31, 2006 and 2005, 35% and 39% of
insurance in force was subject to captive reinsurance programs.
Through December 31, 2006, we had not used captive mortgage
reinsurance or other risk-sharing arrangements with Modified
Pool insurance.
Distribution
Channels
We sell mortgage insurance through two distribution channels.
Our flow channel consists of loans originated by lenders and
submitted to us on a
loan-by-loan
basis. All insurance delivered through the flow channel is
classified as Primary insurance.
3
Through the structured bulk channel, we participate in bids for
structured bulk transactions that meet our loan quality and
pricing criteria. Modified Pool insurance is only written
through the structured bulk channel, and some Primary insurance
is written through the structured bulk channel.
Cancellation
of Insurance
We cannot cancel mortgage insurance coverage except for
nonpayment of premium or certain material violations of the
master policy. Coverage generally remains renewable at the
option of the insured lender. In most cases, mortgage insurance
is renewable at a rate determined when the insurance on the loan
was initially issued.
Insured lenders may cancel insurance acquired through the flow
channel at any time at their option. Pursuant to the Homeowners
Protection Act, lenders are required to automatically cancel the
borrower paid private mortgage insurance on most loans made on
or after July 29, 1999, when the outstanding loan amount is
78% or less of the propertys original purchase price and
certain other conditions are met. A borrower may request that a
loan servicer cancel borrower-paid mortgage insurance on a
mortgage loan when the loan balance is less than 80% of the
propertys current value, but loan servicers are generally
restricted in their ability to grant those requests by secondary
market requirements and by certain other regulatory restrictions.
Mortgage insurance coverage can also be cancelled when an
insured loan is refinanced. If we provide insurance on the
refinanced mortgage, the policy on the refinanced home loan is
considered new insurance written. Therefore, continuation of
coverage from one of our refinanced loans to a new loan results
in both a cancellation of insurance and new insurance written.
During periods of high refinance activity, our earnings and risk
profile are more subject to fluctuations. Our cancellation rate,
defined as the percentage of insurance in force from twelve
months prior that was cancelled during the preceeding
twelve-month period, was 23% and 31% for 2006 and 2005,
respectively.
Customers
Residential mortgage lenders such as mortgage bankers, mortgage
brokers, commercial banks, and savings institutions are the
principal originators of our insurance written through the flow
channel.
To obtain insurance through our flow channel, a mortgage lender
must first apply for and receive a master policy from us. Our
approval of a lender as a master policyholder is based upon
evaluation of the lenders financial position and
demonstrated adherence to sound lending practices as well as
other factors.
The master policy sets forth the terms and conditions of our
mortgage insurance coverage. The master policy does not obligate
the lender to obtain insurance from us, nor does it obligate us
to issue insurance on a particular loan. The master policy
provides that the lender must submit individual loans for
insurance to us, and we must approve each loan, subject to
certain underwriting criteria, to effect coverage (except in the
case of delegated underwriting when the originator has the
authority to approve coverage within certain guidelines that
were agreed to by both parties in advance).
Competition within the mortgage insurance industry continues to
increase as many large mortgage lenders have limited the number
of mortgage insurers with whom they do business. At the same
time, consolidation among national lenders has increased the
share of the mortgage origination market controlled by the
largest lenders and that has led to further concentrations of
business with a relatively small number of lenders. Many of the
national lenders allocate Primary business to several different
mortgage insurers. These allocations can vary over time. Our
strategy is to continue our focus on national lenders while
maintaining the productive relationships that we have built with
regional lenders.
In 2006, our ten largest customers were responsible for 80% of
insurance written through the flow channel compared to 77% in
2005. The loss of, or considerable reduction in, business from
one or more of our significant
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customers, without a corresponding increase from other lenders,
would have an adverse effect on our business. Those customers
whose revenue comprised more than 10% of our consolidated
revenue are listed below:
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Percent of
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Revenues for
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the Year
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Ended
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December 31
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Customer
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2006
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2005
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Wells Fargo Home Mortgage,
Inc.
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17
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%
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20%
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Countrywide Credit Industries, Inc
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11
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%
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14%
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American Home Mortgage
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11
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%
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less than 10%
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Sales and
Marketing
We currently market our insurance products through a dedicated
sales force of approximately 45 professionals, including sales
management, and an exclusive commissioned general agency serving
a specific geographic market. We are licensed to do business in
all 50 states and the District of Columbia.
Our Senior Vice President and National Sales Manager oversees
all of our sales activities and reports directly to our Chief
Executive Officer. Division managers serve key regional accounts
through area sales directors and account executives and report
to our Senior Vice President and National Sales Manager. Also
reporting to our Senior Vice President and National Sales
Manager are national account executives who are responsible for
sales efforts with larger national mortgage originators.
The marketing department develops and implements programs in
support of our sales objectives and to promote our image and
reports directly to the Chief Executive Officer. A variety of
tools and venues are utilized to achieve these goals including
public relations, marketing materials, internal/external
publications, convention trade shows, and the internet.
Contract
Underwriting
We provide fee-based contract underwriting services that enable
customers to improve the efficiency of their operations by
outsourcing all or part of their mortgage loan underwriting. The
fee charged is intended to cover the cost of providing the
services. Contract underwriting involves examining a prospective
borrowers information contained in a lenders
mortgage application file and making a determination whether the
borrower is approved for a mortgage loan subject to the
lenders underwriting guidelines. In addition, we offer
Fannie Maes Desktop
Originator®
and Desktop
Underwriter®
and Freddie Macs Loan
Prospector®
as a service to our contract underwriting customers. These
products, which are designed to streamline and reduce costs in
the mortgage origination process, supply our customers with fast
and accurate information regarding compliance with underwriting
standards and Fannie Maes or Freddie Macs decision
for loan purchase or securitization. We provide contract
underwriting services through our own employees as well as
independent contractors, and these services are provided for
loans that require mortgage insurance as well as loans that do
not require mortgage insurance. In the event that Triad fails to
properly underwrite a loan subject to the lenders
underwriting guidelines, Triad may be required to provide
monetary or other remedies to the lender customer.
Competition
and Market Share
We and other private mortgage insurers compete directly with
federal and state governmental and quasi-governmental agencies,
principally the Federal Housing Administration
(FHA). In addition to competition from federal
agencies, we and other private mortgage insurers face
competition from state-supported mortgage insurance funds, some
of which are either independent agencies or affiliates of state
housing agencies. Indirectly, we also compete with mortgage
lenders that forego private mortgage insurance to self-insure
against the risk of loss from defaults on all or a portion of
their low down payment mortgage loans, and we compete with
products designed to avoid mortgage insurance such as
80-10-10
structures (a combination of an 80% first mortgage loan, a 10%
second mortgage loan usually issued by the same lender, and a
10% down payment).
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Fannie Mae and Freddie Mac are the beneficiaries of the largest
percentage of our mortgage insurance policies, so their business
practices have a significant influence on us. Changes in their
practices could reduce the number of loans they purchase that
are insured by us and consequently reduce our revenues. Some of
the programs put into place by Fannie Mae and Freddie Mac in
recent years require less insurance coverage than they
historically have required, and they have the ability to further
reduce coverage requirements, which could reduce demand for
mortgage insurance or reduce the level of coverage that we
provide, both of which could have a material adverse effect on
our business, financial condition and operating results.
Fannie Mae and Freddie Mac also have the ability to implement
new eligibility requirements for mortgage insurers and to alter
or liberalize underwriting standards on low-down-payment
mortgages they purchase. We cannot predict the extent to which
any new requirements may be enacted or how they may affect the
operations of our mortgage insurance business, our capital
requirements and our products.
Various proposals have been periodically discussed by Congress
and certain federal agencies to reform or modify the charters
under which Fannie Mae and Freddie Mac do business. Management
is unable to predict the scope and content of such proposals, or
whether any such proposals will be enacted into law, and if
enacted, what effect they may have on us.
The private mortgage insurance industry consists of seven major
mortgage insurance companies including Triad, Mortgage Guaranty
Insurance Corporation, Radian Guaranty Inc., PMI Mortgage
Insurance Co., United Guaranty Corporation, Genworth Financial,
Inc. and Republic Mortgage Insurance Company. Triad is the
smallest private mortgage insurer based on 2006 market share
and, according to estimated industry data, had a 9.1% share of
total net new insurance written in 2006 compared to 7.5% in
2005. In February 2007, Mortgage Guaranty Insurance Corporation
and Radian Financial Group announced their intention to merge in
the later part of 2007, subject to various regulatory approvals.
We believe we compete favorably with other private mortgage
insurers principally on the basis of personalized and
professional service, a strong management and sales team,
responsive and versatile technology, innovative products in the
flow market and attractive pricing with respect to certain
products. We compete in competitive bid transactions in the
structured bulk market with both the other private mortgage
insurers and providers of other forms of credit enhancements.
Underwriting
Practices
We consider effective risk management to be critical to our
long-term financial stability. Market analysis, product
analysis, prudent underwriting, the use of automated risk
evaluation models, sophisticated risk modeling, auditing, and
knowledge of our customers are all important elements of our
risk management process.
Underwriting
Personnel
Our Vice President of Underwriting is responsible for the
underwriting of business written through the flow channel in the
home office as well as regional offices in Arizona, California,
Georgia, Illinois, Ohio, Pennsylvania, and Texas. She has been
in her current position for less than one year, however, she has
been with the Company for over 10 years and has over
30 years of industry experience. Our Senior Vice President
of Risk Management is responsible for assessing the risk factors
used in our underwriting procedures. He has been with the
Company since March 2006 and has over 10 years of financial
services industry experience.
We employed an underwriting staff of approximately 35 at
December 31, 2006. Our field underwriters and underwriting
managers are limited in their authority to approve programs for
certain mortgage loans. The authority levels are tied to
underwriting position, knowledge, and experience and relate
primarily to loan amounts and property type. All of our loans
insured are subject to quality control reviews.
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Risk
Management Approach
We evaluate risk based on historical performance of risk factors
and utilize automated underwriting systems in the risk selection
process to assist the underwriter with decision-making. This
process evaluates the following categories of risk:
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Mortgage Lender. We review each lenders
financial statements and management experience before issuing a
master policy. We also track the historical risk performance,
including loan level risk characteristics, of all significant
customers that hold a master policy. This information is
factored into determining the loan programs we approve for
various lenders. We assign delegated underwriting authority only
to lenders with substantial financial resources and established
records of originating good quality loans.
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Purpose and Type of Loan. We analyze various
general characteristics of a loan to evaluate its level of risk
including: (i) LTV ratio; (ii) type of loan
instrument; (iii) purpose of the loan; (iv) level of
documentation; and (v) type of property.
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We believe that an important determinant of claim incidence is
the relative amount of borrowers equity in the home. For
the industry as a whole, historical evidence indicates that, in
general, claim incidence on loans with a higher LTV ratio is
greater than a loan with a lower LTV ratio, all else being
equal. Loans with an LTV ratio greater than 95% are offered
primarily to low and moderate-income borrowers. These loans have
often attracted borrowers with weaker credit histories,
generally resulting in higher loss ratios. The State of Illinois
Division of Insurance, as well as the insurance departments of
several other states, permit mortgage insurers to write coverage
on loans with LTV ratios in excess of 97% up to 100% and, in
certain instances, up to 103%. This determination was made in
response to the development by certain entities in the mortgage
securitization market, including Fannie Mae and Freddie Mac, of
programs that allowed LTV ratios in excess of 97%. These
programs are designed to accommodate the credit-worthy borrower
who lacks the ability or otherwise chooses not to provide a down
payment on a home. In keeping with our established risk
strategy, we have not aggressively solicited loans with high LTV
ratios, and accept loans with LTV ratios greater than 97% on a
limited basis. We do not routinely delegate the underwriting of
high LTV loans. We believe the higher premium rates charged on
high LTV loans adequately reflect the additional risk.
Generally, we seek loan types with sufficient historical data
from which an assessment of risk can be readily made and the
premium received sufficiently offsets that risk. However, the
production of adjustable rate mortgages (ARMs) has
increased in the mortgage market, and we have increased our
production of ARMs as well. We write policies on ARMs that
primarily are positively amortizing. Payments on these loans are
adjusted periodically with interest rate movements. Many of the
ARMs have a fixed rate for a stated period of time (some
significantly below then existing market rates sometimes
referred to as teaser rates), and most of those included in our
recent production have not yet had interest rate-related payment
adjustments. These ARMs that are still in the fixed rate term of
their contract may have a heightened propensity to default
because of possible payment shocks due to interest
rate increases, especially in a period of increasing interest
rates and declining housing prices. We also insure a small
percentage of interest-only mortgages, a variation of an ARM,
where the borrower pays only the interest due on a mortgage for
a specified period of time, usually five to ten years, after
which the loan payment increases to include principal payments.
These interest-only loans may also be subject to a larger
percentage of future defaults than fixed rate loans because of
the same payment shocks due to the expiration of the initial
period of interest-only payments, especially in a period of
increasing interest rates and declining housing prices. We
accept ARMs with potential negative amortization
under certain conditions from approved lenders. ARMs with
potential negative amortization include pay option
ARMs, which we define as those that provide a fixed period of
time for which the borrower has the option to pay monthly
payments that are less than the interest accrued for those
months. If the borrower elects this option, the LTV increases on
the loan. Because the LTV can increase on a pay option ARM,
these types of loans may present more risk to a mortgage insurer
than traditional positive amortizing loans. We classify all
loans with adjustable interest rates as ARMs, including those
for which the interest rate is fixed for a certain period of
time. Although, to date, we have not seen the delinquency rates
on ARMs vary significantly from fixed-rate loans, we do not
believe that we have sufficient default and claim data under
distressed economic conditions to give assurances of their
future performance. Loans, such as these, that do not have
sufficient historical data are charged a higher premium.
7
We believe that 15-year mortgages present a lower level of risk
than 30-year mortgages, primarily as a result of the faster
amortization and the more rapid accumulation of borrower equity
in the property. Accordingly, we charge lower premium rates on
these loans than on comparable 30-year mortgages.
We believe that the type of property securing the insured loan
also affects the risk of claim. In our opinion, loans on
single-family detached housing are subject to less risk of claim
incidence than loans on other types of properties. We believe
that attached housing types, particularly condominiums and
cooperatives, are a higher risk because, in most areas,
condominiums and cooperatives tend to be more susceptible to
downward fluctuations in value than single-family detached
dwellings in the same market.
We believe that loans on non-owner occupied properties represent
a substantially higher risk of claim incidence and are subject
to greater value declines than loans on primary homes. We insure
loans on properties not occupied by the owner (generally second
homes or rental homes) as a normal part of our business from our
existing customers.
Historical evidence indicates that higher-priced properties
experience wider fluctuations in value than moderately priced
residences. These fluctuations exist primarily because there is
a smaller pool of qualified buyers for higher-priced homes,
which, in turn, reduces the likelihood of achieving a quick sale
at fair market value when necessary to avoid a default.
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Individual Loan and Borrower. Individual
insurance applications are evaluated based on analysis of the
borrowers ability and willingness to repay the mortgage
loan and the characteristics and value of the mortgaged
property. The analysis of the borrower includes reviewing the
borrowers housing and total debt ratios as well as the
borrowers Fair, Isaac and Co., Inc. (FICO)
credit score, as reported by credit rating agencies. In addition
to the borrowers willingness and ability to repay the
loan, we believe that mortgage default risk is affected by a
variety of other factors, including the borrowers
employment status. We believe insured mortgage loans made to
self-employed borrowers have higher risk of claim, all other
factors being equal, than loans to borrowers employed by third
parties. Individual insurance applications are reviewed by
Triads underwriting personnel except for loans originated
by lenders under delegated underwriting authority or through
automated underwriting services provided by Fannie Mae and
Freddie Mac. In the case of delegated underwriting, we monitor
compliance with program parameters through periodic audits of
delegated business. Through the automated underwriting services
provided by Fannie Mae and Freddie Mac, lenders are able to
obtain approval for mortgage guaranty insurance with any
participating mortgage insurer. Triad works with both
enterprises in offering insurance services through their systems
while monitoring the risk quality of loans insured through such
systems.
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Geographic Selection of Risk. We place
emphasis on the condition of the regional housing markets in
determining marketing and underwriting policies. Using both
internal and external data, our risk management department
continually monitors the economic conditions in our active and
potential markets. On structured bulk transactions, we may
choose not to insure new loans in geographic areas in which we
have a heavy concentration or that we believe have a higher risk
of loss.
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Risk Dispersion. In the early years of the
Company, only certain high quality loans with limited risk were
accepted. As we developed expertise beyond that limited spectrum
on the risk curve and with the advent of delegated underwriting,
we gradually expanded the breadth of risk we view as acceptable.
Further, the marketplace has changed and many lenders are
promoting Alt-A loan programs, ARMs and other programs with
nonconforming loan characteristics. We define Alt-A as
individual loans having FICO scores greater than 619 that have
been underwritten with reduced or no documentation. As
previously mentioned, we believe these types of loans carry a
higher risk and have a correspondingly higher premium rate than
fully documented, conforming loans. Products such as Alt-A loans
and potential negative amortizing ARMs continue to grow as a
percentage of our Primary insurance in force.
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Underwriting
Process for Our Flow Distribution Channel
We generally utilize nationwide underwriting guidelines to
evaluate the potential risk of default on mortgage loans
submitted for insurance coverage. These guidelines have evolved
over time and take into account the loss
8
experience of the entire private mortgage insurance industry.
They also are largely influenced by the underwriting guidelines
of Fannie Mae and Freddie Mac. Specific underwriting guidelines
applicable to a given local, state, or regional market are
utilized to address concerns resulting from our review of
regional economies and housing patterns.
Subject to our underwriting guidelines and exception approval
procedures, we expect our internal underwriters and contract
underwriters to utilize their experience and business judgment
in evaluating each loan on its own merits. Accordingly, our
underwriting staff has discretionary authority to insure loans
that deviate in certain minor respects from our underwriting
guidelines. More significant exceptions are subject to
management approval. In all such cases, other compensating
factors must be identified. The predominant deviations involve
instances where the borrowers
debt-to-income
ratio exceeds our guidelines. To compensate for exceptions, our
underwriters give favorable consideration to factors such as
excellent borrower credit history, the availability of
satisfactory cash reserves after closing, and borrower
employment stability.
We accept applications for insurance under three basic programs:
a fully-documented program, a credit-score driven reduced
documentation program, and a delegated underwriting program
which allows a lenders underwriters to commit insurance to
a loan based on strict,
agreed-upon
underwriting guidelines. We also accept loans approved through
Freddie Macs or Fannie Maes automated underwriting
systems.
We allow lenders to submit insurance applications with reduced
documentation through automated and non-automated underwriting
programs. Under the automated underwriting program, Triad issues
a commitment of insurance based on the borrowers FICO
credit score or the approval of the loan through either Fannie
Maes or Freddie Macs automated underwriting system.
We issue a commitment of insurance without the standard
underwriting process if certain program parameters are met and
the borrower has a credit score above established thresholds. We
audit lenders files on loans submitted under the automated
underwriting program randomly and through specific
identification of selected risk factors. Documentation
submission requirements for non-automated underwritten loans
vary depending on the borrowers credit score.
We utilize a delegated underwriting program to serve many of the
larger, well-established mortgage originators. Under this
program, standards for type of loan, property type, and credit
history of the borrower are established consistent with our risk
strategy, and the lenders underwriters are able to commit
insurance to a loan based on these standards. Re-underwriting,
re-appraisal, and similar procedures are utilized following
issuance of the policy to ensure quality control. Our delegated
underwriting program accounted for 63% of applications received
through the flow distribution channel in 2006 compared to 65% in
2005. To date, the performance of loans insured under the
delegated underwriting program has been comparable to
non-delegated business. The use of Fannie Maes or Freddie
Macs automated underwriting programs or our delegated
underwriting programs with selected lenders could lead to loss
development patterns different than those experienced when we
control the entire underwriting process.
Underwriting
Process for Our Structured Bulk Distribution
Channel
Our pricing for structured bulk transactions is commensurate
with a transactions overall risk profile based upon its
individual
loan-by-loan
analysis as well as any associated stop loss level or deductible
amount. We analyze structured bulk transactions during the bid
process to evaluate the risk factors of the individual loans
contained within the transaction. The risk factors that we
evaluate include the mortgage lender, purpose and type of loan,
individual borrower, geography, and our risk dispersion as
discussed in the Risk Management Approach section
above. The pertinent risk characteristics of each loan are
evaluated to determine the impact on the entire
transactions persistency and frequency and severity of
loss. We may utilize an outside due diligence firm in this
process as well as mortgage risk analysis models such as
Standard & Poors
LEVELS®
or LoanPerformance. We may request to remove certain loans from
the transaction as a result of the risk review before we submit
a competitive bid. We do not bid on all structured bulk
transactions of which we are notified, depending on the results
of the above evaluation as part of our risk management approach.
9
Other
Risk Management
As discussed earlier, we have expanded the risk characteristics
that we pursue in both the Primary and Modified Pool
marketplaces based, in part, on the change in the overall
mortgage origination market. That change has been overseen by
our Credit Risk Committee, which is composed of certain members
of senior management. The Credit Risk Committee must approve all
new product offerings and changes in types of risk that we are
willing to assume. This includes approval of the expansion of
credit characteristics and review of the overall underwriting
guidelines utilized.
We employ a comprehensive quality assurance audit plan to
determine whether underwriting decisions being made are
consistent with the policies, procedures, and expectations for
quality set forth by management. All areas of business activity
that involve an underwriting decision are examined, with
emphasis on new products, new procedures, contract underwritten
loans, delegated loans, new employees, new master policyholders,
and new branches of an existing master policyholder. The process
used to identify categories of loans selected for audit begins
with identification and evaluation of certain defined and
verifiable risk elements. Each loan is then tested against these
elements to identify loans that fail to meet prescribed policies
or an identified norm. The procedure allows management to
identify concerns that may exist within individual loans as well
as concerns that may exist within a given category of business
and take appropriate action.
Financial
Strength Rating
Credit ratings generally are considered an important element in
a mortgage insurers ability to compete for new business,
indicating the insurers present financial strength and
capacity to pay future claims. Certain national mortgage lenders
and a large segment of the mortgage securitization market,
including Fannie Mae and Freddie Mac, generally will not
purchase high LTV mortgages or mortgage-backed securities
containing high LTV mortgages unless the insurer issuing private
mortgage insurance coverage has a financial strength rating of
at least AA− by either Standard &
Poors Ratings Services (S&P) or Fitch
Ratings (Fitch) or a rating of at least
Aa3 from Moodys Investors Service
(Moodys). Triad is rated AA by
both S&P and Fitch and Aa3 by Moodys.
Private mortgage insurers are not rated by any other independent
nationally-recognized insurance industry rating organization or
agency (such as the A.M. Best Company).
When assigning a financial strength rating, S&P, Fitch, and
Moodys generally consider: (i) the specific risks
associated with the mortgage insurance industry, such as
regulatory climate, market demand, growth, and competition;
(ii) management depth, corporate strategy, and
effectiveness of operations; (iii) historical operating
results and expectations of current and future performance of
the insurers specific portfolio; and (iv) long-term
capital structure, the ratio of debt to equity, the ratio of
risk to capital, near-term liquidity, and cash flow levels, as
well as any reinsurance relationships and the financial strength
ratings of such reinsurers. Ratings are based on factors
relevant to policyholders. Such ratings are not directed to the
protection of shareholders and do not apply to any securities
issued by us.
Some rating agencies issue financial strength ratings based, in
part, upon a companys performance sensitivity to various
economic depression scenarios. In determining capital levels
required to maintain a companys rating, the rating
agencies may allow the use of different forms of capital
including statutory capital, reinsurance, and debt. In January
1998, we completed a $35 million private offering of notes
due January 15, 2028. The notes, which were rated
A by S&P and A+ by Fitch at the time
of issuance, were issued to provide additional capital
considered in the rating agencys depression models.
S&P, Fitch and Moodys will periodically review
Triads rating as they do with all rated insurers. Ratings
can be withdrawn or changed at any time by a rating agency. A
reduction in our rating by S&P, Fitch or Moodys, while
not anticipated, could materially impact our ability to write
new business.
Reinsurance
Triads product offerings include captive mortgage
reinsurance programs whereby an affiliate of a lender reinsures
a portion of the insured risk on loans originated or purchased
by the lender. These programs are designed
10
to allow the lenders to share in the risk of the business. See
further discussion of these programs under the
Risk-sharing
Products section above.
Pursuant to deeper coverage requirements imposed by Fannie Mae
and Freddie Mac, certain loans eligible for sale to such
enterprises with an LTV ratio over 90% require insurance with a
coverage percentage of 30% or more. Certain states limit the
amount of risk a mortgage insurer may retain with respect to
coverage of a loan to 25% of the insured amount, and, as a
result, the deeper coverage portion of such insurance must be
reinsured. To minimize reliance on third-party reinsurers and to
permit it to retain the premiums and related risk on deeper
coverage business, Triad reinsures this deeper coverage business
with its wholly-owned subsidiary, Triad Guaranty Assurance
Corporation (TGAC). As of December 31, 2006 and
2005, TGAC assumed approximately $127 million and
$81 million in risk from Triad, respectively.
We maintain excess of loss reinsurance arrangements designed to
limit our exposure in the event of a catastrophic level of
losses. During 2006, we maintained $125 million of excess
of loss reinsurance through non-affiliated reinsurers that had
financial strength ratings of AA or better from
Standard & Poors. Effective January 1, 2007,
we elected not to renew $25 million of this excess of loss
reinsurance.
The use of reinsurance as a source of capital and as a risk
management tool is well established within the mortgage
insurance industry. Reinsurance does not legally discharge an
insurer from its primary liability for the full amount of the
risk it insures, although it does make the reinsurer liable to
the primary insurer. There can be no assurance that our
reinsurers will be able to meet their obligations under the
reinsurance agreements.
Defaults
and Claims
Defaults
The claim process on private mortgage insurance begins with the
lenders notification to the insurer of a default on an
insureds loan. Default is defined in the primary master
policy as the failure by the borrower to pay, when due, an
amount at least equal to the scheduled monthly mortgage payment
under the terms of the mortgage. The master policy requires
lenders to notify us of default on a mortgage payment within
10 days of either (i) the date on which the borrower
becomes four months in default or (ii) the date on which
any legal proceeding affecting the loan commences, whichever
occurs first. Notification is required within 45 days of
default if it occurs when the first payment is due. The
incidence of default is affected by a variety of factors
including, but not limited to, changes in borrower income,
unemployment, divorce, illness, and the level of interest rates.
Borrowers may cure defaults by making all delinquent loan
payments or by selling the property and satisfying all amounts
due under the mortgage. Defaults that are not cured generally
result in submission of a claim to us. Refer to the
Managements Discussion and Analysis of Financial
Condition and Results of Operations section of this
document for default statistics at December 31 for the last
two years.
Claims
Claims result from defaults that are not cured. During the
default period, we work with the insured as well as the borrower
in an effort to reduce losses through the loss mitigation
efforts described below. The frequency of claims may not
directly correlate to the frequency of defaults due, in part, to
our loss mitigation efforts and the borrowers ability to
overcome temporary financial setbacks. The likelihood that a
claim will result from a default, and the amount of such claim,
principally depend on the borrowers equity at the time of
default and the borrowers (or the lenders) ability
to sell the home for an amount sufficient to satisfy all amounts
due under the mortgage, as well as the effectiveness of loss
mitigation efforts. The time frame from when we first receive a
notice of default until the ultimate claim is paid generally
ranges from six to eighteen months. Changes in various
macroeconomic conditions such as house price appreciation,
employment, and other market conditions over that time frame
also positively or negatively impact the amount of the ultimate
claim paid.
The payment of claims is not evenly spread throughout the
insurance coverage period. For Primary insurance, relatively few
claims are paid during the first year following loan
origination. A period of rising claim payments follows, which,
based on industry experience, has historically reached its
highest level in the second through fifth years after loan
origination. Thereafter, the number of claim payments made has
historically declined at a gradual
11
rate, although the rate of decline can be affected by local
economic conditions. For Modified Pool insurance, the claim
pattern peaks somewhat earlier, with the highest claim payment
levels reached in the second through fourth years. There can be
no assurance that the historical pattern of claims will continue
in the future.
Generally, our master policy provides that we are not liable to
pay a claim for loss if the application for insurance for the
loan in question contains fraudulent information, material
omissions, or misrepresentations that increase the risk
characteristics of the loan. Our master policy also excludes any
cost or expense related to the repair or remedy of any physical
damage (other than normal wear and tear) to the
property collateralizing an insured mortgage loan. Such physical
damage may be caused by accident, natural occurrence, or other
conditions.
Under the terms of the master policy, the lender is required to
file a claim with us no later than 60 days after it has
acquired borrowers title to the underlying property
through foreclosure, a negotiated short sale, or a
deed-in-lieu
of foreclosure. A primary insurance claim amount includes
(i) the amount of unpaid principal due under the loan;
(ii) the amount of accumulated delinquent interest due on
the loan (excluding late charges) to the date of claim filing;
(iii) expenses advanced by the insured under the terms of
the master policy, such as hazard insurance premiums, property
maintenance expenses and property taxes prorated to the date of
claim filing; and (iv) certain foreclosure and other
expenses, including attorneys fees. Such claim amount is subject
to review and possible adjustment by us. Our experience
indicates that the claim amount on a policy generally ranges
from 110% to 115% of the unpaid principal amount of a foreclosed
loan.
Within 60 days after the claim has been filed, we have the
option of either (i) paying the coverage percentage of the
claim as specified on the certificate of insurance (generally
12% to 37% of the claim), with the insured retaining title to
the underlying property and receiving all proceeds from the
eventual sale of the property, or (ii) paying the full
claim amount in exchange for the lenders conveyance of
good and marketable title to the property to us, and selling the
property for our own account. We choose the claim settlement
option believed to cost the least. In most cases, we settle
claims by paying the coverage percentage of the claim amount;
however we continue to expand the use of our option to purchase
properties in settlement of claims. At December 31, 2006,
we held 68 properties with a combined net realizable value of
approximately $10.2 million that were acquired by electing
to pay the full claim amount compared to 48 properties with a
combined net realizable value of approximately $5.7 million
held at December 31, 2005. We record the estimated loss
amount on properties purchased in settlement of claims at the
time of acquisition and refine this estimate when appropriate
until the property is sold. In general, the claims severity is
lower on properties acquired than on those for which we paid the
settlement option, although the number of claims paid under the
settlement option is far greater than those utilizing the
property acquisition option.
Loss
Mitigation
Once a default notice is received, we attempt to mitigate our
loss. Through proactive intervention with insured lenders and
borrowers, we have been successful in reducing the number and
severity of our claims for loss. Loss mitigation techniques
include pre-foreclosure sales, property sales after foreclosure,
advances to assist distressed borrowers who have suffered a
temporary economic setback, and the use of repayment schedules,
refinances, loan modifications, forbearance agreements, and
deeds-in-lieu of foreclosure. Such mitigation efforts typically
result in reduced losses from the coverage percentage stated in
the certificate of insurance. As a result of loss mitigation
efforts, we paid out approximately 77% and 75% of potential
exposure on all claims in 2006 and 2005, respectively. However,
as evidenced in the fourth quarter of 2006, factors such as the
weakness in the housing market beginning in the last half of
2006 may hinder our ability to maintain this level of loss
mitigation success.
Loss
Reserves
We calculate our best estimate of the reserve for losses to
provide for the estimated costs of settling claims on loans
reported in default, and loans in default that are in the
process of being reported to us, as of the date of our financial
statements. Our reserving process incorporates various
components in a model that gives effect to current economic
conditions and segments defaults by a variety of criteria. The
criteria include, among others, policy year, lender, geography
and the number of months and number of times the policy has been
in default, as well as whether the defaults were underwritten as
flow business or as part of a structured bulk transaction. See
the Critical Accounting Policies section of
Managements Discussion and Analysis of Financial
Condition and Results of
12
Operations for a more detailed discussion of the loss
reserving process. Detailed analysis of the activity in loss
reserves is provided in the Losses and Expenses
section of Managements Discussion and Analysis of
Financial Condition and Results of Operations and
Note 4 to the Consolidated Financial Statements.
Direct
Risk in Force
A foundation of our business strategy is proactive risk
selection. We analyze our portfolio in a number of ways to
identify any concentrations of risk or imbalances in risk
dispersion. We believe that the quality of our insurance
portfolio is affected predominantly by (i) the quality of
loan originations (including the credit quality of the borrower
and the marketability of the property); (ii) the attributes
of loans insured {including LTV ratio, purpose of the loan, type
of loan instrument (for example fixed, positively or negatively
amortizing ARM), and type of underlying property securing the
loan}; (iii) the seasoning of the loans insured;
(iv) the geographic dispersion of the underlying properties
subject to mortgage insurance; and (v) the quality,
integrity and past performance of lenders from which we receive
loans to insure.
We had $9.4 billion of direct risk in force as of
December 31, 2006 compared to $8.0 billion as of
December 31, 2005. Direct risk in force includes risk from
both Primary and Modified Pool insurance, adjusted for
applicable stop loss limits and deductibles.
Geographic
Dispersion
The following tables reflect the percentage of direct risk in
force on our book of business for the top ten states and the top
ten metropolitan statistical areas (MSAs) by
location of property as of December 31, 2006.
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Top Ten States
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Top Ten MSAs
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California
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13.6
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%
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Chicago, IL
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3.9
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%
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Florida
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11.1
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Phoenix/Mesa, AZ
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3.8
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Texas
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6.6
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Atlanta, GA
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2.4
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Arizona
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5.0
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Los Angeles/Long Beach, CA
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2.4
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Illinois
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4.3
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Las Vegas, NV
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2.3
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North Carolina
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3.8
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Riverside/San Bernardino, CA
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2.2
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Georgia
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3.7
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Houston, TX
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1.8
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Colorado
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3.3
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Denver, CO
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1.7
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Virginia
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3.1
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Arlington/Fredericksburg, VA
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1.6
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New Jersey
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3.0
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Miami, FL
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1.5
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Total
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57.5
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%
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Total
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23.6
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%
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While we continue to diversify our risk in force geographically,
a prolonged regional recession, particularly in high
concentration areas, or a prolonged national economic recession
could significantly increase loss development.
See the Production and In Force section of
Managements Discussion and Analysis of Financial
Condition and Results of Operations section of this
document for further detailed discussion on the characteristics
of our direct risk in force.
Investment
Portfolio
See a complete discussion of investments in the Investment
Portfolio section in the Managements
Discussion and Analysis of Financial Condition and Results of
Operations section of this document.
13
Regulation
Direct
Regulation
Our insurance subsidiaries are subject to comprehensive,
detailed regulation, principally for the protection of
policyholders rather than for the benefit of investors, by the
insurance departments of the various states in which each
insurer is licensed to transact business. Although their scope
varies, state insurance laws, in general, grant broad powers to
supervisory agencies or officials to examine companies and to
enforce rules or exercise discretion over almost every
significant aspect of the insurance business. These include the
licensing of companies to transact business and varying degrees
of control over claims handling practices, reinsurance
requirements, premium rates, the forms and policies offered to
customers, financial statements, periodic financial reporting,
permissible investments, and adherence to financial standards
relating to statutory surplus, dividends, and other criteria of
solvency intended to assure the satisfaction of obligations to
policyholders.
All states have enacted legislation that requires each insurance
company in a holding company system to register with the
insurance regulatory authority of its state of domicile and
furnish to the regulator financial and other information
concerning the operations of companies within the holding
company system that may materially affect the operations,
management, or financial condition of the insurers within the
system. Generally, all transactions within a holding company
system between an insurer and its affiliates must be fair and
reasonable and the insurers statutory policyholders
surplus following any transaction with an affiliate must be both
reasonable in relation to its outstanding liabilities and
adequate for its needs. Most states also regulate transactions
between insurance companies and their parents
and/or
affiliates. There can be no assurance that state regulatory
requirements will not become more stringent in the future and
have an adverse effect on us.
Because the Company is an insurance holding company and Triad is
an Illinois domiciled insurance company, the Illinois insurance
laws regulate, among other things, certain transactions in the
Companys common stock and certain transactions between
Triad and the Company or affiliates. Specifically, no person
may, directly or indirectly, offer to acquire or acquire
beneficial ownership of more than 10% of any class of
outstanding securities of the Company or its subsidiaries unless
such person files a statement and other documents with the
Illinois Director of Insurance and obtains the Directors
prior approval. These restrictions generally apply to all
persons controlling or under common control with the insurance
companies. Control is presumed to exist if 10% or
more of Triads voting securities is owned or controlled,
directly or indirectly, by a person, although the Illinois
Director may find that control, in fact, does or
does not exist where a person owns or controls either a lesser
or greater amount of securities. Other states in addition to
Illinois may regulate affiliated transactions and the
acquisition of control of the Company or its insurance
subsidiaries.
Triad is required by Illinois insurance laws to provide for a
contingency reserve in an amount equal to at least 50% of earned
premiums in its statutory financial statements. Such reserves
must be maintained for a period of 10 years except in
circumstances where prescribed levels of losses exceed
regulatory thresholds. During 2006, Triad experienced a loss
ratio in excess of 35%, which allowed it to release
approximately $19 million of previously established
contingency reserves to surplus. The contingency reserve,
designed to provide a cushion against the effect of adverse
economic cycles, has the effect of reducing statutory surplus
and restricting dividends and other distributions by Triad. At
December 31, 2006, Triad had statutory policyholders
surplus of $168.4 million and a statutory contingency
reserve of $521.8 million. At December 31, 2005, Triad
had statutory policyholders surplus of $131.6 million
and a statutory contingency reserve of $447.8 million.
Triads statutory earned surplus was $84.7 million at
December 31, 2006, and $47.9 million at
December 31, 2005, reflecting statutory net income for 2006
and a reduction in the deferred tax liability, partially offset
by an increase in the statutory contingency reserve.
The insurance laws of Illinois provide that Triad may pay
dividends only out of statutory earned surplus and further
establish standards limiting the maximum amount of dividends
that may be paid without prior approval by the Illinois
Director. Under such standards, Triad may pay dividends during
any 12-month period equal to the greater of (i) 10% of the
preceding year-end statutory policyholders surplus or
(ii) the preceding years net income. In addition,
insurance regulatory authorities have broad discretion to limit
the payment of dividends by insurance companies. Through
December 31, 2006, there have been no dividends paid by the
insurance subsidiaries to our parent company. Further, as of
December 31, 2006, there are no specific restrictions or
requirements for capital support arrangements between the parent
company and Triad or its subsidiaries.
14
Although not subject to a rating law in Illinois, premium rates
for mortgage insurance are subject to regulation in most states
to protect policyholders against the adverse effects of
excessive, inadequate, or unfairly discriminatory rates and to
encourage competition in the insurance marketplace. Any increase
in premium rates must be justified, generally on the basis of
the insurers loss experience, expenses, and future trend
analysis. The general mortgage default experience also may be
considered.
TGAC, organized as a subsidiary of Triad under the insurance
laws of the state of Illinois in December 1994, is subject to
all Illinois insurance regulatory requirements applicable to
Triad.
Triad Re, organized as a subsidiary of Triad under the insurance
laws of the state of Vermont in November 1999, is subject to all
Vermont insurance regulatory requirements applicable to Triad.
Triad, TGAC, and Triad Re are each subject to examination of
their affairs by the insurance departments of every state in
which they are licensed to transact business. The Illinois
Insurance Director and Vermont Insurance Commissioner
periodically conduct financial condition examinations of
insurance companies domiciled in their states. The most recent
examinations of Triad and TGAC were issued by the Illinois
Insurance Division on June 27, 2005, and covered the period
January 1, 1999, through December 31, 2003. No
adjustments or material recommendations were made as a result of
these examinations. The most recent examination of Triad Re was
issued by the Insurance Division of the State of Vermont on
September 29, 2005, and covered the period of
November 16, 1999 through December 31, 2003. No
adjustments or material recommendations were made as a result of
the examination.
A number of states generally limit the amount of insurance risk
that may be written by a private mortgage insurer to 25 times
the insurers total policyholders surplus. This
restriction is commonly known as the
risk-to-capital
requirement. At December 31, 2006 Triads
risk-to-capital
ratio was
12.5-to-1.
State insurance laws and regulations generally restrict mortgage
insurers to writing residential mortgage guaranty insurance
business only. This restriction generally prohibits Triad from
using its capital resources in support of other types of
insurance and restricts its noninsurance business. However,
noninsurance businesses of the Company would not be subject to
regulation under state insurance laws.
Regulation of reinsurance varies by state. Except for Illinois,
Wisconsin, New York, Ohio, and California, most states have no
special restrictions on reinsurance that would apply to private
mortgage insurers other than standard reinsurance requirements
generally applicable to property and casualty insurance
companies. Certain restrictions, including reinsurance trust
fund or letter of credit requirements, apply under Illinois law
to domestic companies and under the laws of several other states
to any licensed company ceding business to unlicensed
reinsurers. If a reinsurer is not admitted or approved, the
company doing business with the reinsurer cannot take credit in
its statutory financial statements for the risk ceded to such
reinsurer absent compliance with the reinsurance security
requirements. In addition, some states in which Triad does
business have limited private mortgage insurers to a maximum
policy coverage limit of 25% of the insureds claim amount
and require coverages in excess of 25% to be reinsured through
another licensed mortgage insurer.
The National Association of Insurance Commissioners
(NAIC) adopted a risk-based capital
(RBC) formula designed to help regulators identify
property and casualty insurers in need of additional capital.
The RBC formula establishes minimum capital needs based upon
risks applicable to individual insurers, including asset risks,
off-balance sheet risks (such as guarantees for affiliates and
contingent liabilities), and credit risks (such as reinsurance
ceded and receivables). The NAIC and the Illinois Insurance
Division currently do not require mortgage guaranty insurers to
file RBC analysis in their annual statements.
As of the date of this report, we have not received a license to
operate in Canada. The Office of the Superintendent of Financial
Institutions (OSFI) functions as the national
regulator of insurance companies in Canada, and our application
with OSFI is proceeding as expected. After OSFI approval, there
remain other approvals, including a Department of Finance
guaranty and certain provincial approvals.
15
As significant purchasers and sellers of conventional mortgage
loans and beneficiaries of private mortgage guaranty insurance,
Fannie Mae and Freddie Mac impose eligibility requirements on
private mortgage insurers in order for such insurers to acquire
business from them. These requirements include limitations on
the types of risk insured, standards for geographic and customer
diversification of risk, procedures for claims handling and
acceptable underwriting practices. These requirements generally
mirror the financial requirements of statutory insurance
regulations and are subject to change from time to time.
While Triad is an approved mortgage insurer for both Fannie Mae
and Freddie Mac and meets all existing eligibility requirements,
there can be no assurance that such requirements or the
interpretation of the requirements will not change or that Triad
will continue to meet such requirements. In addition, to the
extent Fannie Mae or Freddie Mac assumes default risk for itself
that would otherwise be insured, changes current guarantee fee
arrangements, allows alternative credit enhancements, alters or
liberalizes underwriting guidelines on low down payment
mortgages it purchases, or otherwise changes its business
practices or processes with respect to such mortgages, private
mortgage insurers may be affected. Triad could be adversely
affected if changes in eligibility requirements regarding
captive arrangements were to impede Triads ability to
offer this form of captive reinsurance.
Fannie Mae and Freddie Mac both accept reduced mortgage
insurance coverage from lenders that deliver loans approved by
their automated underwriting services. Generally, Fannie
Maes and Freddie Macs reduced mortgage insurance
coverage options provide for (i) across-the-board
reductions in required MI coverage on 30-year
fixed-rate
loans recommended for approval by their automated underwriting
services to the levels in effect in 1994; (ii) a reduction
in required MI coverage for loans with only a 5% down payment (a
95% LTV loan) from 30% to 25% of the mortgage loan covered by
MI; and (iii) a reduction in required MI coverage for loans
with a 10% down payment (a 90% LTV loan) from 25% to 17% of the
mortgage loan covered by MI. In addition, Fannie Mae and Freddie
Mac have implemented other programs that further reduce MI
coverage upon the payment of an additional fee by the lender.
Under this option, a 95% LTV loan will require 18% of the
mortgage loan to have mortgage insurance coverage. Similarly, a
90% LTV loan will require 12% of the mortgage loan to have
mortgage insurance coverage. In order for the homebuyer to have
MI at these levels, such loans would require a payment at
closing or a higher note rate.
Certain national mortgage lenders and a large segment of the
mortgage securitization market, including Fannie Mae and Freddie
Mac, generally will not purchase mortgages or mortgage-backed
securities unless the private mortgage insurance on the
mortgages has been issued by an insurer with a financial
strength rating of at least AA− from S&P
or Fitch or a rating of at least Aa3 from
Moodys. Fannie Mae and Freddie Mac require mortgage
guaranty insurers to maintain two ratings of
AA− or better. Triad has a financial strength
rating of AA from S&P and Fitch and a rating of
Aa3 from Moodys. S&P, Fitch, and
Moodys consider Triads consolidated operations and
financial position in determining the rating. There can be no
assurance that Triads ratings, the methods by which the
ratings are determined, or the eligibility requirements of
Fannie Mae and Freddie Mac will not change.
The Real Estate Settlement and Procedures Act of 1974
(RESPA) applies to most residential mortgages
insured by Triad, and related regulations provide that the
provision of services involving mortgage insurance is a
settlement service for purposes of loans subject to
RESPA. Subject to limited exceptions, RESPA prohibits persons
from accepting anything of value for referring real estate
settlement services to any provider of such services. Although
many states prohibit mortgage insurers from giving rebates,
RESPA has been interpreted to cover many non-fee services as
well.
Most originators of mortgage loans are required to collect and
report data relating to a mortgage loan applicants race,
nationality, gender, marital status, and census tract to HUD or
the Federal Reserve under the Home Mortgage Disclosure Act of
1975 (HMDA). The purpose of HMDA is to detect
possible discrimination in home lending and, through disclosure,
to discourage such discrimination. Mortgage insurers are not
required pursuant to any law or regulation to report HMDA data,
although under the laws of several states, mortgage insurers are
currently prohibited from discriminating on the basis of certain
classifications. All but one of the active mortgage
16
insurers (including Triad), through their trade association, the
Mortgage Insurance Companies of America (MICA), have
entered into an agreement with the Federal Financial
Institutions Examinations Council (FFIEC) to report
the same data on loans submitted for insurance as is required
for most mortgage lenders under HMDA.
The Homeowners Protection Act of 1998 provides for certain
termination and cancellation requirements for borrower-paid
mortgage insurance and requires mortgage lenders to periodically
update borrowers about their private mortgage insurance. Under
the legislation, borrowers may generally request termination of
mortgage insurance once the LTV reaches 80%, provided that
certain conditions are met. The legislation further requires
lenders to automatically cancel borrower-paid private mortgage
insurance when the LTV reaches 78% if certain conditions are
met. The legislation also requires lenders to notify borrowers
that they have private mortgage insurance and requires certain
disclosures to borrowers of their rights under the law. Because
most mortgage borrowers who obtain private mortgage insurance do
not achieve 20% equity in their homes before the homes are sold
or the mortgages are refinanced, we have not lost and do not
expect to lose a significant amount of insurance in force due to
the enactment of this legislation.
Indirect
Regulation
The Company, Triad, and Triads subsidiaries are also
indirectly, but significantly, impacted by regulations affecting
purchasers of mortgage loans, such as Fannie Mae and Freddie
Mac, and regulations affecting governmental insurers, such as
the FHA and the Department of Veterans Affairs (VA),
as well as regulation affecting lenders. Private mortgage
insurers, including Triad, are highly dependent upon federal
housing legislation and other laws and regulations that affect
the demand for private mortgage insurance and the housing
market. FHA loan limits are adjusted in response to changes in
the Freddie Mac/Fannie Mae conforming loan limits. Currently,
the maximum single-family home mortgage that the FHA can insure
is $362,790. The maximum FHA loan amount is subject to
adjustment and may increase in the future. Any future
legislation that increases the number of persons eligible for
FHA or VA mortgages could have an adverse effect on Triads
ability to compete with the FHA or VA.
Pursuant to the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 (FIRREA), the Office of
Thrift Supervision (OTS) issued risk-based capital
rules for savings institutions. These rules establish a lower
capital requirement for a low down payment loan that is insured
with private mortgage insurance, as opposed to remaining
uninsured. Furthermore, the guidelines for real estate lending
policies applicable to savings institutions and commercial banks
provide that such institutions should require appropriate credit
enhancement in the form of either mortgage insurance or readily
marketable collateral for any high LTV mortgage. Future changes,
if any, to FIRREAs risk-based capital rules or the
guidelines for real estate lending policies applicable to
savings institutions and commercial banks could affect demand
for private mortgage insurance products.
In the first quarter of 2002, the Office of Federal Housing
Enterprise Oversight (OFHEO) released its risk-based
capital rules for Fannie Mae and Freddie Mac. The regulation
provides capital guidelines for Fannie Mae and Freddie Mac in
connection with their use of various types of credit protection
counterparties including a more preferential capital credit for
insurance from a AAA rated private mortgage insurer
than for insurance from a AA rated private mortgage
insurer. The phase-in period for the new rule is ten years. We
do not believe the new rules had an adverse impact on us when
issued or that the new rules will have a significant adverse
impact on us in the future. However, if the new capital
guidelines result in future changes to the preferences of Fannie
Mae and Freddie Mac regarding their use of the various types of
credit enhancements or their choice of mortgage insurers based
on credit rating, our financial condition could be significantly
harmed.
Fannie Mae and Freddie Mac each provide their own automated
underwriting system to be used by mortgage originators selling
mortgages to them. These systems, which are provided by Triad as
a service to the Companys contract underwriting customers,
streamline the mortgage process and reduce costs. The increased
acceptance of these products is driving the automation of the
process by which mortgage originators sell loans to Fannie Mae
and Freddie Mac, a trend that is expected to continue. As a
result, Fannie Mae and Freddie Mac could develop the capability
to become the decision maker regarding selection of a private
mortgage insurer for loans sold to them, a decision
traditionally made by the mortgage originator. We, however, are
not aware of any plans to do so. The concentration of purchasing
power that would be attained if such development, in fact,
occurred could adversely
17
affect, from our perspective, the terms on which mortgage
insurance is written on loans sold to Fannie Mae and Freddie Mac.
Additionally, proposals have been advanced which would allow
Fannie Mae and Freddie Mac additional flexibility in determining
the amount and nature of alternative recourse arrangements or
other credit enhancements that could be utilized as substitutes
for private mortgage insurance. We cannot predict if or when any
of the foregoing legislation or proposals will be adopted, but
if adopted, and depending upon the nature and extent of
revisions made, demand for private mortgage insurance may be
adversely affected. There can be no assurance that other federal
laws affecting such institutions and entities will not change,
or that new legislation or regulation will not be adopted.
In 1996, the Office of the Comptroller of the Currency
(OCC) granted permission to national banks to have a
reinsurance company as a wholly-owned operating subsidiary for
the purpose of reinsuring mortgage insurance written on loans
originated, purchased, or serviced by such banks. Several
subsequent applications by banks to offer reinsurance have been
approved by the OCC including at least one request to engage in
quota share reinsurance. The OTS, which regulates thrifts and
savings institutions, has approved applications for such captive
arrangements as well. The reinsurance subsidiaries of national
banks or savings institutions could become significant
competitors of ours in the future.
In November 1999, the Gramm-Leach-Bliley Act, also known as the
Financial Services Modernization Act of 1999, became effective
and allows holding companies of banks also to own a company that
underwrites insurance. As a result of this Act, banking
organizations that previously were not allowed to be affiliated
with insurance companies may now do so. This legislation has had
very little impact on us to date. However, the evolution of
federal law making it easier for banks to engage in the mortgage
guaranty business through affiliates may subject mortgage
guaranty insurers to more intense competition and risk-sharing
with bank lender customers in the future.
Web Site
Access to Company Reports
Through our web site we make available, free of charge, our
Annual Report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
and amendments to those reports as soon as reasonably
practicable after this material is electronically filed with or
furnished to the Securities and Exchange Commission. This
material may be accessed by visiting the
Investors/Financials/SEC Filings section of our web site at
www.triadguaranty.com.
Employees
As of December 31, 2006, we employed approximately 250
persons. Employees are not covered by any collective bargaining
agreement. We consider our employee relations to be satisfactory.
Executive
Officers
Our executive officers are as follows:
|
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|
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Name
|
|
Position
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|
Age
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Mark K. Tonnesen
|
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President, Chief Executive
Officer, and Director of the Company and Triad
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55
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Kenneth C. Foster
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Executive Vice President,
Structured Transactions and Business Development
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58
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Steven J. Haferman
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Senior Vice President, Risk
Management and Information Technology and Director of Triad
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45
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Kenneth W. Jones
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Senior Vice President and Chief
Financial Officer of the Company and Triad and Director of Triad
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49
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Earl F. Wall
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Senior Vice President, Secretary,
and General Counsel of the Company and Triad and Director of
Triad
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49
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Mark K. Tonnesen was employed as President, Chief
Executive Officer, and a Director of the Company in September
2005. Previously, Mr. Tonnesen was employed by the Royal
Bank of Canada, Toronto, since 1997,
18
where he held a number of positions, including Vice Chairman and
Chief Financial Officer, RBC Insurance and Executive Vice
President, Card Services and Point of Sale. From 1987 to 1997,
he was associated with Banc One Corporation, Columbus, Ohio,
where he served in a variety of senior positions, including
Chief Development Officer and President, Banc One Credit Card
Services Company.
Kenneth C. Foster has been Executive Vice President,
Structured Transactions and Business Development of Triad since
November 2006. Since joining Triad in June 2001, Mr. Foster
has served in several senior management roles in the areas of
product development and risk management. Prior to joining Triad,
Mr. Foster was Principal of Applied Mortgage Solutions from
1994 to 2001. Previously Mr. Foster was employed by MGIC
from 1980 to 1994, most recently as Vice President of
Business/Information Development. Mr. Foster has been
associated with Triad for 9 years and in the
insurance/mortgage industry for over 30 years.
Stephen J. Haferman was employed as Senior Vice
President, Risk Management and Information Technology of the
Company in March 2006. Mr. Haferman was previously with
Cheryl and Company, Columbus, Ohio from 2003, most recently as
Senior Vice President, Chief Operating Officer. From 2001 to
2003 Mr. Haferman was employed by American Electric Power
as Vice President, Marketing Information Management. From 1992
to 2001 he worked for Bank One Corporation in a number of
divisions and a variety of senior management positions
including; Senior Vice President, Direct Marketing for Bank One
Retail; Senior Vice President, Technology Program Manager, Bank
One Retail; Vice President, Risk Department Manager. From 1988
to 1992 he worked for National City Bank where he was Risk
Manager.
Kenneth W. Jones was employed as Senior Vice President
and Chief Financial Officer of the Company in April 2006.
Mr. Jones has over 25 years experience in the
financial management of companies. He had been at RBC Liberty
Insurance Corporation, where he served as Senior Vice President,
Chief Financial Officer, since 2000. Previously, Mr. Jones
was associated with The Liberty Corporation, where he held a
number of management positions, most recently Vice President,
Controller and Acting Chief Financial Officer. Before joining
The Liberty Corporation, Mr. Jones was with
Ernst & Young for 14 years.
Earl F. Wall has been Senior Vice President of Triad
since November 1999, General Counsel of Triad since January
1996, and Secretary since June 1996. Mr. Wall was Vice
President of Triad from 1996 till 1999. Mr. Wall has been
Senior Vice President of the Company since December 1999, and
Secretary and General Counsel of the Company since September
1996. Mr. Wall was Vice President of the Company from 1996
to 1999. From 1982 to 1995, Mr. Wall was employed by
Integon in a number of capacities including Vice President,
Associate General Counsel, and Director of Integon Life
Insurance Corporation and Georgia International Life Insurance
Corporation, Vice President, and General Counsel of Integon
Mortgage Guaranty Insurance Corporation, and Vice President,
General Counsel, and Director of Marketing One, Inc.
Officers of the Company serve at the discretion of the Board of
Directors of the Company.
Our results could be affected by the risk factors discussed
below. These factors may also cause actual results to differ
materially from the results contemplated by forward-looking
statements in our Managements Discussion and Analysis.
Investors should consider these factors in reading this document.
If deteriorating economic conditions alter the frequency and
severity patterns utilized in our estimates for reserves for
losses, we may be required to take additional charges to
earnings.
We calculate our best estimate of the reserve for losses to
provide for the estimated costs of settling claims on loans
reported in default, and loans in default that are in the
process of being reported to us, as of the date of our financial
statements. Our reserving process incorporates various
components in a model that gives effect to current economic
conditions and segments defaults by a variety of criteria. The
criteria include, among others, policy year, lender, geography
and the number of months and number of times the policy has been
in default, as well as whether the defaults were underwritten as
flow business or as part of a structured bulk transaction.
Frequency and severity are the two most significant assumptions
in the establishment of our loss reserves. Frequency is used to
estimate the ultimate number of paid claims associated with the
current defaulted loans. The
19
frequency estimate assumes that long-term historical experience,
taking into consideration criteria such as those described in
the preceding paragraph, and adjusted for current economic
conditions that we believe will significantly impact the
long-term loss development, provides a reasonable basis for
forecasting the number of claims that will be paid. Severity is
the estimate of the dollar amount per claim that will be paid.
The severity factors are estimates of the percent of the risk in
force that will be paid. The severity factors used are based on
an analysis of the severity rates of recently paid claims,
applied to the risk in force of the loans currently in default.
The frequency and severity factors are updated quarterly.
The estimation of loss reserves requires assumptions as to
future events, and there are inherent risks and uncertainties
involved in making these assumptions. Economic conditions that
have affected the development of loss reserves in the past may
not necessarily affect development patterns in the future in
either a similar manner or degree. To the extent that possible
future adverse economic conditions such as increasing
unemployment rates or declining housing prices alter those
historical frequency and severity patterns, actual paid claims
on the existing delinquent loans may be greater than the
reserves that we have provided and require a charge to earnings.
Since, consistent with industry practice, we generally
provide reserves only for loans in default that have been
reported to us and an estimate of loans in default not yet
reported to us, any increase in the level of delinquent loans
reported would require an increase to reserves and a charge to
earnings.
Reserves are provided for the estimated ultimate costs of
settling claims on both loans reported in default and loans in
default that are in the process of being reported to us.
Generally accepted accounting principles preclude us from
establishing loss reserves for future claims on insured loans
that are not currently in default. We generally do not establish
reserves until we are notified that a borrower has failed to
make at least two payments when due. A prolonged deterioration
of general economic conditions such as increasing unemployment
rates or declining housing prices could adversely alter the
historical delinquency patterns resulting in an increase in the
level of loans in default. An increase in the number of loans in
default would require additional reserves and a charge to
earnings as they are reported to us.
Because our business is concentrated among relatively few
major lenders, our revenues and net income could decline if we
lose a significant customer.
Our business depends on a relatively small number of customers.
During 2006, our top ten lenders were responsible for 80% of our
Primary flow new insurance written, compared to 77% in 2005.
Additionally, our top three lenders were responsible for
approximately 65% of our Primary flow new insurance written
during 2006. This concentration of business could increase as a
result of further consolidation in the lending industry or other
factors. The loss of business from one or more of our major
lenders could have an adverse effect on our business, financial
condition and operating results.
If housing values fail to appreciate or decline on a more
significant and larger geographic basis, we may incur a higher
level of losses from paid claims and also be required to
increase reserves.
A component of our mitigation efforts on mortgage insurance
claims is our option of paying the coverage percentage in full
satisfaction of our obligations under the policy or paying off
the entire loan amount and taking title to the mortgaged
property underlying a defaulted loan. The critical assumption
behind the purchase option is that the property has appreciated
in value since the loan was originated and that we will be able
to recover some, or the entire amount at risk, through the
acquisition and subsequent sale of the property. The purchase
option proved successful during the first three quarters of 2006
in mitigating losses, but was less successful in the fourth
quarter of 2006. The assumptions utilized in our reserve
methodology have factored in a certain amount of loss mitigation
resulting from the utilization of the purchase option. If
housing values fail to appreciate or decline on a more
significant and larger geographic basis, the frequency of loans
going into default and eventually to a paid claim could increase
and our ability to mitigate our losses on defaulted mortgages
may be further reduced, which could have a material adverse
effect on our business, financial condition and operating
results.
20
Because a growing portion our business is sensitive to
interest rates, a large increase in rates would cause higher
monthly mortgage payments for borrowers that could potentially
lead to a greater number of defaults, which would adversely
impact our business.
At December 31, 2006, approximately 30% of our Primary risk
in force and 69% of our Modified Pool risk in force is comprised
of adjustable-rate mortgage loans or ARMs. Monthly payments on
these loans are altered periodically through an adjustment of
the interest rate. Many ARMs have a fixed interest rate for a
stated period of time, and accordingly, have not yet been
subject to an interest rate adjustment. In periods of rising
interest rates, a borrowers monthly payment will increase.
A large increase in interest rates over a short period of time
could lead to payment shocks for borrowers that
could potentially lead to more reported defaults.
At December 31, 2006, approximately 12% of our Primary risk
in force and 13% of our Modified Pool risk in force is comprised
of pay option ARMs with the potential for negative amortization
on the loan. These percentages have grown substantially over the
past year. These loans allow borrowers, for a stated period of
time, to make monthly payments that do not cover the interest on
the loan meaning the loan balance will increase. These pay
option ARM loans may have a heightened propensity to default
because of possible payment shocks after the initial
low-payment period expires and because the borrower does not
automatically build equity through loan amortization as payments
are made. The risk of default may be further increased if the
interest rate paid during the payment option period is
significantly below current market rates. Additionally, it is
important to note the lack of long-term historical performance
data associated with pay option ARMs across all market
conditions, could increase the volatility of the estimates used
in our reserve models. If interest rates increase causing
payment shock to borrowers with ARMs, our default
rate could increase which could have a material adverse impact
on our business, financial condition and operating results.
The premiums we charge for mortgage insurance on non-prime
loans, ARMs and Alt-A loans may not be adequate to compensate
for future losses from these products.
Our new insurance written includes non-prime loans, ARMs and
Alt-A loans that have an increased premium over prime, fixed
rate and fully documented loans. The credit quality, loss
development and persistency on these loans can vary
significantly from our traditional prime loan business. For
example, we have experienced a 3.64% delinquency rate on our
Primary Alt-A loan portfolio compared to a 2.47% delinquency
rate on our overall Primary loan portfolio. We expect that we
will continue to experience higher default rates for non-prime
loans, Alt-A loans and ARMs than for our prime fixed rate loans.
Additionally, long-term historical performance data associated
with non-prime loans, ARMs and Alt-A loans across all market
conditions does not exist. We cannot be sure that the premiums
including the additional risk charge that we apply to non-prime,
ARMs and Alt-A loans will adequately offset the associated risk,
which could adversely impact operating results.
A growing portion of our insurance in force consists of loans
with high
loan-to-value
ratios or loans that are non-prime or both, which could result
in more and larger claims than loans with lower
loan-to-value
ratios or prime loans.
A growing portion of our mortgage insurance in force consists of
insurance on mortgage loans with LTVs at origination of more
than 95%. When we are required to pay a claim on a higher LTV
loan, it is generally more difficult to recover our costs from
the underlying property, especially in areas with declining
property values. Therefore, if we experience a higher default
rate and paid claims on higher LTV loans, our results of
operations could be adversely affected.
We also insure non-prime loans. The majority of the non-prime
loans we insure are known as Alt-A loans, which have
credit scores commensurate with prime loans but are processed
with reduced or no documentation. Our Alt-A loans also tend to
have larger loan balances relative to our other loans. Because
we have been insuring non-prime loans for a limited period of
time, we are still developing data regarding the performance of
these loans and there can be no assurance that our estimated
default rates and losses will match our actual results. If our
estimates prove to be inaccurate, our financial condition and
operating results could be adversely affected. Further, we
cannot be sure that the increased premiums that we charge for
mortgage insurance on non-prime loans will be adequate to
compensate us for the losses we incur on these products.
21
A downgrade or potential downgrade of the financial strength
ratings assigned to our primary insurance subsidiary could
weaken our competitive position.
One or more of S&P, Moodys or Fitch could downgrade
the financial strength ratings assigned to our primary insurance
subsidiary, Triad, if they believe that we have experienced
adverse developments in our business, financial condition or
operating results. These ratings are important to our ability to
market our products and to maintain our competitive position and
customer confidence in our products. A downgrade in these
ratings could have a material adverse effect on our business,
financial condition and operating results. If the financial
strength rating assigned to our insurance subsidiary were to
fall below Aa3 from Moodys or the
AA− level from S&P and Fitch, then
mortgage lenders would not purchase mortgage insurance from us
and a large segment of the mortgage securitization market,
including Fannie Mae and Freddie Mac, generally would not
purchase mortgages or mortgage-backed securities insured by us.
Changes in the business practices or legislation relating to
Fannie Mae and Freddie Mac could significantly impact our
business.
Fannie Mae and Freddie Mac are the beneficiaries of the majority
of our policies, so their business practices have a significant
influence on us. Changes in their practices could reduce the
number of policies they purchase that are insured by us and
consequently reduce our revenues. Some of Fannie Mae and Freddie
Macs newer programs require less insurance coverage than
they historically have required, and they have the ability to
further reduce or eliminate coverage requirements, which would
reduce demand for mortgage insurance and have a material adverse
effect on our business, financial condition and operating
results.
Fannie Mae and Freddie Mac also have the ability to implement
new eligibility requirements for mortgage insurers and to alter
or liberalize underwriting standards on low-down-payment
mortgages they purchase which thereby affect the quality of the
risk and the availability of mortgage loans. Additionally,
Fannie Mae and Freddie Mac can alter the terms on which mortgage
insurance coverage can be canceled before reaching the
cancellation thresholds established by law, and the
circumstances in which mortgage servicers must perform
activities intended to avoid or mitigate loss on insured
mortgages that are delinquent. We cannot predict the extent to
which any new requirements may be enacted or how they may affect
the operations of our mortgage insurance business, our capital
requirements and our products.
Legislation and regulatory changes, including changes
impacting the GSEs, could significantly affect our business and
could reduce demand for private mortgage insurance.
Mortgage origination transactions are subject to compliance with
various federal and state consumer protection laws, including
the Real Estate Settlement Procedures Act of 1974, or RESPA, the
Equal Credit Opportunity Act, the Fair Housing Act, the
Homeowners Protection Act, the Fair Credit Reporting Act, the
Fair Debt Collection Practices Act and others. Among other
things, these laws prohibit payments for referrals of settlement
service business, require fairness and non-discrimination in
granting or facilitating the granting of credit, require
cancellation of insurance and refunding of unearned premiums
under certain circumstances, govern the circumstances under
which companies may obtain and use consumer credit information,
and define the manner in which companies may pursue collection
activities. Changes in these laws or regulations could adversely
affect our operations and profitability.
Congress is currently considering proposed legislation relating
to the regulatory oversight of the GSEs, their affordable
housing initiatives, the GSEs products and marketing
activities, the GSEs minimum capital standards, and their
risk-based capital requirements. If adopted in its present form,
OFHEO would be replaced by a new federal agency, the Federal
Housing Enterprise Regulatory Agency, and its director would be
given significant authority over the GSEs including, among other
things, oversight of the operations of the GSEs, capital
adequacy and internal controls and new program approval. The
proposed legislation encompasses substantially all of the
operations of the GSEs and is intended to be a comprehensive
overhaul of the existing regulatory structure. The proposed
legislation could limit the growth of the GSEs, which could
result in a reduction in the size of the mortgage insurance
market. We do not know what form, if any, such legislation will
take, if any, or, if it is enacted, its impact, if any, on our
financial condition and results of operations.
22
In addition, increases in the maximum loan amount or other
features of the FHA mortgage insurance program can reduce the
demand for private mortgage insurance. Future legislative and
regulatory actions could decrease the demand for private
mortgage insurance, which could harm our consolidated financial
condition and results of operations.
Our revenues and profits could decline if we lose market
share as a result of industry competition or if our competitive
position suffers as a result of our inability to introduce and
successfully market new products and programs.
There are seven main mortgage insurance providers, of which we
are the smallest. The mortgage insurance industry is highly
dynamic and intensely competitive. The other private mortgage
insurance providers are Mortgage Guaranty Insurance Corporation,
Radian Guaranty Inc., PMI Mortgage Insurance Company, Genworth
Financial Mortgage Insurance Company, United Guaranty
Residential Insurance Company, and Republic Mortgage Insurance
Company. Two of these are subsidiaries of well-capitalized
companies with stronger insurance financial strength ratings and
greater access to capital than we have.
If we are unable to compete successfully against other private
mortgage insurers, or if we experience delays in introducing
competitive new products and programs or if these products or
programs are less profitable than our existing products and
programs, our business will suffer
If mortgage lenders and investors select alternatives to
private mortgage insurance, the amount of insurance that we
write could decline, which could reduce our revenues and
profits.
There are an increasing number of alternatives to traditional
private mortgage insurance, and new alternatives may develop,
which could reduce the demand for our mortgage insurance.
Existing alternatives include:
|
|
|
|
|
mortgage lenders structuring mortgage originations to avoid
private mortgage insurance utilizing
80-10-10
structures; over the past several years, the volume of these
loans, or variations of them, have increased as alternatives to
loans requiring mortgage insurance;
|
|
|
|
investors using credit enhancements as a partial or complete
substitute for private mortgage insurance;
|
|
|
|
lenders and investors holding mortgages in their portfolios and
self-insuring;
|
|
|
|
member institutions providing credit enhancement on loans sold
to a Federal Home Loan Bank, or FHLB, which do not have the
same requirements for mortgage insurance as Fannie Mae and
Freddie Mac.
|
Changes in regulatory requirements could impact captive
mortgage insurance arrangements for all industry
participants.
State insurance departments or other officials may conduct
investigations or reviews of our business practices such as our
captive reinsurance or other risk sharing arrangements. The
anti-referral fee provisions of RESPA provide that the
Department of Housing and Urban Development (HUD) as
well as the insurance commissioner or attorney general of any
state may bring an action to enjoin violations of these
provisions of RESPA. The insurance law provisions of many states
prohibit paying for the referral of insurance business and
provide various mechanisms to enforce this prohibition. In the
summer of 2005, we received an inquiry from the New York
Insurance Department relating to captive mortgage insurance
arrangements to which we have responded fully. In January of
2006, we received a request for information from the Minnesota
Insurance Department regarding our lender captive reinsurance
arrangements to which we have also responded fully. While we
believe our captive reinsurance arrangements are in conformity
with applicable laws and regulations, it is not possible to
predict the outcome of any such reviews or investigations nor is
it possible to predict their effect on Triad or the entire
mortgage insurance industry.
23
Since we generally cannot cancel mortgage insurance policies
or adjust renewal premiums, unanticipated claims could cause our
financial performance to suffer.
We generally cannot cancel the mortgage insurance coverage that
we provide or adjust renewal premiums during the life of a
mortgage insurance policy. As a result, the impact of
unanticipated claims generally cannot be offset by premium
increases on policies in force or limited by non-renewal or
cancellation of insurance coverage. The premiums we charge may
not be adequate to compensate us for the risks and costs
associated with the insurance coverage provided to our
customers. An increase in the number or size of unanticipated
claims could adversely affect our financial condition and
operating results.
Our loss experience is likely to increase as our policies
continue to age.
We expect the majority of claims on insured loans in our current
portfolio to occur during the second through the fifth years
after loan origination. Primary insurance written from the
period of January 1, 2002 through December 31, 2005
represented 63% of our Primary risk in force as of
December 31, 2006. Accordingly, a significant majority of
our Primary portfolio is in, or approaching, its peak claim
years. We believe our loss experience is likely to increase as
our policies age. If the claim frequency on our risk in force
significantly exceeds the claim frequency that was assumed in
setting our premium rates, our financial condition and results
of operations could be adversely affected.
Our revenues and DAC amortization depend on the renewal of
policies that may terminate or fail to renew.
The large majority of our premiums each month have been derived
from the monthly renewal of policies that we previously have
written. Factors that could cause an increase in non-renewals of
our policies include falling mortgage interest rates (which tend
to lead to increased refinancings and associated cancellations
of mortgage insurance), appreciating home values which can lead
to more refinances and mortgage insurance cancellations, and
changes in the mortgage insurance cancellation requirements
applicable to mortgage lenders and homeowners. Additionally, the
amount of DAC amortization expense would be adversely impacted
if policies terminate at a rate faster than was originally
estimated in our DAC models. A decrease in the length of time
that our mortgage insurance policies remain in force reduces our
revenues and could have an adverse effect on our business,
financial condition and operating results.
Our delegated underwriting program may subject our mortgage
insurance business to unanticipated claims.
A significant percentage of our new insurance written is
underwritten pursuant to a delegated underwriting program. These
programs permit certain mortgage lenders to determine whether
mortgage loans meet our program guidelines and enable these
lenders to commit us to issue mortgage insurance. We may expand
the availability of delegated underwriting to additional
customers. If an approved lender commits us to insure a mortgage
loan, we may refuse to insure, or we may rescind coverage on
that loan if the lender fails to follow our delegated
underwriting guidelines. Even if we terminate a lenders
underwriting authority, we remain at risk for any loans
previously insured on our behalf by the lender before that
termination. The performance of loans insured through programs
of delegated underwriting has not been tested over a period of
extended adverse economic conditions, meaning that the program
could lead to greater losses than we anticipate. If losses are
significantly greater than anticipated, our delegated
underwriting program could have a material adverse effect on our
business, financial condition and operating results.
Geographic concentration of our risk in force could increase
claims and losses and harm our financial performance.
We could be affected by economic downturns, natural disasters
and other events in specific regions of the United States where
a large portion of our business is concentrated. As of
December 31, 2006, 14% of our risk in force was located in
California, 11% was located in Florida and 7% was located in
Texas. California and Florida have seen some of the highest
house price appreciation over the last several years and in
certain areas, have recently experienced house price
depreciation. If housing declines continue or deepen, this could
have an additional impact
24
on the ultimate amount of paid claims in certain geographic
areas and could have a material adverse impact on our business,
financial condition and operating results.
If we fail to properly underwrite mortgage loans when we
provide contract underwriting services, we may be required to
provide monetary and other remedies to the customer.
Under the terms of our contract underwriting agreements existing
with certain lenders, we agree to indemnify the lender against
losses incurred in the event that we make material errors in
determining whether loans processed by our contract underwriters
meet specified underwriting or purchase criteria, subject to
contractual limitations on liability. As a part of the contract
underwriting services, we provide monetary and other remedies to
our customers in the event that we fail to properly underwrite a
mortgage loan. As a result, we assume credit and interest rate
risk in connection with our contract underwriting services.
Worsening economic conditions, a deterioration in the quality of
our underwriting services or other factors could cause our
contract underwriting liabilities to increase and have an
adverse effect on our financial condition and results of
operations. Although we have established a reserve to provide
for potential claims in connection with our contract
underwriting services, we have limited historical experience
that we can use to establish reserves for these potential
liabilities, and these reserves may not be adequate to cover
liabilities that may arise.
We have committed to an operational presence in Canada during
2007. Our ability to successfully organize, develop successful
administrative systems and gain meaningful market share in
Canada is dependent on many factors over which we have no
control.
As of the date of this report, we have not received a license to
operate in Canada. There are several regulatory approvals that
we are awaiting including an approval by the Department of
Finance that allows lenders in Canada to obtain capital relief
for lenders requiring borrowers to purchase mortgage insurance
on mortgage loans. Obtaining all regulatory approvals is a
process that cannot be accelerated and our ultimate entrance
date into Canada is unknown at this time. Additionally, we are
in the process of building policy administrative systems and
lender interfaces that are different than those used in the
U.S. These systems will allow the interchange of data to
facilitate the underwriting process.
In Canada, we will compete with Canada Mortgage and Housing
Corporation (CMHC), a Crown corporation that is not subject to
the same capital requirements or profit objectives as we will
be. Additionally, we will compete with Genworth Financial
Mortgage Insurance Company Canada which is a well-established
private mortgage insurer that has been in Canada for many years
as well as several other mortgage insurers that have announced
plans to enter that market. Our ability to differentiate
ourselves from the other mortgage insurance companies as well as
CMHC and gain a meaningful market share in Canada is dependent
on our ability to execute our entrance strategy effectively.
Success in Canada is expected to have a meaningful impact on our
bottom line in the long term; however, we do not expect the
Canadian operations to have a significant financial impact in
2007.
|
|
Item 1B.
|
Unresolved
Staff Comments
|
We received a letter from the Division of Corporate Finance of
the Securities and Exchange Commission dated December 22,
2006, requesting additional information relating to our
Form 10-K
for 2005. Specifically, the Commission staff requested
information to better understand our disclosure relating to the
following points:
|
|
|
|
|
The calculation of loss reserves related to defaults incurred
but not reported,
|
|
|
|
Additional sensitivity analysis around the frequency and
severity factors utilized in our loss reserve projections as
described in the Critical Accounting Policies,
|
|
|
|
Additional disclosures related to the subsequent loss reserve
deficiency reported in 2005 and 2004 based upon the reported
reserves at December 31, 2004 and 2003.
|
On January 31, 2007, we responded to the Commissions
comments in a detailed letter addressing each of the above
items. On March 9, 2007, we had further conversations with
the Commission and the staff requested additional clarification
of certain issues and an additional schedule.
25
The Company leases office space in its Winston-Salem
headquarters and its seven underwriting offices located
throughout the country under leases expiring between 2007 and
2012 and which require annual lease payments of approximately
$1.5 million in 2007. With respect to all facilities, the
Company either has renewal options or believes it will be able
to obtain lease renewals on satisfactory terms. The Company
believes its existing properties are well utilized and are
suitable and adequate for its present circumstances.
Effective March 2007, the Company has entered into a lease to
rent office space in Toronto, Canada for its Canadian operations
under a lease expiring in 2009. Annual lease payments would be
approximately $135,000 in 2007.
The Company maintains mid-range and micro-computer systems from
its corporate data center located in its headquarters building
to support its data processing requirements for accounting,
policy administration, claims, marketing, risk management, and
underwriting. The Company has in place back-up procedures in the
event of emergency situations.
|
|
Item 3.
|
Legal
Proceedings
|
The Company is involved in litigation in the ordinary course of
business including the named case below. No pending litigation
is expected to have a material adverse affect on the financial
position of the Company.
Triad is a defendant in Broessel v. Triad. This
action was commenced on January 15, 2004 with a filing in
Federal District Court for the Western District of Kentucky
seeking class action status on behalf of a nationwide class of
home mortgage borrowers. The complaint alleges that Triad
violated the Fair Credit Reporting Act (FCRA) by
failing to provide notices to certain borrowers when mortgage
insurance was offered to lenders with respect to those
borrowers mortgage loans at a rate in excess of
Triads lowest available rate. Discovery is currently
underway with respect to class certification. While the ultimate
outcome of the FCRA litigation is uncertain, the litigation is
not expected to have a material adverse effect on the financial
position of the Company.
|
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
None.
26
PART II
|
|
Item 5.
|
Market
for Registrants Common Equity and Related Stockholder
Matters and Issuer Purchases of Equity Securities
|
(a) Market information
The Companys Common Stock trades on The NASDAQ Global
Select
Market®
under the symbol TGIC. At December 31, 2006,
14,856,401 shares were issued and outstanding. The
following table sets forth the highest and lowest closing prices
of the Companys Common Stock, $0.01 par value, as
reported by NASDAQ during the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
First Quarter
|
|
$
|
46.95
|
|
|
$
|
42.00
|
|
|
$
|
59.50
|
|
|
$
|
50.20
|
|
Second Quarter
|
|
$
|
56.07
|
|
|
$
|
45.77
|
|
|
$
|
55.04
|
|
|
$
|
49.50
|
|
Third Quarter
|
|
$
|
52.88
|
|
|
$
|
45.69
|
|
|
$
|
53.88
|
|
|
$
|
37.74
|
|
Fourth Quarter
|
|
$
|
57.31
|
|
|
$
|
49.11
|
|
|
$
|
45.85
|
|
|
$
|
35.75
|
|
(b) Holders
As of March 1, 2007, the number of stockholders of record
of the Companys Common Stock was approximately 325. In
addition, there were an estimated 6,650 beneficial owners of
shares held by brokers and fiduciaries.
(c) Dividends
Payments of future dividends are subject to declaration by the
Companys Board of Directors. The dividend policy is
dependent also on the ability of Triad to pay dividends to the
parent company. Currently, there are no intentions to pay
dividends.
(d) Issuer purchases of equity securities
None.
27
|
|
Item 6.
|
Selected
Financial Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(Dollars in thousands, except per share amounts)
|
|
|
Income Statement Data
(for period ended):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums written:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
256,706
|
|
|
$
|
207,260
|
|
|
$
|
176,696
|
|
|
$
|
154,046
|
|
|
$
|
124,214
|
|
Ceded
|
|
|
(46,140
|
)
|
|
|
(40,644
|
)
|
|
|
(35,365
|
)
|
|
|
(27,310
|
)
|
|
|
(18,345
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
210,566
|
|
|
$
|
166,616
|
|
|
$
|
141,331
|
|
|
$
|
126,736
|
|
|
$
|
105,869
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
$
|
210,856
|
|
|
$
|
168,997
|
|
|
$
|
140,992
|
|
|
$
|
119,732
|
|
|
$
|
105,067
|
|
Net investment income
|
|
|
26,696
|
|
|
|
22,998
|
|
|
|
19,754
|
|
|
|
17,082
|
|
|
|
16,099
|
|
Net realized gains (losses)
|
|
|
1,584
|
|
|
|
36
|
|
|
|
504
|
|
|
|
3,029
|
|
|
|
(2,519
|
)
|
Other income
|
|
|
8
|
|
|
|
15
|
|
|
|
16
|
|
|
|
24
|
|
|
|
72
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
239,144
|
|
|
|
192,046
|
|
|
|
161,266
|
|
|
|
139,867
|
|
|
|
118,719
|
|
Net losses and loss adjustment
expenses
|
|
|
94,227
|
|
|
|
66,855
|
|
|
|
35,864
|
|
|
|
23,833
|
|
|
|
14,063
|
|
Interest expense on debt
|
|
|
2,774
|
|
|
|
2,773
|
|
|
|
2,772
|
|
|
|
2,772
|
|
|
|
2,771
|
|
Amortization of deferred
acquisition cost
|
|
|
16,268
|
|
|
|
14,902
|
|
|
|
14,256
|
|
|
|
18,112
|
|
|
|
13,742
|
|
Other operating expenses (net of
acquisition cost deferred)
|
|
|
35,556
|
|
|
|
29,610
|
|
|
|
26,483
|
|
|
|
22,776
|
|
|
|
22,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
90,319
|
|
|
|
77,906
|
|
|
|
81,891
|
|
|
|
72,374
|
|
|
|
65,243
|
|
Income taxes
|
|
|
24,684
|
|
|
|
21,093
|
|
|
|
23,474
|
|
|
|
21,283
|
|
|
|
20,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
65,635
|
|
|
$
|
56,813
|
|
|
$
|
58,417
|
|
|
$
|
51,091
|
|
|
$
|
45,103
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
4.44
|
|
|
$
|
3.87
|
|
|
$
|
4.04
|
|
|
$
|
3.57
|
|
|
$
|
3.21
|
|
Diluted earnings per share
|
|
$
|
4.40
|
|
|
$
|
3.84
|
|
|
$
|
3.98
|
|
|
$
|
3.52
|
|
|
$
|
3.15
|
|
Weighted average common and common
share equivalents outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
14,769,859
|
|
|
|
14,691,478
|
|
|
|
14,458,453
|
|
|
|
14,322,216
|
|
|
|
14,060,420
|
|
Diluted
|
|
|
14,912,519
|
|
|
|
14,808,387
|
|
|
|
14,681,228
|
|
|
|
14,509,538
|
|
|
|
14,331,581
|
|
Balance Sheet Data
(at year end):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
895,631
|
|
|
$
|
767,503
|
|
|
$
|
672,035
|
|
|
$
|
575,579
|
|
|
$
|
482,886
|
|
Total invested assets
|
|
$
|
607,312
|
|
|
$
|
547,019
|
|
|
$
|
476,913
|
|
|
$
|
399,571
|
|
|
$
|
326,537
|
|
Reserve for losses and loss
adjustment expenses
|
|
$
|
84,352
|
|
|
$
|
51,074
|
|
|
$
|
34,042
|
|
|
$
|
27,186
|
|
|
$
|
21,360
|
|
Unearned premiums
|
|
$
|
13,193
|
|
|
$
|
13,494
|
|
|
$
|
15,942
|
|
|
$
|
15,630
|
|
|
$
|
8,539
|
|
Long-term debt
|
|
$
|
34,510
|
|
|
$
|
34,501
|
|
|
$
|
34,493
|
|
|
$
|
34,486
|
|
|
$
|
34,479
|
|
Stockholders equity
|
|
$
|
570,224
|
|
|
$
|
499,191
|
|
|
$
|
437,343
|
|
|
$
|
369,930
|
|
|
$
|
309,407
|
|
Statutory
Ratios(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio
|
|
|
44.7
|
%
|
|
|
39.6
|
%
|
|
|
25.4
|
%
|
|
|
19.9
|
%
|
|
|
13.4
|
%
|
Expense ratio
|
|
|
23.4
|
%
|
|
|
25.2
|
%
|
|
|
29.4
|
%
|
|
|
33.0
|
%
|
|
|
38.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
68.1
|
%
|
|
|
64.8
|
%
|
|
|
54.8
|
%
|
|
|
52.9
|
%
|
|
|
51.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio
|
|
|
44.7
|
%
|
|
|
39.6
|
%
|
|
|
25.4
|
%
|
|
|
19.9
|
%
|
|
|
13.4
|
%
|
Expense ratio
|
|
|
24.6
|
%
|
|
|
26.7
|
%
|
|
|
28.8
|
%
|
|
|
32.3
|
%
|
|
|
34.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
69.3
|
%
|
|
|
66.3
|
%
|
|
|
54.2
|
%
|
|
|
52.2
|
%
|
|
|
48.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Statutory Data
(dollars in millions)(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct insurance in force
|
|
$
|
56,828.4
|
|
|
$
|
44,407.0
|
|
|
$
|
36,827.0
|
|
|
$
|
31,747.8
|
|
|
$
|
25,379.1
|
|
Direct risk in force (gross)
|
|
$
|
9,440.5
|
|
|
$
|
8,016.3
|
|
|
$
|
7,627.0
|
|
|
$
|
7,024.0
|
|
|
$
|
5,790.9
|
|
Risk-to-capital
|
|
|
12.5:1
|
|
|
|
12.6:1
|
|
|
|
14.0:1
|
|
|
|
15.3:1
|
|
|
|
15.5:1
|
|
|
|
|
(1) |
|
Based on statutory accounting practices and derived from
combined statutory financial statements of Triad. |
28
|
|
Item 7.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
Managements Discussion and Analysis of Financial Condition
and Results of Operations analyzes the consolidated financial
condition, changes in financial position, and results of
operations for the three years ended December 31, 2006, of
the Company. The discussion should be read in conjunction with
the Consolidated Financial Statements and Notes contained herein.
Certain of the statements contained herein, other than
statements of historical fact, are forward-looking statements.
These statements are made pursuant to the safe harbor provisions
of the Private Securities Litigation Reform Act of 1995 and
include estimates and assumptions related to economic,
competitive, and legislative developments. These forward-looking
statements are subject to change and uncertainty, which are, in
many instances, beyond our control and have been made based upon
our expectations and beliefs concerning future developments and
their potential effect on us. Actual developments and their
results could differ materially from those expected by us,
depending on the outcome of certain factors, including the
possibility of general economic and business conditions that are
different than anticipated, legislative developments, changes in
interest rates or the stock markets, stronger than anticipated
competitive activity, as well as the factors described in the
Safe Harbor Statement under the Private Securities
Litigation Reform Act of 1995 section below with respect
to forward-looking statements contained herein.
Critical
Accounting Policies and Estimates
Accounting estimates and assumptions discussed in this section
are those that we consider to be the most critical to an
understanding of our financial statements because they
inherently involve significant judgments and uncertainties. In
developing these estimates, we make subjective and complex
judgments that are inherently uncertain and subject to material
change as facts and circumstances develop. Although variability
is inherent in these estimates, we believe the amounts provided
are appropriate based on the facts available upon compilation of
the financial statements. Also, see Note 1 to the
Consolidated Financial Statements, Summary of Significant
Accounting Policies for a complete discussion of our significant
accounting policies.
Reserve
for Losses and Loss Adjustment Expenses
We calculate our best estimate of the reserve for losses to
provide for the estimated costs of settling claims on loans
reported in default, as of the date of our financial statements.
Additionally, we provide a reserve for loans in default that are
in the process of being reported to us (incurred by not
reported) using an estimate based on the percentage of actual
reported defaults. Our reserving process incorporates various
components in a model that gives effect to current economic
conditions and segment defaults by a variety of criteria. The
criteria include, among others, policy year, lender, geography
and the number of months and number of times the policy has been
in default, as well as whether the defaults were underwritten as
flow business or as part of a structured bulk transaction.
Frequency and severity are the two most significant assumptions
in the establishment of our loss reserves. Frequency is used to
estimate the ultimate number of paid claims associated with the
current defaulted loans. The frequency estimate assumes that
long-term historical experience, taking into consideration
criteria such as those described in the preceding paragraph, and
adjusted for current economic conditions that we believe will
significantly impact the long-term loss development, provides a
reasonable basis for forecasting the number of claims that will
be paid. Severity is the estimate of the dollar amount per claim
that will be paid. The severity factors are estimates of the
percent of the risk in force that will be paid. The severity
factors used are based on an analysis of the severity rates of
recently paid claims, applied to the risk in force of the loans
currently in default. The frequency and severity factors are
updated quarterly. Economic conditions and other data upon which
these factors are based may change more frequently than once a
quarter. Therefore, significant changes in reserve requirements
may become evident three or more months following the underlying
events that would necessitate the change.
29
The estimation of loss reserves requires assumptions as to
future events, and there are inherent risks and uncertainties
involved in making these assumptions. Economic conditions that
have affected the development of loss reserves in the past may
not necessarily affect development patterns in the future in
either a similar manner or degree. To provide a measure of the
sensitivity on pretax income and loss reserves carried on the
balance sheet, we have provided the following table that
quantifies the impact of percentage increases and decreases in
both the average frequency and severity as of December 31,
2006:
|
|
|
|
|
|
|
|
|
|
|
Sensitivity Analysis
|
|
|
|
Effect on Pretax Income from
|
|
|
|
Changes in Assumptions
|
|
|
|
Decrease in Factors
|
|
|
Increase in Factors
|
|
|
|
Resulting in an
|
|
|
Resulting in a
|
|
|
|
Increase in Pretax
|
|
|
(Decrease) in
|
|
|
|
Income
|
|
|
Pretax Income
|
|
|
|
(In thousands)
|
|
|
10% Increase (Decrease) in the
Frequency Factors Utilized in the Loss Reserve Model
|
|
$
|
7,045
|
|
|
$
|
(7,145
|
)
|
10% Increase (Decrease) in the
Severity Factors Utilized in the Loss Reserve Model
|
|
$
|
8,325
|
|
|
$
|
(8,325
|
)
|
10% Increase (Decrease) in Both
the Frequency and Severity Factors Utilized in the Loss Reserve
Model
|
|
$
|
14,665
|
|
|
$
|
(16,185
|
)
|
The impact on loss reserves on the balance sheet would be to
decrease reserves under favorable development and to increase
reserves for unfavorable development. There would be no impact
on liquidity resulting from the change in reserves. However,
there would be a change in cash or invested assets equal to the
increase or decrease in the ultimate paid claims related to the
change in reserves. We believe that a 10% increase or decrease
in frequency or severity is reasonably likely based on potential
changes in future economic conditions and past experience.
Economic conditions that could give rise to an increase in the
frequency rate could be a sudden increase, or a prolonged period
of increase in the unemployment rate while, conversely, a sudden
drop in interest rates or a sustained period of economic and job
growth could decrease the frequency rate. A sudden nationwide or
widespread regional decline in home prices, or a prolonged
period of flat or slowly depreciating home prices could increase
the severity while a significant increase, or steady sustained
growth in house price appreciation could decrease the severity.
Because the estimate for loss reserves is sensitive to the
estimates of claims frequency and severity, we perform analyses
to test the reasonableness of the best estimate generated by our
loss reserve process. Our loss reserve estimation process and
our analyses support the reasonableness of the best estimate of
loss reserves recorded in our financial statements. See the
Losses and Expenses section below for a more
detailed discussion of the reserves for losses and loss
adjustment expenses.
Investments
Valuing our investment portfolio involves a variety of
assumptions and estimates, particularly for investments that are
not actively traded. We rely on external pricing sources for
highly liquid, publicly traded securities and use an internal
pricing matrix developed by our outside investment advisors for
privately placed securities. This matrix relies on our judgment
concerning a) the discount rate we use in calculating
expected future cash flows, b) credit quality and
c) expected maturity.
We regularly monitor our investment portfolio to ensure that
investments that may be
other-than-temporarily
impaired are identified in a timely fashion, properly valued,
and any
other-than-temporary
impairments are charged against earnings in the proper period.
The timely identification and valuation of potentially impaired
securities involves many judgments. The most significant
judgments that we make relate to the estimated future cash flows
on potentially impaired securities and our intent and ability to
hold a security to anticipated recovery of value. Inherently,
there are risks and uncertainties involved in making these
judgments. See further discussion of the valuation of our
investment portfolio and the methodology to identify potential
impairments under the Investment Portfolio section
below.
30
Deferred
Policy Acquisition Costs
The costs of acquiring new business, principally commissions and
certain policy underwriting and issue costs which are primarily
related to the production of new business, are capitalized as
deferred policy acquisition costs (DAC).
Amortization of DAC is charged to expense in proportion to
premium recognized over the estimated policy life. We make
judgments in the determination of estimated policy life utilized
in the amortization assumptions. The most significant judgment
that we make is the estimated life of the DAC. See further
discussion of DAC under the Financial Position
section below.
Overview
Through our subsidiaries, we provide Primary and Modified Pool
mortgage guaranty insurance coverage to residential mortgage
lenders and investors as a credit-enhancement vehicle. We
classify insurance as Primary when we are in the first loss
position and the LTV is 80% or greater when the loan is first
insured. We classify all other insurance as Modified Pool. The
majority of our Primary insurance is delivered through the flow
channel, which is defined as loans originated by lenders and
submitted to us on a
loan-by-loan
basis. We also provide mortgage insurance to lenders and
investors who seek additional default protection (typically
secondary coverage or on loans for which the individual borrower
has greater than 20% equity), capital relief, and
credit-enhancement on groups of loans that are sold in the
secondary market. These transactions are referred to as our
structured bulk channel business. Those individual loans in the
structured bulk channel in which we are in the first loss
position and the LTV ratio is greater than 80% are classified as
Primary. All of our Modified Pool insurance is delivered through
the structured bulk channel.
Our revenues principally consist of a) initial and renewal
earned premiums from flow business (net of reinsurance premiums
ceded as part of our risk management strategies),
b) initial and renewal earned premiums from structured bulk
transactions, and c) investment income on invested assets.
We also realize investment gains, net of investment losses,
periodically as a source of revenue when the opportunity
presents itself within the context of our overall investment
strategy.
Our expenses essentially consist of a) amounts paid on
claims submitted, b) changes in reserves for estimated
future claim payments on loans that are currently in default,
c) general and administrative costs of acquiring new
business and servicing existing policies, d) other general
business expenses, and e) income taxes.
Our profitability depends largely on a) the volume of
business insured combined with the adequacy of our product
pricing and underwriting discipline relative to the risks
insured, b) persistency levels, c) operating
efficiencies, and d) the level of investment yield,
including realized gains and losses, on our investment
portfolio. We define persistency as the percentage of insurance
in force remaining from twelve months prior. Cancellations of
policies originated during the past twelve months are not
considered in our calculation of persistency. This method of
calculating persistency may vary from that of other mortgage
insurers. We believe that our calculation presents an accurate
measure of the percentage of insurance in force remaining from
twelve months prior. Cancellations result primarily from the
borrower refinancing or selling insured mortgaged residential
properties and, to a lesser degree, from the borrower achieving
prescribed equity levels at which the lender no longer requires
mortgage guaranty insurance.
31
Consolidated
Results of Operations
Following is selected financial information for the last three
years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
% Change
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006 vs. 2005
|
|
|
2005 vs. 2004
|
|
|
|
(In thousands, except percentages and per share
information)
|
|
|
Earned premiums
|
|
$
|
210,856
|
|
|
$
|
168,997
|
|
|
$
|
140,992
|
|
|
|
24.8
|
%
|
|
|
19.9
|
%
|
Net losses and loss adjustment
expenses
|
|
|
94,227
|
|
|
|
66,855
|
|
|
|
35,864
|
|
|
|
40.9
|
|
|
|
86.4
|
|
Other operating expenses
|
|
|
35,556
|
|
|
|
29,610
|
|
|
|
26,483
|
|
|
|
20.1
|
|
|
|
11.8
|
|
Net income
|
|
|
65,635
|
|
|
|
56,813
|
|
|
|
58,417
|
|
|
|
15.5
|
|
|
|
(2.7
|
)
|
Diluted earnings per share
|
|
$
|
4.40
|
|
|
$
|
3.84
|
|
|
$
|
3.98
|
|
|
|
14.6
|
|
|
|
(3.5
|
)
|
Net income for 2006 grew over 2005 as a result of strong growth
in earned premiums that exceeded growth of operating expenses
and net losses and loss adjustment expenses. Growth of our
insurance in force and strong persistency coupled with an
increase in basis points on Primary business generated the
growth in earned premiums. Basis points on Primary business
increased due to higher premiums charged on new insurance with
risk-adjusted rates such as Alt-A loans and adjustable rate
mortgages (ARMs), including potential negative
amortization loans. Production of these products increased
throughout 2006 as discussed further in the Production and
In Force and Revenues sections below.
Growth and seasoning of our insurance in force combined with
refinements in the frequency and severity factors utilized in
our calculation of our reserves caused net losses and loss
adjustment expenses for 2006 to increase significantly over
2005. Insurance in force was $56.8 billion at
December 31, 2006 compared to $44.4 billion at
December 31, 2005 and $36.8 billion at
December 31, 2004. This growth along with a greater
percentage of loans entering the peak claim paying period
increased both the number and amount of paid claims during 2006.
Direct paid losses increased to $59.0 million for 2006 from
$48.8 million for 2005. The actual number of claims paid
for 2006 increased 20.6% over 2005 as well. In addition to paid
claims, net losses and loss adjustment expenses also includes
the change in reserves. We increased reserves $33.3 million
during 2006 compared to $17.0 million during 2005. The
increase in 2006 was due to an increase in the number of
defaults, but also reflects the impacts of the increase in the
frequency and severity factors due to the declining housing
market and growth in our average portfolio loan size.
Other operating expenses for 2006 increased over 2005 due to
organizational changes and staff additions to support our
growth, expensing of stock options in 2006, and strategic
initiatives, including expenses associated with entering the
Canadian market. In July 2006, we announced our intention to
submit an application to incorporate a Canadian subsidiary to
begin operations in Canada. The Canadian company will be a
monoline provider of mortgage guaranty insurance and, pending
regulatory approvals, could start operations sometime in 2007.
We incurred approximately $690,000 of expenses in 2006 relating
to legal fees, consulting, personnel and application fees in
connection with this process. We expect these expenses to
increase during 2007 as we continue to put the necessary
personnel and infrastructure into place in anticipation of the
commencement of business in that year.
The increase in diluted earnings per share for 2006 over 2005
was consistent with the increase in net income. Realized
investment gains, net of taxes, increased diluted earnings per
share in 2006 by $0.07 and had no impact on diluted earnings per
share in 2005. Diluted realized gains and losses per share is a
non-GAAP measure. We believe this is relevant and useful
information to investors because, except for write-downs on
other-than-temporarily
impaired securities, it shows the effect that our discretionary
sales of investments had on earnings.
Net income for 2005 declined from 2004, as losses and loss
adjustment expenses grew faster than earned premium during 2005.
The growth in net losses and loss adjustment expenses in 2005
was principally a result of the ongoing seasoning of our
insurance portfolio. In 2005, we experienced an increase in the
number of paid claims and the number of reported defaults that
caused us to significantly increase our reserve for losses to
reflect these trends. We experienced growth in earned premiums
in 2005, driven by moderate growth of our risk in force combined
with an increase in premium basis points related to specific
lender programs and a change in the mix of business. Realized
investment gains increased diluted earnings per share by $0.02
in 2004.
We describe our results in greater detail in the discussions
that follow. The information is presented in three categories:
Production and In Force, Revenues, and Losses and Expenses.
32
Production
and In Force
Below is a summary of new production:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
% Change
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006 vs. 2005
|
|
|
2005 vs. 2004
|
|
|
|
(In millions, except percentages)
|
|
|
Primary insurance written
|
|
$
|
12,088
|
|
|
$
|
10,488
|
|
|
$
|
10,709
|
|
|
|
15.3
|
%
|
|
|
(2.1
|
)%
|
Modified Pool insurance written
|
|
|
12,672
|
|
|
|
10,681
|
|
|
|
6,463
|
|
|
|
18.6
|
|
|
|
65.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance written
|
|
$
|
24,760
|
|
|
$
|
21,169
|
|
|
$
|
17,172
|
|
|
|
17.0
|
%
|
|
|
23.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary new insurance written in 2006 increased over 2005 due to
increased production primarily of products with risk-adjusted
pricing such as Alt-A loans and ARMs, including loans with
potential negative amortization. Primary new insurance written
also increased due to an increase in lender paid transactions,
which included, in some cases, products with risk-adjusted
pricing. Loans with potential negative amortization include pay
option ARMs. We classify all loans with adjustable interest
rates as ARMs, including those for which the interest rate is
fixed for a certain period of time. We define pay option ARMs as
those that provide a fixed period of time during which the
borrower has the option to pay monthly payments that are less
than the interest accrued for those months. If the borrower
elects this option, the LTV increases on the loan. Because the
LTV can increase on a pay option ARM, these types of loans may
present more risk to a mortgage insurer than traditional
amortizing loans. We define ARMs with positive amortization as
those that have scheduled loan principal amortization and those
for which monthly payments are interest only for a fixed period
of time and then convert to scheduled loan principal
amortization. A relatively flat mortgage loan origination market
in 2005 combined with a decline in the percentage of loan
originations for which mortgage insurance was provided caused
the decline in Primary insurance written in 2005 from that of
2004.
Using MICA definitions, net new primary insurance written for
the entire industry declined approximately 5% for 2006 from 2005
based on information available from MICA and other public
sources. Our increased production of products with risk-adjusted
pricing combined with a gain in market share in 2006 mitigated
the effects of this industry decline.
We believe that the overall mortgage loan origination market
will continue to contract in 2007, which could reduce our
Primary new insurance written. However, we believe that
alternative credit enhancements such as
80-10-10s,
which can limit the need for mortgage insurance, have become
less attractive to borrowers as short-term interest rates have
risen. Further, the recent passing of legislation that makes
mortgage insurance tax deductible in certain circumstances may
also mitigate any potential reduction of Primary insurance
written.
We write Modified Pool insurance only through our structured
bulk channel. Structured bulk transactions for the entire
industry increased approximately 9% for 2006 over 2005,
according to information available from MICA and other publicly
available data. Our Modified Pool insurance written for 2006
increased over 2005 as a result of this industry increase and a
gain in our market share as shown in the table below. These same
factors caused the increase in Modified Pool insurance written
in 2005 over 2004. Our Modified Pool insurance written is likely
to vary significantly from period to period due to: a) the
limited number of transactions (but with larger size) occurring
in this market, b) the level of competition from other
mortgage insurers, c) the relative attractiveness in the
marketplace of mortgage insurance versus other forms of credit
enhancement, and d) the changing loan composition and
underwriting criteria of the market. We believe there will
continue to be opportunities in 2007 in the structured bulk
transaction market that meet our loan quality and pricing
objectives.
The following table provides estimates of our national market
share of net new insurance written, using MICA definitions,
through our flow and structured bulk channels based on
information available from MICA and other public sources for the
years ended December 31, 2006, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Flow channel
|
|
|
6.3
|
%
|
|
|
5.7
|
%
|
|
|
4.8
|
%
|
Structured bulk channel
|
|
|
14.5
|
%
|
|
|
11.5
|
%
|
|
|
11.3
|
%
|
Total
|
|
|
9.1
|
%
|
|
|
7.5
|
%
|
|
|
6.0
|
%
|
33
Our market share of new insurance written through the flow
channel increased in 2006 and 2005 as a result of acquiring
business from new lenders and increased writings with our
targeted lenders, specifically with special lender-paid programs
that applied primarily to non-prime loans. These special
lender-paid programs are competitively priced among mortgage
insurers and the production can vary from period to period,
depending upon our willingness to accept the specific risk
characteristics of these products. Our structured bulk market
share will vary from period to period since our share of this
market is dependent on the availability and size of transactions
that meet our credit quality and pricing benchmarks and on our
ability to bid successfully for these transactions.
A significant trend over the last three years in our Primary
production has been our increased participation in the Alt-A
marketplace. We have defined Alt-A loans as individual loans
having FICO scores greater than 619 and that have been
underwritten with reduced or no documentation. The following
table summarizes the credit quality characteristics of our
Primary new insurance written over the past three years and
reflects the growth in our Alt-A production. We have defined A
Minus loans as those loans having FICO credit scores greater
than 574, but less than 620. We have defined Sub Prime loans as
those loans with credit scores less than 575.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit Quality
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Prime
|
|
|
68.4
|
%
|
|
|
76.1
|
%
|
|
|
81.7
|
%
|
Alt-A
|
|
|
29.2
|
|
|
|
18.3
|
|
|
|
13.6
|
|
A Minus
|
|
|
2.1
|
|
|
|
4.3
|
|
|
|
4.0
|
|
Sub Prime
|
|
|
0.3
|
|
|
|
1.3
|
|
|
|
0.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Another significant trend in our Primary production over the
past three years was the increase in ARMs, especially those
loans subject to potential negative amortization. The following
table summarizes the loan type characteristics of our Primary
new insurance written over the past three years and reflects the
growth in ARMs, especially the loans subject to potential
negative amortization in 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan Type
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Fixed
|
|
|
58.1
|
%
|
|
|
62.9
|
%
|
|
|
65.6
|
%
|
ARM (positive amortization)
|
|
|
14.3
|
|
|
|
25.0
|
|
|
|
33.1
|
|
ARM (potential negative
amortization)
|
|
|
27.6
|
|
|
|
12.1
|
|
|
|
1.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk characteristics that we consider in our underwriting
discipline also include, among other factors, the LTV of the
loan. The following table summarizes the percentage of our
Primary production by LTV over the past three years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan to Value
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
LTV
ratio:
|
|
|
|
|
|
|
|
|
|
|
|
|
Greater than 95%
|
|
|
15.5
|
%
|
|
|
12.4
|
%
|
|
|
12.7
|
%
|
90.01% to 95.00%
|
|
|
23.9
|
|
|
|
35.5
|
|
|
|
34.9
|
|
90.00% and below
|
|
|
60.6
|
|
|
|
52.1
|
|
|
|
52.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LTVs on policies originated in the structured bulk channel are
generally lower than those on policies we receive via the flow
channel. Those policies generally also have other Primary
coverage in front of our risk.
34
Periodically we enter into structured bulk transactions
involving loans that have insurance effective dates within the
current reporting period but for which detailed loan information
regarding the insured loans is not provided by the issuer of the
transaction until later. When this situation occurs, we accrue
premiums that are due but not yet paid based upon the estimated
commitment amount of the transaction in the reporting period
with respect to each loans insurance effective date.
However, these policies are not reflected in our insurance in
force, new insurance written, or related industry data totals
until we verify the loan level detail. At December 31,
2006, we had approximately $119 million of structured
transactions with effective dates within 2006 for which loan
level detail had not been received and, therefore, are not
included in our own data or industry totals. These amounts will
be reported as new production and insurance in force totals in
2007, when the issuer of the transactions provides accurate loan
level detail to us. We have included in premium written and
premium earned the respective estimated amounts due and earned
during 2006 related to this insurance. At December 31,
2005, we had approximately $979 million of structured
transactions with effective dates within 2005 for which loan
level detail had not been received.
The following table provides detail on our direct insurance in
force at December 31, 2006, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
% Change
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006 vs. 2005
|
|
|
2005 vs. 2004
|
|
|
|
(In millions, except percentages)
|
|
|
Primary insurance
|
|
$
|
34,109
|
|
|
$
|
29,792
|
|
|
$
|
28,964
|
|
|
|
14.5
|
%
|
|
|
2.9
|
%
|
Modified Pool insurance
|
|
|
22,719
|
|
|
|
14,615
|
|
|
|
7,863
|
|
|
|
55.4
|
|
|
|
85.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance
|
|
$
|
56,828
|
|
|
$
|
44,407
|
|
|
$
|
36,827
|
|
|
|
28.0
|
%
|
|
|
20.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our Primary insurance in force grew in 2006 and in 2005 as a
result of production during those years and improving
persistency rates. Primary insurance annual persistency improved
to 76.6% at December 31, 2006 compared to 70.0% at
December 31, 2005 and 68.5% at December 31, 2004. If
interest rates remain near current levels, we anticipate that
persistency rates will also continue near current levels for
2007. However, persistency may be adversely affected if interest
rates decline significantly from the levels experienced during
2006.
Our Modified Pool insurance in force grew significantly in 2006
and in 2005 due to our strong production in the structured bulk
channel as well as an improving persistency rate. Approximately
34%, 39% and 81% of our insurance written attributable to our
structured bulk channel during 2006, 2005, and 2004,
respectively, was structured with deductibles that put us in the
second loss position. The declines in Modified Pool insurance
written with deductibles in 2006 and 2005 were the result of
increased business with entities that do not utilize deductibles
in their structures, although the use of deductibles remains an
effective part of our Modified Pool risk management strategy.
As mentioned earlier, our Modified Pool insurance in force is
comprised entirely of structured bulk transactions. Although
terms vary, the structured bulk market can be broadly
categorized into three different segments, or tiers, depending
on the risk characteristics of the loans comprising a
transaction. The loan characteristics of the three segments are
a) predominantly high credit quality, low LTV, fully
underwritten loans that may have niche characteristics such as
non-conforming loan balances and risk concentrations related to
geography, transaction purpose, or occupancy type; b) loans
that generally have high credit quality and low to moderate LTVs
that have been underwritten with reduced, streamlined, or no
documentation; and c) generally fully underwritten loans
with credit impaired borrowers (FICO credit score less than
575). In general, we believe that structured bulk business
originated in segments b) and c) will report a higher
default rate than our Primary business. However, we also believe
that the lower LTVs associated with the structured bulk business
originated in segments a) and b) will ultimately
generate lower claim rates as a proportion of the reported
defaults and lower levels of severity than Primary business.
Most of our structured bulk insurance in force is comprised of
the first two segments mentioned above, while only approximately
1% of our insurance in force attributable to structured bulk
transactions was categorized in segment c) above.
35
Similar to the trend in new insurance written discussed above,
Alt-A continues to grow as a percentage of our insurance in
force. The following table shows the percentage of our insurance
in force that we have classified as Alt-A at December 31,
2006, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Primary insurance in force
|
|
|
15.4
|
%
|
|
|
9.9
|
%
|
|
|
7.3
|
%
|
Modified Pool insurance in force
|
|
|
70.7
|
%
|
|
|
66.9
|
%
|
|
|
56.2
|
%
|
Total insurance in force
|
|
|
37.5
|
%
|
|
|
28.6
|
%
|
|
|
17.7
|
%
|
The following table provides information on risk in force at
December 31, 2006, 2005 and 2004. As is evidenced by the
following table, we have moved further out on the risk curve
based upon the trends in these risk characteristics. Indicators
of increased risk would include the following:
|
|
|
|
|
A decline in the percentage of business with prime credit quality
|
|
|
|
An increase in the percentage of Alt-A business
|
|
|
|
An increase in Primary LTV greater than 95%
|
|
|
|
An increase in potential negative amortization loan types
|
|
|
|
An increase in condominium property types
|
|
|
|
A decline in primary residence occupancy status
|
This increase in risk embedded in our portfolio increased the
basis points that we charged for mortgage insurance in 2006 and
2005.
36
Risk in
Force(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary
|
|
|
Modified Pool
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In millions, except percentages)
|
|
|
Direct Risk in Force
|
|
$
|
8,652
|
|
|
$
|
7,471
|
|
|
$
|
7,158
|
|
|
$
|
788
|
|
|
$
|
545
|
|
|
$
|
374
|
|
Net Risk in Force
|
|
$
|
7,824
|
|
|
$
|
6,767
|
|
|
$
|
6,587
|
|
|
$
|
788
|
|
|
$
|
545
|
|
|
$
|
374
|
|
Credit quality:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
|
80.2
|
%
|
|
|
84.2
|
%
|
|
|
86.3
|
%
|
|
|
30.5
|
%
|
|
|
32.8
|
%
|
|
|
42.2
|
%
|
Alt-A
|
|
|
15.7
|
|
|
|
10.8
|
|
|
|
8.2
|
|
|
|
68.5
|
|
|
|
65.9
|
|
|
|
55.3
|
|
A Minus
|
|
|
3.5
|
|
|
|
4.2
|
|
|
|
4.5
|
|
|
|
0.8
|
|
|
|
1.1
|
|
|
|
2.1
|
|
Sub Prime
|
|
|
0.6
|
|
|
|
0.8
|
|
|
|
1.0
|
|
|
|
0.2
|
|
|
|
0.2
|
|
|
|
0.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LTV:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
95.01% and above
|
|
|
16.6
|
%
|
|
|
14.3
|
%
|
|
|
12.6
|
%
|
|
|
|
%
|
|
|
|
%
|
|
|
|
%
|
90.01% to 95.00%
|
|
|
37.1
|
|
|
|
41.9
|
|
|
|
42.2
|
|
|
|
|
|
|
|
0.5
|
|
|
|
0.5
|
|
90.00% and below
|
|
|
46.3
|
|
|
|
43.8
|
|
|
|
45.2
|
|
|
|
100.0
|
|
|
|
99.5
|
|
|
|
99.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan Type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
|
|
|
70.1
|
%
|
|
|
73.7
|
%
|
|
|
76.4
|
%
|
|
|
31.0
|
%
|
|
|
41.3
|
%
|
|
|
59.9
|
%
|
ARM (positive amortization)
|
|
|
18.3
|
|
|
|
22.2
|
|
|
|
23.1
|
|
|
|
55.6
|
|
|
|
58.7
|
|
|
|
40.1
|
|
ARM (potential negative
amortization)
|
|
|
11.6
|
|
|
|
4.1
|
|
|
|
0.5
|
|
|
|
13.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage Term:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15 years and under
|
|
|
2.6
|
%
|
|
|
4.2
|
%
|
|
|
6.0
|
%
|
|
|
2.2
|
%
|
|
|
3.7
|
%
|
|
|
6.1
|
%
|
Over 15 years
|
|
|
97.4
|
|
|
|
95.8
|
|
|
|
94.0
|
|
|
|
97.8
|
|
|
|
96.3
|
|
|
|
93.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property Type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condominium
|
|
|
9.6
|
%
|
|
|
7.8
|
%
|
|
|
6.9
|
%
|
|
|
8.0
|
%
|
|
|
5.9
|
%
|
|
|
1.3
|
%
|
Other (principally single-family
detached)
|
|
|
90.4
|
|
|
|
92.2
|
|
|
|
93.1
|
|
|
|
92.0
|
|
|
|
94.1
|
|
|
|
98.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Occupancy Status:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary residence
|
|
|
89.4
|
%
|
|
|
91.9
|
%
|
|
|
93.5
|
%
|
|
|
73.7
|
%
|
|
|
74.2
|
%
|
|
|
74.1
|
%
|
Secondary home
|
|
|
7.4
|
|
|
|
4.6
|
|
|
|
3.3
|
|
|
|
6.2
|
|
|
|
5.7
|
|
|
|
5.2
|
|
Non-owner occupied
|
|
|
3.2
|
|
|
|
3.5
|
|
|
|
3.2
|
|
|
|
20.1
|
|
|
|
20.1
|
|
|
|
20.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage Amount:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$200,000 or less
|
|
|
58.4
|
%
|
|
|
67.7
|
%
|
|
|
71.2
|
%
|
|
|
38.4
|
%
|
|
|
46.4
|
%
|
|
|
50.4
|
%
|
Over $200,000
|
|
|
41.6
|
|
|
|
32.3
|
|
|
|
28.8
|
|
|
|
61.6
|
|
|
|
53.6
|
|
|
|
49.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Percentages represent distribution of direct risk in force on a
per policy basis and does not account for applicable stop-loss
amounts or deductibles. |
37
Our book of business is relatively unseasoned, having a weighted
average life of 2.3 years at December 31, 2006
compared to 2.4 years at December 31, 2005 and
2.2 years at December 31, 2004. The following table
shows direct risk in force as of December 31, 2006, 2005
and 2004 by year of loan origination.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
Direct Risk
|
|
|
|
|
|
Direct Risk
|
|
|
|
|
|
Direct Risk
|
|
|
|
|
Certificate Year
|
|
in Force
|
|
|
Percent
|
|
|
in Force
|
|
|
Percent
|
|
|
in Force
|
|
|
Percent
|
|
|
|
(In millions, except percentages)
|
|
|
2000 and before
|
|
$
|
196.6
|
|
|
|
2.1
|
%
|
|
$
|
262.2
|
|
|
|
3.3
|
%
|
|
$
|
383.2
|
|
|
|
5.1
|
%
|
2001
|
|
|
211.1
|
|
|
|
2.2
|
|
|
|
289.4
|
|
|
|
3.6
|
|
|
|
488.4
|
|
|
|
6.5
|
|
2002
|
|
|
503.9
|
|
|
|
5.3
|
|
|
|
687.0
|
|
|
|
8.6
|
|
|
|
1,088.5
|
|
|
|
14.4
|
|
2003
|
|
|
1,598.3
|
|
|
|
16.9
|
|
|
|
2,111.7
|
|
|
|
26.3
|
|
|
|
2,991.2
|
|
|
|
39.7
|
|
2004
|
|
|
1,589.8
|
|
|
|
16.9
|
|
|
|
2,077.7
|
|
|
|
25.9
|
|
|
|
2,580.6
|
|
|
|
34.3
|
|
2005
|
|
|
2,255.2
|
|
|
|
23.9
|
|
|
|
2,588.3
|
|
|
|
32.3
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
3,085.5
|
|
|
|
32.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
9,440.4
|
|
|
|
100.0
|
%
|
|
$
|
8,016.3
|
|
|
|
100.0
|
%
|
|
$
|
7,531.9
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We offer mortgage insurance structures designed to allow lenders
to share in the risks of mortgage insurance. One such structure
is our captive reinsurance program under which a reinsurance
company, generally an affiliate of the lender, assumes a portion
of the risk associated with the lenders insured book of
business in exchange for a percentage of the premium. The
following table shows the percentage of our Primary flow channel
insurance in force as well as the percentage of our total
insurance in force that was subject to captive reinsurance
arrangements at December 31, 2006, 2005 and 2004.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Primary flow channel insurance in
force
|
|
|
61.0
|
%
|
|
|
59.0
|
%
|
|
|
56.6
|
%
|
Total insurance in force
|
|
|
35.5
|
%
|
|
|
39.0
|
%
|
|
|
43.4
|
%
|
The growth of the percentage of Primary direct insurance in
force that was subject to captive reinsurance arrangements in
2006 and in 2005 was the result of the addition of new lenders
that participate in captive reinsurance arrangements as well as
increased writings with existing lenders that participate in
captive reinsurance arrangements. The declines in the percentage
of total direct insurance in force subject to captive
reinsurance in 2006 and in 2005 reflect the fact that a greater
portion of our insurance in force consists of Modified Pool
business. None of our Modified Pool insurance in force is
subject to captive reinsurance arrangements.
We believe captive reinsurance arrangements are an effective
risk management tool as selected lenders share in the risk under
these arrangements. Additionally, captive reinsurance
arrangements are structured so that we receive credit against
the capital required in certain risk-based capital models
utilized by rating agencies. We remain committed to structuring
captive reinsurance arrangements, including deep ceded
arrangements where the net premium cede rate is greater than
25%, on a
lender-by-lender
basis as we deem it to be prudent depending on a number of
considerations including competition, market share and lender
quality. We will continue to be an active participant with our
qualified lenders in captive reinsurance arrangements.
38
Revenues
A summary of the individual components of our revenue for the
past three years follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
% Change
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006 vs. 2005
|
|
|
2005 vs. 2004
|
|
|
|
(In thousands, except percentages)
|
|
|
Direct premium written
|
|
$
|
256,706
|
|
|
$
|
207,260
|
|
|
$
|
176,696
|
|
|
|
23.9
|
%
|
|
|
17.3
|
%
|
Ceded premium written
|
|
|
(46,140
|
)
|
|
|
(40,644
|
)
|
|
|
(35,365
|
)
|
|
|
13.5
|
|
|
|
14.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premium written
|
|
|
210,566
|
|
|
|
166,616
|
|
|
|
141,331
|
|
|
|
26.4
|
|
|
|
17.9
|
|
Change in unearned premiums
|
|
|
290
|
|
|
|
2,381
|
|
|
|
(339
|
)
|
|
|
(87.8
|
)
|
|
|
802.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
$
|
210,856
|
|
|
$
|
168,997
|
|
|
$
|
140,992
|
|
|
|
24.8
|
%
|
|
|
19.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
26,696
|
|
|
$
|
22,998
|
|
|
$
|
19,754
|
|
|
|
16.1
|
%
|
|
|
16.4
|
%
|
Total revenues
|
|
$
|
239,144
|
|
|
$
|
192,046
|
|
|
$
|
161,266
|
|
|
|
24.5
|
%
|
|
|
19.1
|
%
|
We experienced strong growth in earned premiums in both 2006 and
2005 due to increases in net premium written in both years.
Direct premium written is comprised of premium written for both
Primary and Modified Pool business. Our growth in total direct
premiums written in 2006 and 2005 was the result of the growth
of our insurance in force through the strong production of
Primary insurance products with risk-based pricing as noted
previously in the Production and In Force section as
well as growth in our Modified Pool business. Because of the
increased production of products with risk-based pricing, the
premium rate expressed in terms of basis points on our average
Primary insurance in force for 2006 has risen approximately 7%
over 2005. Additionally, favorable persistency levels increased
renewal premium in both years, which is included in direct
premium written. Annual persistency was at 76.8% at
December 31, 2006 compared to 68.7% at December 31,
2005 and 67.6% at December 31, 2004.
Ceded premium written is comprised of premiums written under
excess of loss reinsurance treaties with captive as well as
non-captive reinsurance companies. The growth in ceded premium
written in 2006 and 2005 was not as large as the increase in
direct premium written as a result of Modified Pool business
comprising a larger percentage of direct premium written in both
years. Further, ceded premium written in 2006 was reduced by a
no claims bonus on a terminated excess of loss reinsurance
treaty of approximately $840 thousand. The following table
provides further data on ceded premiums for the years ended
December 31, 2006, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Premium cede rate (ceded premiums
written as a percentage of direct premiums written)
|
|
|
18.0
|
%
|
|
|
19.6
|
%
|
|
|
20.0
|
%
|
Captive reinsurance premium cede
rate (ceded premiums written under captive reinsurance
arrangements as a percentage of direct premiums written)
|
|
|
17.2
|
%
|
|
|
18.1
|
%
|
|
|
18.0
|
%
|
Average captive premium cede rate
(ceded premiums written under captive reinsurance arrangements
as a percentage of direct premiums written under captive
reinsurance arrangements)
|
|
|
36.6
|
%
|
|
|
36.7
|
%
|
|
|
36.9
|
%
|
The table below provides data on insurance written that was
subject to captive reinsurance arrangements for the years ended
December 31, 2006, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Primary flow insurance written
|
|
|
50.4
|
%
|
|
|
54.1
|
%
|
|
|
54.4
|
%
|
Total insurance written
|
|
|
22.3
|
%
|
|
|
26.8
|
%
|
|
|
33.9
|
%
|
The percentage of Primary flow insurance written subject to
captive reinsurance declined in 2006 from 2005 due to increased
production of certain lender-paid programs that were not subject
to captive reinsurance arrangements. The percentage of Primary
flow insurance written subject to captive reinsurance was
relatively flat in 2005 compared to 2004. The declines in the
percentage of total insurance written subject to captive
reinsurance in 2006 and in 2005 is again reflective of the fact
that Modified Pool insurance written comprised a greater portion
of our total insurance written in both of these years.
39
The difference between net written premiums and earned premiums
is the change in the unearned premium reserve, which is
established primarily on premiums received on annual products.
Our unearned premium liability declined $0.3 million during
2006 compared to a decline of $2.4 million in 2005 and an
increase of $0.3 million during 2004 due to fluctuations in
the amount and timing of annual premiums received.
Assuming no significant decline in interest rates, we expect our
persistency will remain near current levels in 2007. We
anticipate that this should continue to have a positive effect
on renewal earned premiums and total earned premiums in 2007.
Net investment income grew in 2006 and in 2005 primarily due to
the growth in average invested assets in both years, partially
offset by declines in portfolio yields. Average invested assets
at cost or amortized cost grew by 13.4% in 2006 and 17.6% in
2005 as a result of the investment of positive cash flows from
operations. Our investment portfolio tax-equivalent yield was
6.71%, 6.77%, and 6.99% at December 31, 2006, 2005 and
2004, respectively. We expect to see a growth in invested assets
in 2007; however, we anticipate a continuing decline in the
overall portfolio tax-equivalent yield as current interest rates
remain below our average portfolio rate. See further discussion
in the Investment Portfolio section of this document.
Net realized investment gains, except for write-downs on
other-than-temporarily
impaired securities, are the result of our discretionary
dispositions of investment securities in the context of our
overall portfolio management strategies and are likely to vary
significantly from period to period. We wrote down
other-than-temporarily
impaired securities by approximately $0.4 million in 2006
compared to $0.2 million in 2005 and $0.5 million in
2004. See further discussion of impairment write-downs in the
Realized Losses and Impairments section below.
Losses
and Expenses
A summary of the significant individual components of losses and
expenses and the
year-to-year
percentage changes follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
% Change
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006 vs. 2005
|
|
|
2005 vs. 2004
|
|
|
|
(In thousands, except percentages)
|
|
|
Net losses and loss adjustment
expenses
|
|
$
|
94,227
|
|
|
$
|
66,855
|
|
|
$
|
35,864
|
|
|
|
40.9
|
%
|
|
|
86.4
|
%
|
Amortization of deferred policy
acquisition costs
|
|
$
|
16,268
|
|
|
$
|
14,902
|
|
|
$
|
14,256
|
|
|
|
9.2
|
%
|
|
|
4.5
|
%
|
Other operating expenses (net of
acquisition costs deferred)
|
|
$
|
35,556
|
|
|
$
|
29,610
|
|
|
$
|
26,483
|
|
|
|
20.1
|
%
|
|
|
11.8
|
%
|
Loss ratio
|
|
|
44.7
|
%
|
|
|
39.6
|
%
|
|
|
25.4
|
%
|
|
|
|
|
|
|
|
|
Expense ratio
|
|
|
24.6
|
%
|
|
|
26.7
|
%
|
|
|
28.8
|
%
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
69.3
|
%
|
|
|
66.3
|
%
|
|
|
54.2
|
%
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses (LAE) for
2006 increased over 2005 due to growth and seasoning of our
insurance in force combined with refinements in the frequency
and severity factors utilized in our calculation of our
reserves. These refinements, most of which occurred in the
fourth quarter of 2006, were made primarily to reflect a
weakening housing market. The increases in the amortization of
deferred policy acquisition costs in 2006 and 2005 are
consistent with the growth in that asset balance. Other
operating expenses increased in 2006 over 2005, reflecting the
growth of our insurance in force as well as several key
initiatives that have taken place in 2006. The discussion below
provides more detail on both losses and expenses.
Net losses and LAE is comprised of the net claims paid and the
change in loss reserves. Loss reserves represent our estimate of
the ultimate claim costs of those loans reported to us as in
default and those loans in default that are in the process of
being reported to us. We will discuss each of these components
separately and the impact on our financial results.
40
The following table provides detail on paid claims for the years
ended December 31, 2006, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
% Change
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006 vs. 2005
|
|
|
2005 vs. 2004
|
|
|
|
(In thousands, except percentages)
|
|
|
Paid claims:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance
|
|
$
|
54,923
|
|
|
$
|
44,369
|
|
|
$
|
25,695
|
|
|
|
23.8
|
%
|
|
|
72.7
|
%
|
Modified Pool insurance
|
|
|
4,104
|
|
|
|
4,457
|
|
|
|
2,640
|
|
|
|
(7.9
|
)
|
|
|
68.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
59,027
|
|
|
$
|
48,826
|
|
|
$
|
28,335
|
|
|
|
20.9
|
%
|
|
|
72.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of claims paid:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance
|
|
|
2,073
|
|
|
|
1,671
|
|
|
|
1,104
|
|
|
|
24.1
|
|
|
|
51.4
|
|
Modified Pool insurance
|
|
|
204
|
|
|
|
217
|
|
|
|
186
|
|
|
|
(6.0
|
)
|
|
|
16.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
2,277
|
|
|
|
1,888
|
|
|
|
1,290
|
|
|
|
20.6
|
|
|
|
46.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average severity of claims paid:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance
|
|
$
|
26.5
|
|
|
$
|
26.6
|
|
|
$
|
23.3
|
|
|
|
(0.4
|
)%
|
|
|
14.2
|
%
|
Modified Pool insurance
|
|
$
|
20.1
|
|
|
$
|
20.5
|
|
|
$
|
14.2
|
|
|
|
(2.0
|
)%
|
|
|
44.4
|
%
|
Total
|
|
$
|
25.9
|
|
|
$
|
25.9
|
|
|
$
|
22.0
|
|
|
|
0.0
|
%
|
|
|
17.7
|
%
|
Total paid claims increased in 2006 and in 2005 due to the
overall growth of the insurance portfolio and the seasoning of
our portfolio. As interest rates dropped to historical lows in
2003 and 2004, many borrowers refinanced. This meant most of the
loans originated in years 2000 to 2002 canceled, and loans
originated in 2003 and 2004 comprised a greater percentage of
our total portfolio at the end of 2004. Historically, the
highest anticipated claim frequency period is between years two
to five from loan origination. Therefore, paid claims in 2004
were disproportionately low compared to the entire size of the
portfolio because the portfolio was not seasoned. The growth in
the number and amounts of Primary paid claims in 2005 and 2006
is consistent with aging of the portfolio as a greater
percentage of policies are reaching their anticipated highest
claim frequency period. The declines in both the dollar amount
and number of paid claims on Modified Pool insurance in 2006
from 2005 were due to the seasoning of the business that was
structured with deductibles. During 2006, a greater percentage
of Modified Pool claims filed were on loans that were part of
transactions structured with deductibles. Because of these
deductibles, a greater percentage of the Modified Pool claims
filed in 2006 did not result in a paid claim. The growth in paid
losses in 2005 from 2004 was impacted by the increase in total
average severity shown above. This increase was reflective of
the growth of Alt-A loans that generally have a larger average
loan balance than the rest of our portfolio, resulting in a
higher claim payment.
Although for the year ended December 31, 2006 average
severity remained relatively flat when compared to 2005, we
experienced a significant increase in average severity for both
Primary and Modified Pool insurance in the fourth quarter of
2006. The following table shows the average quarterly severity
of paid claims during 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
September 30,
|
|
|
June 30,
|
|
|
March 31,
|
|
|
|
December 31, 2006
|
|
|
2006
|
|
|
2006
|
|
|
2006
|
|
|
|
(In thousands)
|
|
|
Average severity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance
|
|
$
|
28.1
|
|
|
$
|
25.8
|
|
|
$
|
25.8
|
|
|
$
|
26.3
|
|
Modified Pool insurance
|
|
$
|
26.2
|
|
|
$
|
18.2
|
|
|
$
|
19.4
|
|
|
$
|
16.4
|
|
Total
|
|
$
|
27.9
|
|
|
$
|
25.3
|
|
|
$
|
25.3
|
|
|
$
|
25.1
|
|
During the first three quarters of 2006, the average severity
dropped compared to 2005. This was partially the result of the
loss mitigation processes implemented during 2005. During the
fourth quarter of 2006, we experienced a significant change in
our ability to reduce claims through our traditional mitigation
processes, which we believe was related to weakness in the
housing market. In many cases, properties on which loans have
defaulted are sold during the foreclosure process, which
generally reduces our loss. When the property does not sell
prior to foreclosure, we often pay the full amount of our
coverage, which we call a full option settlement. In the fourth
41
quarter of 2006, full option settlements were a larger
percentage of our paid claims. The lack of mitigation
opportunities contributed to the increase in severity for the
fourth quarter.
As shown in the Production and In Force section
above, we are insuring a larger percentage of mortgages in
excess of $200,000. Claim payments on defaults of these larger
mortgages are greater even if coverage percentages remain
constant. Claim payments on these larger mortgages also
increased severity in the fourth quarter of 2006. We expect the
average severity will continue to trend upward as the average
loan amounts in our portfolio continue to rise and as the
housing market continues to experience a general deterioration,
which reduces our loss mitigation opportunities. However, our
average severity on paid losses can fluctuate from quarter to
quarter as a result of the relatively small number of claims
paid in a given period, especially in regards to our Modified
Pool insurance. The increase in severity and the further
seasoning of the insurance portfolio indicate that paid losses
will continue to trend upward in 2007.
The table below provides the cumulative paid loss ratios by
certificate year (calculated as direct losses paid divided by
direct premiums received, in each case for a particular policy
year) that have developed through December 31, 2006, 2005
and 2004. It excludes the effects of reinsurance.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative Paid Loss Ratios as of December 31
|
|
Certificate Year
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
1996
|
|
|
14.5
|
%
|
|
|
13.9
|
%
|
|
|
13.6
|
%
|
1997
|
|
|
10.0
|
|
|
|
9.9
|
|
|
|
9.6
|
|
1998
|
|
|
6.5
|
|
|
|
6.4
|
|
|
|
6.0
|
|
1999
|
|
|
9.7
|
|
|
|
9.0
|
|
|
|
7.8
|
|
2000
|
|
|
34.7
|
|
|
|
32.0
|
|
|
|
27.8
|
|
2001
|
|
|
29.0
|
|
|
|
23.7
|
|
|
|
15.9
|
|
2002
|
|
|
29.2
|
|
|
|
22.4
|
|
|
|
10.2
|
|
2003
|
|
|
13.0
|
|
|
|
7.8
|
|
|
|
1.2
|
|
2004
|
|
|
10.2
|
|
|
|
2.0
|
|
|
|
|
|
2005
|
|
|
4.2
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
The table above reflects relatively higher cumulative ratios of
losses paid to premium received for the 2000 through 2002 policy
years at this stage of development. This is due, in part, to a
large portion of this business refinancing in subsequent years
and the resulting lower aggregate level of premium received for
these policy years.
42
Net losses and loss adjustment expenses also include the change
in reserves for losses and loss adjustment expenses. The
following table provides further information about our loss
reserves at December 31, 2006, 2005 and 2004 and the
related changes for the years then ended:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% Change
|
|
|
% Change
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2006 vs. 2005
|
|
|
2005 vs. 2004
|
|
|
|
(In thousands, except percentages)
|
|
|
Primary insurance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults
|
|
$
|
65,417
|
|
|
$
|
44,198
|
|
|
$
|
28,408
|
|
|
|
48.0
|
%
|
|
|
55.6
|
%
|
Reserves for defaults incurred but
not reported
|
|
|
5,676
|
|
|
|
4,536
|
|
|
|
3,493
|
|
|
|
25.1
|
|
|
|
29.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance
|
|
|
71,093
|
|
|
|
48,734
|
|
|
|
31,901
|
|
|
|
45.9
|
|
|
|
52.8
|
|
Modified Pool insurance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults
|
|
|
11,477
|
|
|
|
1,836
|
|
|
|
1,809
|
|
|
|
525.1
|
|
|
|
1.5
|
|
Reserves for defaults incurred but
not reported
|
|
|
773
|
|
|
|
403
|
|
|
|
235
|
|
|
|
91.8
|
|
|
|
71.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Modified Pool insurance
|
|
|
12,250
|
|
|
|
2,239
|
|
|
|
2,044
|
|
|
|
447.1
|
|
|
|
9.5
|
|
Reserve for loss adjustment
expenses
|
|
|
1,009
|
|
|
|
101
|
|
|
|
97
|
|
|
|
899.0
|
|
|
|
4.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total reserve for losses and loss
adjustment expenses
|
|
$
|
84,352
|
|
|
$
|
51,074
|
|
|
$
|
34,042
|
|
|
|
65.2
|
%
|
|
|
50.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in reserve for losses
and loss adjustment expenses
|
|
$
|
33,278
|
|
|
$
|
17,032
|
|
|
$
|
6,856
|
|
|
|
95.4
|
%
|
|
|
148.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The reserve for losses and loss adjustment expenses increased in
2006 primarily due to refinements in the frequency and severity
factors utilized in our reserving methodology based upon the
development of claims paid in 2006. An increase in the number of
reported loans in default also contributed to the increase in
the reserve for losses and LAE to a lesser extent. The number of
loans in default includes all reported delinquencies that are in
excess of two payments in arrears at the reporting date and all
reported delinquencies that were previously in excess of two
payments in arrears and have not been brought current.
We continually monitor our reserves and claim development. As
new data emerges, we consider its impact on our reserve
calculation, and when necessary, refine our estimates. During
2005 and the first three quarters of 2006, we refined our
segmentation for the reserve calculation and monitored emerging
trends. These changes resulted in an increase in frequency
factors utilized in our reserve calculation, which increased
reserves during 2006 significantly more than the 5% increase in
the number of reserved defaults from December 31, 2005 to
December 31, 2006.
In the fourth quarter of 2006, we experienced a significant
increase in our paid loss severity due to the deteriorating
developments in the housing market as well as changes in our
insured portfolio. After careful evaluation of these items, we
determined that it was prudent to significantly increase the
severity factors utilized in our reserving methodology to
reflect trends in the housing markets that will reduce our
opportunity for loss mitigation.
Increases in frequency factors also contributed to the increase
in reserves during 2005, although the primary factor was an
increase in the number of reported defaults at December 31,
2005 from December 31, 2004. A significant portion of this
increase in defaults occurred in FEMA-designated areas as a
result of hurricanes Katrina and Rita. At December 31,
2005, the number of defaults without deductibles in these areas
represented approximately 11% of our total number of defaults
without deductibles. Given the unique circumstances surrounding
that situation and absent any evidence that these would develop
differently, we reserved for these defaults at our normal level.
As a result, we increased reserves approximately
$3.4 million for the hurricane related defaults during the
fourth quarter of 2005.
43
Primary and Modified Pool insurance defaults without deductibles
from these FEMA-designated areas totaled 421 at
December 31, 2006 compared to 693 at December 31,
2005. The terms of our coverage exclude any cost or expense
related to the repair or remedy of any physical damage to the
property collateralizing an insured mortgage loan. We have not
obtained detailed property assessments for the defaults in the
FEMA-designated areas. Our exposure could be limited if such
assessments demonstrate that there is significant un-repaired
physical damage to properties securing loans for which we have
provided mortgage insurance. Additionally, we believe that many
borrowers living in these areas did not make scheduled mortgage
payments due to forbearance granted by Fannie Mae, Freddie Mac
and lenders, even though the individual borrowers
financial condition was not significantly impacted. We continued
to reserve for these defaults at our normal level through
December 31, 2006. At December 31, 2006 there were
reserves of $3.7 million for defaults in the
FEMA-designated areas compared to $4.5 million at
December 31, 2005. The reserve for these defaults has not
declined as greatly as the decline in the number of defaults
primarily due to the increase in the frequency and severity
factors discussed above. We will continue to monitor this
situation as the longer-term impacts develop.
The following table shows default statistics as of
December 31, 2006, 2005 and 2004. Prior to 2006,
information that came in late in the quarter from lenders was
considered in our incurred but not reported reserve, but the
default counts were not reflected in our default statistics.
During 2006, we included the default information in our
statistics and restated the 2005 and 2004 statistical
information below. The number of loans in default restatement
did not have a significant impact on the delinquency ratio. The
table below includes these default counts in the default
statistics for all years presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Total business:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force
|
|
|
338,086
|
|
|
|
302,488
|
|
|
|
266,574
|
|
Number of loans in default
|
|
|
8,566
|
|
|
|
7,753
|
|
|
|
5,922
|
|
With deductibles
|
|
|
1,898
|
|
|
|
1,389
|
|
|
|
634
|
|
Without deductibles
|
|
|
6,668
|
|
|
|
6,364
|
|
|
|
5,288
|
|
Percentage of loans in default
(default rate)
|
|
|
2.53
|
%
|
|
|
2.56
|
%
|
|
|
2.22
|
%
|
Percentage of loans in default
excluding deductibles*
|
|
|
2.41
|
%
|
|
|
2.48
|
%
|
|
|
2.25
|
%
|
Primary insurance:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force
|
|
|
225,531
|
|
|
|
217,397
|
|
|
|
218,011
|
|
Number of loans in default
|
|
|
5,565
|
|
|
|
5,617
|
|
|
|
4,430
|
|
Percentage of loans in default
|
|
|
2.47
|
%
|
|
|
2.58
|
%
|
|
|
2.03
|
%
|
Modified Pool insurance:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force
|
|
|
112,555
|
|
|
|
85,091
|
|
|
|
48,563
|
|
Number of loans in default
|
|
|
3,001
|
|
|
|
2,136
|
|
|
|
1,492
|
|
With deductibles
|
|
|
1,898
|
|
|
|
1,389
|
|
|
|
634
|
|
Without deductibles
|
|
|
1,103
|
|
|
|
747
|
|
|
|
858
|
|
Percentage of loans in default
|
|
|
2.67
|
%
|
|
|
2.51
|
%
|
|
|
3.07
|
%
|
Percentage of loans in default
excluding deductibles*
|
|
|
2.16
|
%
|
|
|
1.91
|
%
|
|
|
5.15
|
%
|
Primary Alt-A business**:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force
|
|
|
22,385
|
|
|
|
16,378
|
|
|
|
12,714
|
|
Number of loans in default
|
|
|
814
|
|
|
|
590
|
|
|
|
442
|
|
Percentage of loans in default
|
|
|
3.64
|
%
|
|
|
3.60
|
%
|
|
|
3.48
|
%
|
|
|
|
* |
|
Excludes loans written as part of structured bulk transactions
with deductibles and defaults on these loans. |
|
** |
|
Included in Primary insurance amounts above. |
The decline in the default rate for Primary insurance at
December 31, 2006 from December 31, 2005 is
attributable to the strong production during the 2006 that has
yet to move into the period of highest anticipated default
frequency. During 2006, our number of Primary insured loans in
force increased approximately 4%
44
compared to a small decline during 2005. As this business
seasons, we expect default rates to increase. The increase in
the Primary insurance default rate at December 31, 2005
from December 31, 2004 was due largely to seasoning of the
portfolio.
Our Modified Pool insurance continues to season, and the default
rate increased accordingly at December 31, 2006 from
December 31, 2005. As shown in the table above, this
business is growing rapidly, which will cause fluctuations in
the default rate from period to period.
At December 31, 2006, no individual structured bulk
transaction with deductibles as part of the structure had
incurred total losses that were nearing its individual
deductible amount. We do not provide reserves on Modified Pool
defaults with deductibles until the incurred losses for that
specific structured bulk transaction is projected to exceed the
deductible.
We have mentioned the increase in our writings of products
subject to risk-adjusted pricing such as Alt-A and ARMs. The
incidence rates of delinquencies on these products typically
increase in the second through fourth year following loan
origination. Much of the business that we have added subject to
risk-adjusted pricing, especially those ARMs that have potential
negative amortization, have not yet reached an age where we
would expect to see an increase in delinquencies. We anticipate
our number of loans in default for both Primary and Modified
Pool insurance will increase as a larger percentage of our
insurance in force reaches the period of the highest expected
incidence of defaults, especially those newer products subject
to risk-adjusted pricing. Most of the potential negative
amortization ARM products that we insure have not yet been
subject to rate resets. These rate resets could significantly
increase the borrowers required monthly payment, which we
believe increases the risk of default over that of a fixed rate
loan. We also expect default rates to increase, as these
products become a larger percentage of our insurance in force.
Consequently, we expect reserves will continue to increase.
We are cautious about housing market conditions in certain
regions that have recently experienced rapid house price
appreciation. Changes in the economic environment could
accelerate paid and incurred loss development. Our reserving
model incorporates managements judgments and assumptions
regarding these factors; however, due to the uncertainty of
future premium levels, losses, economic conditions, and other
factors that affect earnings, it is difficult to predict the
impact of such higher claim frequencies on future earnings.
Amortization of DAC increased in 2006 and 2005, primarily due to
growth in the asset balance, partially offset by improved
persistency. A full discussion of the impact of persistency on
DAC amortization is included in the Deferred Policy
Acquisition Costs section below.
Other operating expenses increased in 2005 due to growth in our
insurance in force and due to expenses incurred in connection
with the organizational changes following the hiring of a new
chief executive officer in 2005 and a new chief financial
officer in 2006. Because the growth in net premiums written was
greater than the growth in expenses, the expense ratio (ratio of
the amortization of deferred policy acquisition costs and other
operating expenses to net premiums written) for 2006 improved to
24.6% from 26.7% for 2005 and 28.8% for 2004.
Our effective tax rate was 27.3% for 2006 compared to 27.1% for
2005 and 28.7% for 2004. The variance in the effective tax rates
between years was due primarily to the change in tax-preferred
interest income on investments as a percentage of pre-tax
income. We expect our effective tax rate to remain near current
levels, or increase slightly if total pre-tax income grows
faster than tax-preferred income.
Significant
Customers
Competition within the mortgage insurance industry continues to
increase as many large mortgage lenders have limited the number
of mortgage insurers with whom they do business. At the same
time, consolidation among national lenders has increased the
share of the mortgage origination market controlled by the
largest lenders and that has led to further concentrations of
business with a relatively small number of lenders. Many of the
national lenders allocate Primary business to several different
mortgage insurers. These allocations can vary over time. Our
strategy is to continue our focus on national lenders while
maintaining the productive relationships that we have built with
regional lenders. Our ten largest customers were responsible for
80%, 77%, and 71% of insurance written through the flow channel
during 2006, 2005, and 2004, respectively. In 2006, we had three
customers that individually were responsible for more than 10%
of insurance written through the flow channel. In the aggregate,
these customers
45
were responsible for 65% of insurance written through the flow
channel. In 2005 and 2004, we had two customers that
individually were responsible for more than 10% of insurance
written through the flow channel. In the aggregate, these
customers were responsible for 58% and 55% of insurance written
through the flow channel in 2005 and 2004, respectively. Through
actively seeking business with other lenders that meet our
criteria, we are broadening our customer base in order to limit
our concentration among lenders. The loss of, or considerable
reduction in, business from one or more of these significant
customers, without a corresponding increase from other lenders,
would have an adverse effect on our business.
Financial
Position
Total assets increased 17% to $896 million at
December 31, 2006 over the same date in 2005, primarily the
result of positive cash flows from operations. Total liabilities
increased to $325 million at December 31, 2006, from
$268 million at December 31, 2005, primarily driven by
an increase in reserves for losses and loss adjustment expenses
coupled with an increase in deferred tax liabilities. This
section identifies several items on our balance sheet that are
important in the overall understanding of our financial
position. These items include deferred policy acquisition costs,
prepaid federal income tax and related deferred income taxes.
The majority of our assets are contained in our investment
portfolio. A separate Investment Portfolio section
follows this Financial Position section and reviews
our investment portfolio, key portfolio management strategies,
and methodologies by which we manage credit risk.
Deferred
Policy Acquisition Costs
Costs expended to acquire new business are capitalized as DAC
and recognized as expense over the anticipated premium paying
life of the policy in a manner that approximates the estimated
gross profits. We employ a dynamic model that calculates
amortization of DAC separately for each year of policy
origination. The model relies on assumptions that we make based
upon historical industry experience and our own unique
experience regarding the annual persistency development of each
year of policy origination. Persistency is the most important
assumption utilized in determining the timing of reported
amortization expense reflected in the income statement and the
carrying value of DAC on the balance sheet. A change in the
assumed persistency can impact the current and future
amortization expense as well as the carrying value on the
balance sheet. Our model accelerates DAC amortization through a
dynamic adjustment when actual persistency for a particular year
of policy origination is lower than the estimated persistency
originally utilized in the model. This dynamic adjustment
applies only to lower than assumed persistency, and we do not
decrease DAC amortization below the levels assumed in the model
when persistency increases above those levels. When actual
persistency is lower than that assumed in our models, the
dynamic adjustment effectively adjusts the estimated policy life
utilized in the model to a policy life based upon the current
actual persistency. As seen below, the actual persistency is
very close to the persistency assumed in the model as evidenced
by the declining impact of the dynamic adjustment.
In addition, the recoverability of DAC carrying value on the
balance sheet is tested by calculating an estimated future gross
profit on the existing book of business and comparing that to
the DAC balance. If this comparison indicates a premium
deficiency, the DAC carrying value is reduced to the extent of
that deficiency through a charge to expense.
Our DAC models separate the costs capitalized and the
amortization streams between transactions arising from the
structured bulk and flow distribution channels. Generally,
structured bulk transactions have significantly lower
acquisition costs associated with the production of the business
and they also have a shorter original estimated policy life. We
apply the dynamic adjustment to the structured bulk DAC models
utilizing the same methodology. At December 31, 2006 and
2005, net unamortized DAC relating to structured bulk
transactions amounted to 7.3% and 6.8% of the total DAC asset on
the balance sheet.
46
The following table shows the DAC asset for the previous three
years and the effect of persistency on amortization (dollar
amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DAC Asset
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Balance beginning of
year
|
|
$
|
33,684
|
|
|
$
|
32,453
|
|
|
$
|
29,363
|
|
Costs capitalized
|
|
|
17,727
|
|
|
|
16,133
|
|
|
|
17,346
|
|
Amortization normal
|
|
|
(15,990
|
)
|
|
|
(13,191
|
)
|
|
|
(12,194
|
)
|
Amortization dynamic
adjustment
|
|
|
(278
|
)
|
|
|
(1,711
|
)
|
|
|
(2,062
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amortization
|
|
|
(16,268
|
)
|
|
|
(14,902
|
)
|
|
|
(14,256
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance end of year
|
|
$
|
35,143
|
|
|
$
|
33,684
|
|
|
$
|
32,453
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Persistency
|
|
|
76.8
|
%
|
|
|
68.7
|
%
|
|
|
67.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The growth in the normal DAC amortization is driven by growth in
the DAC assets. Improvements in persistency during 2006 and 2005
decreased DAC amortization resulting from the dynamic
adjustment. Assuming no significant increases in persistency, we
anticipate DAC amortization to increase at a rate similar to the
growth in the DAC asset during 2007. See further information on
the accounting for DAC in Note 1 in the Notes to
Consolidated Financial Statements.
Prepaid
Federal Income Taxes and Deferred Income Taxes
We purchase ten-year non-interest bearing United States Mortgage
Guaranty Tax and Loss Bonds (Tax and Loss Bonds) to
take advantage of a special contingency reserve deduction that
mortgage guaranty companies are allowed for tax purposes. We
record these bonds on our balance sheet as prepaid federal
income taxes. Purchases of Tax and Loss Bonds are essentially a
prepayment of federal income taxes that will become due in ten
years, when the contingency reserve is released, and the Tax and
Loss Bonds mature. The proceeds from the maturity of the Tax and
Loss Bonds are used to fund the income tax payments due in the
same year. Prepaid income taxes were $166.9 million and
$139.5 million at December 31, 2006 and 2005,
respectively. The change from year to year approximates the
change in the deferred income tax liability for the year.
Deferred income taxes are provided for the differences in
reporting taxable income in the financial statements and on the
tax return. These cumulative differences are enumerated in
Note 6 in the Notes to Consolidated Financial Statements.
The largest cumulative difference is the special contingency
reserve deduction for mortgage insurers mentioned above. The
remainder of the deferred tax liability has primarily arisen
from book and tax reporting differences related to DAC and
unrealized investment gains.
Investment
Portfolio
Portfolio
Description
Our strategy for managing our investment portfolio is to
optimize investment returns while preserving capital and
liquidity and adhering to regulatory and rating agency
requirements. We invest for the long term, and most of our
investments are held until they mature. Our investment portfolio
includes primarily fixed income securities, and the majority of
these are tax-preferred state and municipal bonds. We have
established a formal investment policy that describes our
overall quality and diversification objectives and limits. Our
investment policy and strategies are subject to change depending
upon regulatory, economic, and market conditions as well as our
existing financial condition and operating requirements,
including our tax position. Although we invest for the long
term, we classify our debt and equity securities with readily
determinable market values as available for sale. This
classification allows us the flexibility to dispose of
securities in order to pursue our investment strategy and meet
our operating requirements. Investments classified as available
for sale are carried on our balance sheet at fair value.
Investments without readily determinable market values are
classified as other investments and are also carried at fair
value.
47
The following table shows the growth and diversification of our
investment portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
|
(In thousands, except percentages)
|
|
|
Fixed maturity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government obligations
|
|
$
|
11,842
|
|
|
|
2.0
|
%
|
|
$
|
12,124
|
|
|
|
2.2
|
%
|
State and municipal bonds
|
|
|
558,131
|
|
|
|
91.9
|
|
|
|
500,027
|
|
|
|
91.4
|
|
Corporate bonds
|
|
|
16,572
|
|
|
|
2.7
|
|
|
|
21,855
|
|
|
|
4.0
|
|
Mortgage-backed bonds
|
|
|
49
|
|
|
|
|
|
|
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
586,594
|
|
|
|
96.6
|
|
|
|
534,064
|
|
|
|
97.6
|
|
Equity securities
|
|
|
10,417
|
|
|
|
1.7
|
|
|
|
8,159
|
|
|
|
1.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
available-for-sale
securities
|
|
|
597,011
|
|
|
|
98.3
|
|
|
|
542,223
|
|
|
|
99.1
|
|
Other investments
|
|
|
5,000
|
|
|
|
0.8
|
|
|
|
|
|
|
|
|
|
Short-term
investments
|
|
|
5,301
|
|
|
|
0.9
|
|
|
|
4,796
|
|
|
|
0.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
607,312
|
|
|
|
100.0
|
%
|
|
$
|
547,019
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We seek to provide liquidity in our investment portfolio through
cash equivalent investments and through diversification and
investment in publicly traded securities. We attempt to maintain
a level of liquidity and duration in our investment portfolio
consistent with our business outlook and the expected timing,
direction, and degree of changes in interest rates. See
Note 2 in Notes to Consolidated Financial Statements that
describes the scheduled maturity of our fixed maturity
investments.
We also manage risk and liquidity by limiting our exposure on
individual securities. The following table shows the ten largest
exposures to an individual creditor, or issuer in the case of
equity securities, in our investment portfolio as of
December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
Carrying
|
|
|
% of Total
|
|
Name of Creditor
|
|
Value
|
|
|
Invested Assets
|
|
|
|
(In thousands, except percentages)
|
|
|
Atlanta, Georgia Airport
|
|
$
|
6,824
|
|
|
|
1.12
|
%
|
State of Connecticut
|
|
|
6,653
|
|
|
|
1.10
|
%
|
State of Pennsylvania
|
|
|
6,110
|
|
|
|
1.01
|
%
|
State of Hawaii
|
|
|
5,406
|
|
|
|
0.89
|
%
|
Federal National Mortgage
Association
|
|
|
5,388
|
|
|
|
0.89
|
%
|
State of Utah
|
|
|
5,263
|
|
|
|
0.87
|
%
|
Structured Credit Holdings Plc
(common stock)
|
|
|
5,000
|
|
|
|
0.82
|
%
|
Port of Seattle, Washington
|
|
|
4,592
|
|
|
|
0.76
|
%
|
City of Chicago, Illinois
|
|
|
4,562
|
|
|
|
0.75
|
%
|
Cook County, Illinois
|
|
|
4,258
|
|
|
|
0.70
|
%
|
As shown above, no investment in the securities of any single
issuer exceeded 2% of our investment portfolio at
December 31, 2006.
48
The following table shows the results of our investment
portfolio for the last three years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands, except percentages)
|
|
|
Average investments at cost or
amortized cost
|
|
$
|
559,378
|
|
|
$
|
493,256
|
|
|
$
|
419,467
|
|
Pre-tax net investment income
|
|
$
|
26,696
|
|
|
$
|
22,998
|
|
|
$
|
19,754
|
|
Effective pre-tax yield
|
|
|
4.8
|
%
|
|
|
4.7
|
%
|
|
|
4.7
|
%
|
Tax-equivalent
yield-to-maturity
|
|
|
6.7
|
%
|
|
|
6.8
|
%
|
|
|
7.0
|
%
|
Pre-tax realized investment gains
|
|
$
|
1,584
|
|
|
$
|
36
|
|
|
$
|
504
|
|
The drop in the tax-equivalent
yield-to-maturity
shown above reflects the investment of our cash flows from
operations and reinvestment of proceeds from the maturity or
call of higher yielding investments at new money rates, which
were and are projected to continue to be lower than that of our
overall portfolio yield. We anticipate this trend to continue
into 2007.
Unrealized
Gains and Losses
The following table summarizes by category our unrealized gains
and losses in our securities portfolio at December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
Fixed maturity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government obligations
|
|
$
|
12,119
|
|
|
$
|
4
|
|
|
$
|
(281
|
)
|
|
$
|
11,842
|
|
State and municipal bonds
|
|
|
541,389
|
|
|
|
17,306
|
|
|
|
(564
|
)
|
|
|
558,131
|
|
Corporate bonds
|
|
|
15,438
|
|
|
|
1,138
|
|
|
|
(4
|
)
|
|
|
16,572
|
|
Mortgage-backed bonds
|
|
|
46
|
|
|
|
3
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities
|
|
|
568,992
|
|
|
|
18,451
|
|
|
|
(849
|
)
|
|
|
586,594
|
|
Equity securities
|
|
|
9,530
|
|
|
|
954
|
|
|
|
(67
|
)
|
|
|
10,417
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities
|
|
$
|
578,522
|
|
|
$
|
19,405
|
|
|
$
|
(916
|
)
|
|
$
|
597,011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
These unrealized gains and losses do not necessarily represent
future gains or losses that we will realize. Changing conditions
related to specific securities, overall market interest rates,
or credit spreads, as well as our decisions concerning the
timing of a sale, may impact values we ultimately realize. We
monitor unrealized losses through further analysis according to
maturity date, credit quality, individual creditor exposure and
the length of time the individual security has continuously been
in an unrealized loss position. Of the gross unrealized losses
on fixed maturity securities shown above, approximately $440,000
related to bonds with a maturity date in excess of ten years.
The largest individual unrealized loss on any one security at
December 31, 2006 was approximately $100,000 on a bond
issued by a Government-Sponsored Enterprise with an amortized
cost of $5.0 million. Gross unrealized gains and losses at
December 31, 2005 were $18.5 million and $(1.4)
million, respectively.
49
Credit
Risk
Credit risk is inherent in an investment portfolio. We manage
this risk through a structured approach to internal investment
quality guidelines and diversification while assessing the
effects of the changing economic landscape. One way we attempt
to limit the inherent credit risk in our portfolio is to
maintain investments with high ratings. The following table
shows our investment portfolio by credit ratings (dollars in
thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
|
(In thousands, except percentages)
|
|
|
Fixed Maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds
|
|
$
|
11,842
|
|
|
|
2.0
|
%
|
|
$
|
12,124
|
|
|
|
2.3
|
%
|
AAA
|
|
|
464,042
|
|
|
|
79.1
|
|
|
|
420,489
|
|
|
|
78.7
|
|
AA
|
|
|
72,051
|
|
|
|
12.3
|
|
|
|
52,812
|
|
|
|
9.9
|
|
A
|
|
|
25,054
|
|
|
|
4.3
|
|
|
|
30,176
|
|
|
|
5.7
|
|
BBB
|
|
|
10,782
|
|
|
|
1.9
|
|
|
|
9,780
|
|
|
|
1.8
|
|
BB
|
|
|
50
|
|
|
|
|
|
|
|
781
|
|
|
|
0.1
|
|
CC and lower
|
|
|
279
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not rated
|
|
|
2,494
|
|
|
|
0.4
|
|
|
|
7,902
|
|
|
|
1.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
$
|
586,594
|
|
|
|
100.0
|
%
|
|
$
|
534,064
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stocks:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AA
|
|
$
|
1,708
|
|
|
|
16.4
|
%
|
|
$
|
1,709
|
|
|
|
20.9
|
%
|
A
|
|
|
2,035
|
|
|
|
19.5
|
|
|
|
1,559
|
|
|
|
19.1
|
|
BBB
|
|
|
1,132
|
|
|
|
10.9
|
|
|
|
1,125
|
|
|
|
13.8
|
|
Not rated
|
|
|
|
|
|
|
|
|
|
|
490
|
|
|
|
6.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,875
|
|
|
|
46.8
|
|
|
|
4,883
|
|
|
|
59.8
|
|
Common stocks
|
|
|
5,542
|
|
|
|
53.2
|
|
|
|
3,276
|
|
|
|
40.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities
|
|
$
|
10,417
|
|
|
|
100.0
|
%
|
|
$
|
8,159
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We regularly review our entire investment portfolio to identify
securities that may have suffered impairments in value that will
not be recovered, termed potentially distressed securities. In
identifying potentially distressed securities, we screen all
securities held with a particular emphasis on those that have a
fair value to cost or amortized cost ratio of less than 80%.
Additionally, as part of this identification process, we utilize
the following information:
|
|
|
|
|
Length of time the fair value was below amortized cost
|
|
|
|
Industry factors or conditions related to a geographic area
negatively affecting the security
|
|
|
|
Downgrades by a rating agency
|
|
|
|
Past due interest or principal payments or other violation of
covenants
|
|
|
|
Deterioration of the overall financial condition of the specific
issuer
|
In analyzing our potentially distressed securities list for
other-than-temporary
impairments, we pay special attention to securities that have
been on the list continually for a period greater than six
months. Our ability and intent to retain the investment for a
sufficient time to recover its value is also considered. We
assume that, absent reliable contradictory evidence, a security
that is potentially distressed for a continuous period greater
than nine months has incurred an
other-than-temporary
impairment. Such reliable contradictory evidence might include,
among other factors, a liquidation analysis performed by our
investment advisors, improving financial performance of the
issuer, or valuation of underlying assets specifically pledged
to support the credit.
50
When we conclude that a decline is other than temporary, the
security is written down to fair value through a charge to
realized investment gains and losses. We adjust the amortized
cost for securities that have experienced
other-than-temporary
impairments to reflect fair value at the time of the impairment.
We consider factors that lead to an
other-than-temporary
impairment of a particular security in order to determine
whether these conditions have impacted other similar securities.
Of the approximate $0.9 million of gross unrealized losses
at December 31, 2006, securities with a fair value to cost
or amortized cost ratio of less than 90% had a combined
unrealized loss of approximately $39,000.
Information about unrealized gains and losses is subject to
changing conditions. The values of securities with unrealized
gains and losses will fluctuate, as will the values of
securities that we identify as potentially distressed. Our
current evaluation of
other-than-temporary
impairments reflects our intent to hold securities for a
reasonable period of time sufficient for a forecasted recovery
of fair value. However, our intent to hold certain of these
securities may change in future periods as a result of facts and
circumstances impacting a specific security. If our intent to
hold a security with an unrealized loss changes, and we do not
expect the security to fully recover prior to the expected time
of disposition, we will write down the security to its fair
value in the period that our intent to hold the security changes.
Realized
Losses and Impairments
Realized losses include both write-downs of securities with
other-than-temporary
impairments and losses from the sales of securities. We wrote
down securities by a total of approximately $375,000, $170,000
and $480,000 during 2006, 2005, and 2004, respectively, due to
other-than-temporary
declines in fair value.
Liquidity
and Capital Resources
Our sources of operating funds consist primarily of premiums
written and investment income. Operating cash flow is generally
applied to the payment of claims, interest, expenses, and
prepaid federal income taxes in the form of Tax and Loss Bonds.
We generated positive cash flow from operating activities of
$88.4 million in 2006 compared to $70.8 million for
2005 and $68.9 million for 2004. The increases in cash flow
from operating activities reflects the growth in premiums and
investment income received, partially offset by increases in
paid losses and operating expenses.
Positive cash flows are invested pending future payments of
claims and expenses. Our business does not routinely require
significant capital expenditures other than for enhancements to
our computer systems and technological capabilities. Cash flow
shortfalls, if any, could be funded through sales of short-term
investments and other investment portfolio securities. We have
no existing lines of credit due to the sufficiency of the
operating funds from the sources described above.
The insurance laws of the State of Illinois impose certain
restrictions on dividends that an insurance subsidiary can pay
the parent company. These restrictions, based on statutory
accounting practices, include requirements that dividends may be
paid only out of statutory earned surplus and that limit the
amount of dividends that may be paid without prior approval of
the Illinois Insurance Department. As of December 31, 2006,
there have been no dividends paid by the insurance subsidiaries
to the parent company. We are considering, among other
alternatives, partial funding of the estimated $45 million
initial capital required to commence business in Canada through
a dividend from Triad to the parent company. Based upon current
Canadian capital requirements and possibilities for growth in
that market, we anticipate there may be a need for further
capital infusions and dividends from Triad may be considered. As
of December 31, 2006 there are no specific restrictions or
requirements for capital support arrangements between the parent
company and Triad or its subsidiaries.
We cede business to captive reinsurance affiliates of certain
mortgage lenders (captives), primarily under excess
of loss reinsurance agreements. Generally, reinsurance
recoverables on loss reserves and unearned premiums ceded to
these captives are backed by trust funds or letters of credit.
Total stockholders equity increased to $570.2 million
at December 31, 2006, from $499.2 million at
December 31, 2005. This increase resulted primarily from
2006 net income of $65.6 million and additional
51
paid-in-capital
of $4.5 million resulting from activity related to
share-based compensation to employees and the associated tax
benefit.
Statutory capital, for the purpose of computing the net risk in
force to statutory capital ratio, includes both
policyholders surplus and the contingency reserve. The
following table provides information regarding our statutory
capital position at December 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
Statutory policyholders
surplus
|
|
$
|
168.5
|
|
|
$
|
131.6
|
|
Statutory contingency reserve
|
|
|
521.8
|
|
|
|
447.8
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
690.3
|
|
|
$
|
579.4
|
|
|
|
|
|
|
|
|
|
|
The primary difference between statutory policyholders
surplus and equity computed under generally accepted accounting
principles is the statutory contingency reserve. Mortgage
insurance companies are required to add to the contingency
reserve an amount equal to 50% of calendar year earned premiums
and retain the reserve for 10 years, even if the insurance
is no longer in force. Therefore, a growing company such as
Triad normally has a greater increase in its contingency reserve
rather than in statutory surplus. The contingency reserve can be
released if the loss ratio exceeds 35%. Our loss ratio for 2006
exceeded this threshold, and we released approximately
$19.7 million of contingency reserve to surplus.
Triads ability to write insurance depends on the
maintenance of its financial strength ratings. A number of
states generally limit Triads
risk-to-capital
ratio to
25-to-1. As
of December 31, 2006, Triads
risk-to-capital
ratio was
12.5-to-1 as
compared to
12.6-to-1 at
December 31, 2005. The
risk-to-capital
ratio is calculated using net risk in force as the numerator and
statutory capital as the denominator. Net risk in force accounts
for risk ceded under reinsurance arrangements, including captive
risk-sharing arrangements as well as any applicable stop-loss
limits and deductible amounts.
Triad is rated AA by both Standard &
Poors Ratings Services and Fitch Ratings and
Aa3 by Moodys Investors Service. S&P has
not changed its Stable rating outlook for the
U.S. private mortgage insurance industry that was issued in
February of 2005. In December 2006, Fitch maintained its
Negative rating outlook for the U.S. private
mortgage insurance industry. Currently, Fitch, S&P, and
Moodys all report a Stable ratings outlook for
Triad. A reduction in Triads rating or outlook could
adversely affect our operations.
Fannie Mae has approval requirements for mortgage insurers. The
rules require prior approval by Fannie Mae for many of
Triads activities and new products, allow for other
approved types of mortgage insurers rated less than
AA, and give Fannie Mae increased rights to revise
the eligibility standards of mortgage insurers. We have not seen
any material impact on our operations and do not see any
material impact on our current or future operations as a result
of these rules. However, a material impact could still occur if
Fannie Mae were to begin to utilize mortgage insurers rated
below AA or revise eligibility standards of mortgage
insurers in a way that would be adverse to Triad.
The Office of Federal Housing Enterprise Oversight
(OFHEO) issued its risk-based capital rules for
Fannie Mae and Freddie Mac in the first quarter of 2002. The
regulation provides capital guidelines for Fannie Mae and
Freddie Mac in connection with their use of various types of
credit protection counterparties including a more preferential
capital credit for insurance from a AAA rated
private mortgage insurer than for insurance from a
AA rated private mortgage insurer. The phase-in
period for OFHEOs risk-based capital rules is ten years.
We do not believe the new risk-based capital rules had an
adverse impact on our financial condition or operations through
2006 or that these rules will have a significant adverse impact
on our financial condition or operations in the future. However,
if the risk-based capital rules result in future changes to the
preferences of Fannie Mae and Freddie Mac regarding their use of
the various types of credit enhancements or their choice of
mortgage insurers based on their credit rating, our operations
and financial condition could be significantly impacted.
52
Off
Balance Sheet Arrangements and Aggregate Contractual
Obligations
We had no material off-balance sheet arrangements at
December 31, 2006.
We lease office facilities, automobiles, and office equipment
under operating leases with minimum lease commitments that range
from one to ten years. We had no capitalized leases or material
purchase commitments at December 31, 2006.
Our long-term debt has a single maturity date of 2028. The
following table represents our aggregate contractual obligations
as of December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due By Period
|
|
|
|
|
|
|
Less Than
|
|
|
|
|
|
|
|
|
More Than
|
|
Contractual Obligations
|
|
Total
|
|
|
1 Year
|
|
|
1-3 years
|
|
|
3-5 years
|
|
|
5 Years
|
|
|
|
(In thousands)
|
|
|
Long-term debt
|
|
$
|
35,000
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
35,000
|
|
Operating leases
|
|
|
10,378
|
|
|
|
2,267
|
|
|
|
3,797
|
|
|
|
2,937
|
|
|
|
1,377
|
|
Other long-term liabilities
reflected on the Registrants balance sheet under GAAP
|
|
|
84,352
|
|
|
|
67,815
|
|
|
|
16,537
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
129,730
|
|
|
$
|
70,082
|
|
|
$
|
20,334
|
|
|
$
|
2,937
|
|
|
$
|
36,377
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The other long-term liabilities reflected on the
Registrants balance sheet under GAAP category above is
comprised of our reserve for losses and loss adjustment
expenses. The establishment of loss reserves is subject to
inherent uncertainty and requires significant judgment by
management. The future loss payment periods are estimated based
upon historical experience.
Market
Risk Exposure
Fixed maturity securities represented approximately 97% of our
invested assets at December 31, 2006. While the fair value
of these fixed rate securities generally bears an inverse
relationship to changes in prevailing market interest rates, a
change in market interest rates would not immediately impact
earnings because we have the ability and intent to hold these
securities until maturity. However, a decrease in market
interest rates generally will have the effect of initiating an
early call provision of those securities possessing such
provisions. The proceeds relating to the early called securities
in a decreasing interest rate environment generally are invested
in lower yielding investments that would ultimately decrease
earnings. Our long-term debt matures in 2028 with no early call
or put provisions and bears interest at a fixed rate of
7.9% per annum. The fair value of this debt is sensitive to
changes in prevailing interest rates; however, a change in rates
would not impact earnings. We believe that a 20% increase or
decrease in market interest rates is reasonable for the upcoming
year. A 20% relative increase or decrease in market interest
rates that affect our financial instruments would not have a
material impact on earnings during the next fiscal year.
Safe
Harbor Statement under the Private Securities Litigation Reform
Act of 1995
Managements Discussion and Analysis and this Report
contain forward-looking statements relating to future plans,
expectations, and performance, which involve various risks and
uncertainties, including, but not limited to, the following:
|
|
|
|
|
interest rates may increase or decrease from their current
levels;
|
|
|
|
housing prices may increase or decrease from their current
levels;
|
|
|
|
housing transactions requiring mortgage insurance may decrease
for many reasons including changes in interest rates or economic
conditions or alternative credit enhancement products;
|
|
|
|
our market share may change as a result of changes in
underwriting criteria or competitive products or rates;
|
53
|
|
|
|
|
the amount of insurance written could be adversely affected by
changes in federal housing legislation, including changes in the
Federal Housing Administration loan limits and coverage
requirements of Freddie Mac and Fannie Mae
(Government-Sponsored Enterprises);
|
|
|
|
our financial condition and competitive position could be
affected by legislation or regulation impacting the mortgage
guaranty industry or the Government-Sponsored Enterprises,
specifically, and the financial services industry in general;
|
|
|
|
rating agencies may revise methodologies for determining our
financial strength ratings and may revise or withdraw the
assigned ratings at any time;
|
|
|
|
decreases in persistency, which are affected by loan
refinancings in periods of low interest rates, may have an
adverse effect on earnings;
|
|
|
|
the amount of insurance written and the growth in insurance in
force or risk in force as well as our performance may be
adversely impacted by the competitive environment in the private
mortgage insurance industry, including the type, structure, mix
and pricing of our products and services and our competitors;
|
|
|
|
if we fail to properly underwrite mortgage loans under contract
underwriting service agreements, we may be required to assume
the costs of repurchasing those loans;
|
|
|
|
with consolidation occurring among mortgage lenders and our
concentration of insurance in force generated through
relationships with significant lender customers, our margins may
be compressed and the loss of a significant customer or a change
in their business practices affecting mortgage insurance may
have an adverse effect on our earnings;
|
|
|
|
our performance may be impacted by changes in the performance of
the financial markets and general economic conditions;
|
|
|
|
economic downturns in regions where our risk is more
concentrated could have a particularly adverse effect on our
financial condition and loss development;
|
|
|
|
revisions in risk-based capital rules by the OFHEO for Fannie
Mae and Freddie Mac could severely limit our ability to compete
against various types of credit protection counterparties,
including AAA rated private mortgage insurers;
|
|
|
|
changes in the eligibility guidelines of Fannie Mae or Freddie
Mac could have an adverse effect on the Company;
|
|
|
|
proposed regulation by the Department of Housing and Urban
Development to exclude packages of real estate settlement
services, which may include any required mortgage insurance
premium paid at closing, from the anti-referral provisions of
the Real Estate Settlement Procedures Act could adversely affect
our earnings;
|
|
|
|
our financial and competitive position could be affected by
regulatory activity requiring changes to mortgage industry
business practices, such as captive reinsurance;
|
|
|
|
failure to gain significant market share in Canada.
|
Accordingly, actual results may differ from those set forth in
the forward-looking statements. Attention also is directed to
other risk factors set forth in documents filed by the Company
with the Securities and Exchange Commission.
|
|
Item 7A.
|
Qualitative
and Quantitative Disclosures about Market Risks
|
See information in this report under the heading Market
Risk Exposures in the Managements Discussion
and Analysis of Financial Condition and Results of
Operations section of this document.
54
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
The Financial Statements and Supplementary Data are presented in
a separate section of this report.
|
|
Item 9.
|
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
None.
|
|
Item 9A.
|
Controls
and Procedures
|
Conclusions
Regarding the Effectiveness of Disclosure Controls and
Procedures
Triad Guaranty Inc. maintains disclosure controls and procedures
that are designed to ensure that information required to be
disclosed in its periodic reports to the Securities and Exchange
Commission (SEC) is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and
forms, and that such information is accumulated and communicated
to Triad Guaranty Inc.s management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate,
to allow timely decisions regarding required disclosure based
upon the definition of disclosure controls and
procedures as defined under
Rules 13a-15(e)
and
15d-15(e) of
the Securities Exchange Act of 1934. In designing and evaluating
the disclosure controls and procedures, management recognized
that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving
the desired control objectives, and management necessarily was
required to apply its judgment to the cost-benefit relationship
of possible controls and procedures.
As of December 31, 2006, an evaluation was performed under
the supervision and with the participation of management,
including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the
Companys disclosure controls and procedures. Based upon
that evaluation, management has concluded that disclosure
controls and procedures as of December 31, 2006 were
effective in ensuring that material information required to be
disclosed in this
Form 10-K
was recorded, processed, summarized, and reported on a timely
basis. Additionally, there were no changes in the Companys
internal controls over financial reporting that occurred during
the quarter ended December 31, 2006 that have materially
affected, or are reasonably likely to materially affect, the
Companys internal controls over financial reporting.
Changes
in Internal Control over Financial Reporting
There have been no significant changes in Triad Guaranty
Inc.s internal control over financial reporting during the
quarter ended December 31, 2006 that would have materially
affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting in an
adverse manner.
Managements
Annual Report on Internal Control over Financial
Reporting
Management of Triad Guaranty Inc. is responsible for
establishing and maintaining adequate internal control over
financial reporting as defined in
Rules 13a-15(f)
and
15d-15(f)
under the Securities and Exchange Act of 1934. Triad Guaranty
Inc.s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
accounting principles generally accepted in the United States.
Internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of Triad
Guaranty Inc.; (2) provide reasonable assurance that the
transactions are recorded as necessary to permit preparation of
financial statements in accordance with accounting principles
generally accepted in the United States; (3) provide
reasonable assurance that receipts and expenditures of Triad
Guaranty Inc. are being made in accordance with authorization of
management and directors of Triad Guaranty Inc; and
(4) provide reasonable assurance regarding the prevention
of or timely detection of unauthorized acquisition, use or
disposition of assets that could have a material effect on the
consolidated financial statements. Internal control over
financial reporting includes the controls themselves, monitoring
(including internal auditing practices) and actions taken to
correct deficiencies as identified.
55
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of Triad Guaranty
Inc.s internal control over financial reporting as of
December 31, 2006. Management based this assessment on
criteria for effective internal control over financial reporting
described in Internal Control Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based upon this
assessment, management determined that, as of December 31,
2006, Triad Guaranty Inc. maintained effective internal control
over financial reporting.
Ernst & Young LLP, Triad Guaranty Inc.s
independent registered public accounting firm that audits the
consolidated financial statements of Triad Guaranty Inc.
included in this report has audited managements assessment
of the effectiveness of internal control over financial
reporting as of December 31, 2006 as stated in their report
which appears below.
56
Report of
Independent Registered Public Accounting Firm on Internal
Control
Over Financial Reporting
The Board
of Directors and Stockholders of Triad Guaranty Inc.
We have audited managements assessment, included in the
accompanying Managements Annual Report on Internal
Control over Financial Reporting, that Triad Guaranty Inc.
maintained effective internal control over financial reporting
as of December 31, 2006, based on criteria established in
Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). Triad Guaranty Inc.s management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on managements assessment and an
opinion on the effectiveness of the companys internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Triad Guaranty
Inc. maintained effective internal control over financial
reporting as of December 31, 2006, is fairly stated, in all
material respects, based on the COSO criteria. Also, in our
opinion, Triad Guaranty Inc. maintained, in all material
respects, effective internal control over financial reporting as
of December 31, 2006, based on the COSO criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Triad Guaranty Inc. as of
December 31, 2006 and 2005, and the related consolidated
statements of income, stockholders equity, and cash flows
for each of the three years in the period ended
December 31, 2006 of Triad Guaranty Inc. and our report
dated March 7, 2007 expressed an unqualified opinion
thereon.
Greensboro, North Carolina
March 7, 2007
57
|
|
Item 9B.
|
Other
Information
|
None.
PART III
|
|
Item 10.
|
Directors
and Executive Officers of the Registrant
|
Information regarding our directors and nominees for directors
is included in our Proxy Statement for the 2007 Annual Meeting
of Stockholders, and is hereby incorporated by reference.
For information regarding our executive officers, reference is
made to the section entitled Executive Officers in
Part I, Item 1 of this Report.
The Board of Directors has adopted a Code of Ethics for the
Companys principal executive and senior financial
officers. This Code supplements the Companys Code of
Conduct applicable to all employees and directors and is
intended to promote honest and ethical conduct, full and
accurate reporting, and compliance with laws as well as other
matters. Both of these documents can be found on the
Companys website at
http://www.triadguaranty.com
on the Corporate Governance page or will be provided free of
charge upon written request.
|
|
Item 11.
|
Executive
Compensation
|
This information is included in our Proxy Statement for the 2007
Annual Meeting of Stockholders, and is hereby incorporated by
reference.
|
|
Item 12.
|
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
This information is included in our Proxy Statement for the 2007
Annual Meeting of Stockholders, and is hereby incorporated by
reference.
|
|
Item 13.
|
Certain
Relationships and Related Transactions
|
This information is included in our Proxy Statement for the 2007
Annual Meeting of Stockholders, and is hereby incorporated by
reference.
|
|
Item 14.
|
Principal
Accountant Fees and Services
|
This information is included in our Proxy Statement for the 2007
Annual Meeting of Stockholders, and is hereby incorporated by
reference.
PART IV
|
|
Item 15.
|
Exhibits
and Financial Statement Schedules
|
(a) (1) and (2) The response to this portion of
Item 15 is submitted as a separate section of this report.
(a) (3) Listing of Exhibits The response
to this portion of Item 15 is submitted as a separate
section of this report.
(b) Reports on
Form 8-K
filed or furnished during the fourth quarter of 2006 and through
the date of this
Form 10-K
filing.
October 26, 2006 Triad Guaranty Inc. issued a
news release announcing its financial results for the
three-month and nine-month periods ending September 30,
2006.
December 28, 2006 Triad Guaranty Inc. entered
into a Phantom Stock Award Agreement with Mark K. Tonnesen,
President and Chief Executive Officer of the Company, and
amended a prior letter agreement
58
dated September 9, 2005 (the Prior Agreement)
between the Company and Mr. Tonnesen (the amendment to he
Prior Agreement is referred to herein as the
Amendment). The purpose of the Phantom Stock Award
Agreement and the Amendment was to resolve an ambiguity in the
Prior Agreement and to preserve tax deductibility of certain
equity awards.
January 19, 2007 Triad Guaranty Inc. entered
into a second amendment to an employment agreement with
Mr. Ron D. Kessinger (Exhibit 10.42). Triad Guaranty
Inc. also announced that Gregory J. McKenzie had been hired as
the President and CEO of the Canadian operations.
January 25, 2007 Triad Guaranty Inc. issued a
news release announcing its financial results for the
three-month and twelve-month periods ending December 31,
2006.
(c) Exhibits The response to this portion of
Item 15 is submitted as a separate section of this report.
(d) Financial Statement Schedules The response
to this portion of Item 15 is submitted as a separate
section of this report.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized on the 7th day of March 2007.
Mark K. Tonnesen
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below on the 7th day of March,
2007 by the following persons on behalf of the Registrant in the
capacities indicated.
|
|
|
|
|
Signature
|
|
Title
|
|
/s/ William
T.
Ratliff, III
William
T. Ratliff, III
|
|
Chairman of the Board
|
|
|
|
/s/ Mark
K. Tonnesen
Mark
K. Tonnesen
|
|
President, Chief Executive
Officer, and Director
|
|
|
|
/s/ Kenneth
W. Jones
Kenneth
W. Jones
|
|
Senior Vice President, Chief
Financial Officer
|
|
|
|
/s/ Kenneth
S. Dwyer
Kenneth
S. Dwyer
|
|
Vice President, and Chief
Accounting Officer
|
|
|
|
/s/ David
W. Whitehurst
David
W. Whitehurst
|
|
Director
|
|
|
|
/s/ Robert
T. David
Robert
T. David
|
|
Director
|
|
|
|
/s/ Michael
A. F. Roberts
Michael
A. F. Roberts
|
|
Director
|
|
|
|
/s/ Richard
S. Swanson
Richard
S. Swanson
|
|
Director
|
|
|
|
/s/ Glenn
T.
Austin, Jr.
Glenn
T. Austin, Jr.
|
|
Director
|
|
|
|
/s/ H.
Lee Durham
H.
Lee Durham
|
|
Director
|
60
ANNUAL
REPORT ON FORM 10-K
ITEM 8,
ITEM 15(a)(1) and (2), (3), (c), and (d)
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
INDEX TO
EXHIBITS
CONSOLIDATED
FINANCIAL STATEMENTS
FINANCIAL
STATEMENT SCHEDULES
CERTAIN
EXHIBITS
YEAR
ENDED DECEMBER 31, 2006
TRIAD
GUARANTY INC.
WINSTON-SALEM,
NORTH CAROLINA
61
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(Item 15(a) 1 and 2)
|
|
|
|
|
|
|
Page
|
|
Consolidated Financial
Statements
|
|
|
|
|
|
|
|
65
|
|
|
|
|
66
|
|
|
|
|
67
|
|
|
|
|
68
|
|
|
|
|
69
|
|
|
|
|
70
|
|
Financial Statement
Schedules
|
|
|
|
|
Schedules at and for each of the
three years in the period ended December 31, 2006
|
|
|
|
|
|
|
|
87
|
|
|
|
|
88
|
|
|
|
|
93
|
|
All other schedules are omitted since the required information
is not present or is not present in amounts sufficient to
require submission of the schedules, or because the information
required is included in the consolidated financial statements
and notes thereto.
62
INDEX TO
EXHIBITS
(Item 15(a) 3)
|
|
|
|
|
Exhibit Number
|
|
Description of Exhibit
|
|
|
3
|
.1
|
|
Certificate of Incorporation of
the Registrant, as amended (5) (Exhibit 3.1)
|
|
3
|
.2
|
|
By-Laws of the Registrant as
amended March 21, 2003 (10)(Exhibit 3.2(c))
|
|
4
|
.1
|
|
Form of Common Stock certificate
(1) (Exhibit 4(a))
|
|
4
|
.2
|
|
Indenture Between Triad Guaranty
Inc. and Bankers Trust Co. (6) (Exhibit 4.2)
|
|
10
|
.6
|
|
Registration Agreement among the
Registrant, Collateral Investment Corp. and Collateral Mortgage,
Ltd. (2) (Exhibit 10.6)
|
|
10
|
.16
|
|
Economic Value Added Incentive
Bonus Program (Senior Management) (4) (Exhibit 10.16)
|
|
10
|
.21
|
|
Excess of Loss Reinsurance
Agreement between Triad Guaranty Insurance Corporation, Capital
Mortgage Reinsurance Company, and Federal Insurance Company. (7)
(Exhibit 10.21)
|
|
10
|
.22
|
|
Excess of Loss Reinsurance
Agreement between Triad Guaranty Insurance Corporation and Ace
Capital Mortgage Reinsurance Company. (8) (Exhibit 10.22)
|
|
10
|
.23
|
|
Employment Agreement between the
Registrant and Earl F. Wall (3)(9) (Exhibit 10.23)
|
|
10
|
.26
|
|
Employment Agreement between the
Registrant and Kenneth C. Foster (3)(10) (Exhibit 10.26)
|
|
10
|
.27
|
|
Consulting Agreement between the
Registrant, Triad Guaranty Insurance Corporation, Triad Guaranty
Assurance Company and Collateral Mortgage, Ltd. Providing advice
and counsel regarding the investment strategy and tactics of
Conning Asset Management Company, the Registrants new
investment advisor. (11) (Exhibit 10.27)
|
|
10
|
.28
|
|
Administrative Services Agreement
between the Registrant, Triad Guaranty Insurance Corporation,
Collateral Mortgage, Ltd., Collat, Inc., and New South Federal
Savings Bank. (11) (Exhibit 10.28)
|
|
10
|
.30
|
|
Exchange Agreement by and among
the Registrant, Collateral Investment Corp. and the Shareholders
of Collateral Investment Corp. Listed on the Signature Pages
Hereto.(12)(Exhibit 10.30)
|
|
10
|
.32
|
|
Employment Agreement and Related
Document between the Registrant and Mark K. Tonnesen.
(3)(13)(Exhibit 10.32)
|
|
10
|
.34
|
|
Summary of plan of compensation
for directors of the Registrant. (3) (14)
|
|
10
|
.35
|
|
Form of 2006 Triad Guaranty Inc.
2006 Long-Term Stock Incentive Plan, replacing previous Exhibit
10.1 (3) (15) (Exhibit 10.35)
|
|
10
|
.36
|
|
Amendment to Employment Agreement
between the Registrant and Ron D. Kessinger, replacing previous
Exhibit 10.33 (3) (15) (Exhibit 10.36)
|
|
10
|
.37
|
|
Agreement entered into between the
Registrant and Kenneth W. Jones (3) (15) (Exhibit 10.37)
|
|
10
|
.38
|
|
Resignation and Release Agreement
entered into between the Registrant and Eric B. Dana (3) (15)
(Exhibit 10.38)
|
|
10
|
.39
|
|
Employment Agreement between the
Registrant and Kenneth N. Lard, replacing previous Exhibits
10.25 and 10.31 (3) (15) (Exhibit 10.39)
|
|
10
|
.40
|
|
Amendment to Employment Agreement
between the Registrant and Mark K. Tonnesen, amending Exhibit
10.32 (3) (16) (Exhibit 10.40)
|
|
10
|
.41
|
|
Executive/Key Employee Phantom
Stock Award Agreement between Registrant and Mark K. Tonnesen
(3) (16) (Exhibit 10.41)
|
|
10
|
.42
|
|
Amendment to Employment Agreement
between the Registrant and Ron D. Kessinger, replacing previous
Exhibit 10.36 (3) (17) (Exhibit 10.42)
|
|
*10
|
.43
|
|
Form of Executive Restricted Stock
Agreement
|
|
*10
|
.44
|
|
Form of Executive Stock Option
Agreement
|
|
*10
|
.45
|
|
Form of Outside Director
Restricted Stock Agreement
|
|
*10
|
.46
|
|
Form of Outside Director Stock
Option Agreement
|
|
21
|
.1
|
|
Subsidiaries of the Registrant (7)
(Exhibit 21.1)
|
|
*23
|
.1
|
|
Consent of Independent Registered
Public Accounting Firm (Exhibit 23.1)
|
63
|
|
|
|
|
Exhibit Number
|
|
Description of Exhibit
|
|
|
*31
|
.1
|
|
Chief Executive Officer
Sarbanes-Oxley Act Section 302 Certification dated March 7,
2007, for the Triad Guaranty Inc.s Annual report on Form
10-K for the year ended December 31, 2006.
|
|
*31
|
.2
|
|
Chief Financial Officer
Sarbanes-Oxley Act Section 302 Certification dated March 7,
2007, for the Triad Guaranty Inc.s Annual report on Form
10-K for the year ended December 31, 2006.
|
|
*32
|
.1
|
|
Chief Executive Officer
Sarbanes-Oxley Act Section 906 Certification dated March 7,
2007, for the Triad Guaranty Inc.s Annual report on Form
10-K for the year ended December 31, 2006.
|
|
*32
|
.2
|
|
Chief Financial Officer
Sarbanes-Oxley Act Section 906 Certification dated March 7,
2007, for the Triad Guaranty Inc.s Annual report on Form
10-K for the year ended December 31, 2006.
|
|
|
|
* |
|
Filed Herewith. |
|
(1) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the Registrants
Registration Statement on
Form S-1
filed October 22, 1993 and amendments thereto. |
|
(2) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the 1993
Form 10-K. |
|
(3) |
|
Denotes management contract or compensatory plan of arrangement
required to be filed as an exhibit to this report pursuant to
Item 601 of
Regulation S-K. |
|
(4) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the 1996
Form 10-K. |
|
(5) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the June 30, 1997
Form 10-Q. |
|
(6) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the 1997
Form 10-K. |
|
(7) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the 1999
Form 10-K. |
|
(8) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the 2000
Form 10-K. |
|
(9) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the June 30, 2002
Form 10-Q. |
|
(10) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the 2002
Form 10-K. |
|
(11) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the 2004
Form 10-K. |
|
(12) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the June 30, 2005
Form 10-Q. |
|
(13) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the September 30, 2005
Form 10-Q. |
|
(14) |
|
Incorporated by reference to the
Form 8-K
Current Report filed March 2, 2006. |
|
(15) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the June 30, 2006
Form 10-Q. |
|
(16) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the December 26, 2006
Form 8-K
Current Report. |
|
(17) |
|
Incorporated by reference to the exhibit identified in
parentheses, filed as an exhibit in the January 18, 2007
Form 8-K
Current Report. |
64
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
of Triad Guaranty Inc.
We have audited the accompanying consolidated balance sheets of
Triad Guaranty Inc. as of December 31, 2006 and 2005, and
the related consolidated statements of income,
stockholders equity, and cash flows for each of the three
years in the period ended December 31, 2006. Our audits
also included the financial statement schedules listed in the
Index at item 15(a). These financial statements and
schedules are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Triad Guaranty Inc. at December 31,
2006 and 2005, and the consolidated results of its operations
and its cash flows for each of the three years in the period
ended December 31, 2006 in conformity with
U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedules, when
considered in relation to the basic financial statements taken
as a whole, present fairly in all material respects the
information set forth therein.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Triad Guaranty Inc.s internal control
over financial reporting as of December 31, 2006, based on
criteria established in Internal Control Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission and our report dated March 7, 2007
expressed an unqualified opinion thereon.
Greensboro, North Carolina
March 7, 2007
65
TRIAD
GUARANTY INC.
CONSOLIDATED
BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands, except share data)
|
|
|
ASSETS
|
Invested assets:
|
|
|
|
|
|
|
|
|
Securities
available-for-sale,
at fair value:
|
|
|
|
|
|
|
|
|
Fixed maturities (amortized cost:
2006 $568,992; 2005 $518,137)
|
|
$
|
586,594
|
|
|
$
|
534,064
|
|
Equity securities (cost:
2006 $9,530; 2005 $7,001)
|
|
|
10,417
|
|
|
|
8,159
|
|
Other investments
|
|
|
5,000
|
|
|
|
|
|
Short-term investments
|
|
|
5,301
|
|
|
|
4,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
607,312
|
|
|
|
547,019
|
|
Cash and cash equivalents
|
|
|
38,609
|
|
|
|
8,934
|
|
Real estate acquired in claim
settlement
|
|
|
10,170
|
|
|
|
5,721
|
|
Accrued investment income
|
|
|
8,054
|
|
|
|
7,237
|
|
Deferred policy acquisition costs
|
|
|
35,143
|
|
|
|
33,684
|
|
Property and equipment, at cost
less accumulated depreciation (2006 $21,160;
2005 $18,628)
|
|
|
7,678
|
|
|
|
7,827
|
|
Prepaid federal income tax
|
|
|
166,908
|
|
|
|
139,465
|
|
Income taxes recoverable
|
|
|
51
|
|
|
|
181
|
|
Reinsurance recoverable
|
|
|
841
|
|
|
|
948
|
|
Other assets
|
|
|
20,865
|
|
|
|
16,487
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
895,631
|
|
|
$
|
767,503
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND
STOCKHOLDERS EQUITY
|
Liabilities:
|
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses
|
|
$
|
84,352
|
|
|
$
|
51,074
|
|
Unearned premiums
|
|
|
13,193
|
|
|
|
13,494
|
|
Amounts payable to reinsurers
|
|
|
5,909
|
|
|
|
4,810
|
|
Deferred income taxes
|
|
|
176,483
|
|
|
|
155,189
|
|
Long-term debt
|
|
|
34,510
|
|
|
|
34,501
|
|
Accrued interest on debt
|
|
|
1,275
|
|
|
|
1,275
|
|
Accrued expenses and other
liabilities
|
|
|
9,685
|
|
|
|
7,969
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
325,407
|
|
|
|
268,312
|
|
Commitments and contingencies
(Notes 5, 7, and 14)
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
Preferred stock, par value
$0.01 per share authorized
1,000,000 shares, no shares issued and outstanding
|
|
|
|
|
|
|
|
|
Common stock, par value
$0.01 per share authorized
33,091,400 shares, issued and outstanding
14,856,401 shares at December 31, 2006, and 14,774,153
at December 31, 2005
|
|
|
149
|
|
|
|
148
|
|
Additional paid-in capital
|
|
|
104,981
|
|
|
|
103,657
|
|
Accumulated other comprehensive
income, net of income tax liability of $6,471 at
December 31, 2006, and $5,980 at December 31, 2005
|
|
|
12,018
|
|
|
|
11,106
|
|
Deferred compensation
|
|
|
|
|
|
|
(3,161
|
)
|
Retained earnings
|
|
|
453,076
|
|
|
|
387,441
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
570,224
|
|
|
|
499,191
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders equity
|
|
$
|
895,631
|
|
|
$
|
767,503
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
66
TRIAD
GUARANTY INC.
CONSOLIDATED
STATEMENTS OF INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands, except share data)
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums written:
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
256,706
|
|
|
$
|
207,260
|
|
|
$
|
176,696
|
|
Ceded
|
|
|
(46,140
|
)
|
|
|
(40,644
|
)
|
|
|
(35,365
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written
|
|
|
210,566
|
|
|
|
166,616
|
|
|
|
141,331
|
|
Change in unearned premiums
|
|
|
290
|
|
|
|
2,381
|
|
|
|
(339
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
|
210,856
|
|
|
|
168,997
|
|
|
|
140,992
|
|
Net investment income
|
|
|
26,696
|
|
|
|
22,998
|
|
|
|
19,754
|
|
Net realized investment gains
|
|
|
1,584
|
|
|
|
36
|
|
|
|
504
|
|
Other income
|
|
|
8
|
|
|
|
15
|
|
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
239,144
|
|
|
|
192,046
|
|
|
|
161,266
|
|
Losses and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment
expenses
|
|
|
94,227
|
|
|
|
66,855
|
|
|
|
35,864
|
|
Interest expense on debt
|
|
|
2,774
|
|
|
|
2,773
|
|
|
|
2,772
|
|
Amortization of deferred policy
acquisition costs
|
|
|
16,268
|
|
|
|
14,902
|
|
|
|
14,256
|
|
Other operating expenses (net of
acquisition costs deferred)
|
|
|
35,556
|
|
|
|
29,610
|
|
|
|
26,483
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
148,825
|
|
|
|
114,140
|
|
|
|
79,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
90,319
|
|
|
|
77,906
|
|
|
|
81,891
|
|
Income taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
4,078
|
|
|
|
2,805
|
|
|
|
2,295
|
|
Deferred
|
|
|
20,606
|
|
|
|
18,288
|
|
|
|
21,179
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24,684
|
|
|
|
21,093
|
|
|
|
23,474
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
65,635
|
|
|
$
|
56,813
|
|
|
$
|
58,417
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common and common
equivalent share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
4.44
|
|
|
$
|
3.87
|
|
|
$
|
4.04
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
4.40
|
|
|
$
|
3.84
|
|
|
$
|
3.98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing earnings
per common and common equivalent share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
14,769,859
|
|
|
|
14,691,478
|
|
|
|
14,458,453
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
14,912,519
|
|
|
|
14,808,387
|
|
|
|
14,681,228
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
67
TRIAD
GUARANTY INC.
CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
|
|
|
Paid-In
|
|
|
Comprehensive
|
|
|
Deferred
|
|
|
Retained
|
|
|
|
|
|
|
Stock
|
|
|
Capital
|
|
|
Income
|
|
|
Compensation
|
|
|
Earnings
|
|
|
Total
|
|
|
|
(In thousands, except share data)
|
|
|
Balance at January 1, 2004
|
|
$
|
144
|
|
|
$
|
87,513
|
|
|
$
|
11,190
|
|
|
$
|
(1,128
|
)
|
|
$
|
272,211
|
|
|
$
|
369,930
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58,417
|
|
|
|
58,417
|
|
Other comprehensive
income net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in net unrealized gain
|
|
|
|
|
|
|
|
|
|
|
2,028
|
|
|
|
|
|
|
|
|
|
|
|
2,028
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
60,445
|
|
Issuance of common stock under
stock incentive plan
|
|
|
2
|
|
|
|
3,739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,741
|
|
Tax effect of exercise of
non-qualified stock options
|
|
|
|
|
|
|
1,995
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,995
|
|
Net issuance of restricted stock
under stock incentive plan
|
|
|
|
|
|
|
1,605
|
|
|
|
|
|
|
|
(1,605
|
)
|
|
|
|
|
|
|
|
|
Amortization of deferred
compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,232
|
|
|
|
|
|
|
|
1,232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
146
|
|
|
|
94,852
|
|
|
|
13,218
|
|
|
|
(1,501
|
)
|
|
|
330,628
|
|
|
|
437,343
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56,813
|
|
|
|
56,813
|
|
Other comprehensive
income net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in net unrealized gain
|
|
|
|
|
|
|
|
|
|
|
(2,112
|
)
|
|
|
|
|
|
|
|
|
|
|
(2,112
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
54,701
|
|
Issuance of common stock under
stock incentive plan
|
|
|
2
|
|
|
|
3,267
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,269
|
|
Tax effect of exercise of
non-qualified stock options and vesting of restricted stock
|
|
|
|
|
|
|
2,090
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,090
|
|
Net issuance of restricted stock
under stock incentive plan
|
|
|
|
|
|
|
3,448
|
|
|
|
|
|
|
|
(3,448
|
)
|
|
|
|
|
|
|
|
|
Amortization of deferred
compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,788
|
|
|
|
|
|
|
|
1,788
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
|
148
|
|
|
|
103,657
|
|
|
|
11,106
|
|
|
|
(3,161
|
)
|
|
|
387,441
|
|
|
|
499,191
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65,635
|
|
|
|
65,635
|
|
Other comprehensive
income net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in net unrealized gain
|
|
|
|
|
|
|
|
|
|
|
912
|
|
|
|
|
|
|
|
|
|
|
|
912
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
66,547
|
|
Adoption of SFAS 123(R)
|
|
|
|
|
|
|
(3,161
|
)
|
|
|
|
|
|
|
3,161
|
|
|
|
|
|
|
|
|
|
Share-based compensation
|
|
|
|
|
|
|
3,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,476
|
|
Issuance of common stock under
stock incentive plan
|
|
|
|
|
|
|
747
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
747
|
|
Tax effect of exercise of
non-qualified stock options and vesting of restricted stock
|
|
|
|
|
|
|
263
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
263
|
|
Net issuance of restricted stock
under stock incentive plan
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
$
|
149
|
|
|
$
|
104,981
|
|
|
$
|
12,018
|
|
|
$
|
|
|
|
$
|
453,076
|
|
|
$
|
570,224
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
68
TRIAD
GUARANTY INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
Operating activities
|
|
(In thousands)
|
|
|
Net income
|
|
$
|
65,635
|
|
|
$
|
56,813
|
|
|
$
|
58,417
|
|
Adjustments to reconcile net
income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses, loss adjustment expenses
and unearned premium reserves
|
|
|
32,977
|
|
|
|
14,584
|
|
|
|
7,169
|
|
Accrued expenses and other
liabilities
|
|
|
1,716
|
|
|
|
1,421
|
|
|
|
(1,817
|
)
|
Current taxes payable
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
Income taxes recoverable
|
|
|
130
|
|
|
|
796
|
|
|
|
(977
|
)
|
Amounts due to/from reinsurers
|
|
|
1,206
|
|
|
|
559
|
|
|
|
941
|
|
Accrued investment income
|
|
|
(817
|
)
|
|
|
(1,008
|
)
|
|
|
(1,654
|
)
|
Policy acquisition costs deferred
|
|
|
(17,727
|
)
|
|
|
(16,133
|
)
|
|
|
(17,346
|
)
|
Amortization of deferred policy
acquisition costs
|
|
|
16,268
|
|
|
|
14,902
|
|
|
|
14,256
|
|
Net realized investment gains
|
|
|
(1,584
|
)
|
|
|
(36
|
)
|
|
|
(504
|
)
|
Provision for depreciation
|
|
|
2,531
|
|
|
|
3,456
|
|
|
|
3,319
|
|
Accretion of discount on
investments
|
|
|
130
|
|
|
|
(118
|
)
|
|
|
(836
|
)
|
Deferred income taxes
|
|
|
20,606
|
|
|
|
18,288
|
|
|
|
21,179
|
|
Prepaid federal income taxes
|
|
|
(27,443
|
)
|
|
|
(20,333
|
)
|
|
|
(21,008
|
)
|
Real estate acquired in claim
settlement, net of write-downs
|
|
|
(4,449
|
)
|
|
|
(5,510
|
)
|
|
|
(65
|
)
|
Other assets
|
|
|
(4,378
|
)
|
|
|
(916
|
)
|
|
|
3,050
|
|
Other operating activities
|
|
|
3,645
|
|
|
|
4,082
|
|
|
|
4,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
88,446
|
|
|
|
70,847
|
|
|
|
68,918
|
|
Investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities
available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases fixed
maturities
|
|
|
(172,782
|
)
|
|
|
(130,475
|
)
|
|
|
(153,262
|
)
|
Sales fixed maturities
|
|
|
116,101
|
|
|
|
35,900
|
|
|
|
57,864
|
|
Maturities fixed
maturities
|
|
|
6,386
|
|
|
|
11,715
|
|
|
|
20,097
|
|
Purchases equities
|
|
|
(4,805
|
)
|
|
|
|
|
|
|
(809
|
)
|
Sales equities
|
|
|
3,183
|
|
|
|
1,853
|
|
|
|
2,674
|
|
Purchases of other investments
|
|
|
(5,000
|
)
|
|
|
|
|
|
|
|
|
Net change in short-term
investments
|
|
|
(505
|
)
|
|
|
7,724
|
|
|
|
(817
|
)
|
Purchases of property and equipment
|
|
|
(2,382
|
)
|
|
|
(2,339
|
)
|
|
|
(2,895
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(59,804
|
)
|
|
|
(75,622
|
)
|
|
|
(77,148
|
)
|
Financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Excess tax benefits from
share-based compensation
|
|
|
286
|
|
|
|
|
|
|
|
|
|
Proceeds from exercise of stock
options
|
|
|
747
|
|
|
|
3,269
|
|
|
|
3,741
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing
activities
|
|
|
1,033
|
|
|
|
3,269
|
|
|
|
3,741
|
|
Net change in cash and cash
equivalents
|
|
|
29,675
|
|
|
|
(1,506
|
)
|
|
|
(4,489
|
)
|
Cash and cash equivalents at
beginning of year
|
|
|
8,934
|
|
|
|
10,440
|
|
|
|
14,929
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end
of year
|
|
$
|
38,609
|
|
|
$
|
8,934
|
|
|
$
|
10,440
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental schedule of cash
flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes and United States
Mortgage Guaranty Tax and Loss Bonds
|
|
$
|
34,454
|
|
|
$
|
24,733
|
|
|
$
|
23,692
|
|
Interest
|
|
$
|
2,765
|
|
|
$
|
2,765
|
|
|
$
|
2,765
|
|
See accompanying notes.
69
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006
Nature
of Business
Triad Guaranty Inc. is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation
(Triad), provides mortgage insurance coverage in the
United States. This allows buyers to achieve homeownership with
a reduced down payment, facilitates the sale of mortgage loans
in the secondary market and protects lenders from credit
default-related expenses. Triad Guaranty Inc. and its subsidiary
are collectively referred to as the Company.
Basis
of Presentation
The accompanying consolidated financial statements have been
prepared in conformity with United States generally accepted
accounting principles (GAAP), which vary in some respects from
statutory accounting practices which are prescribed or permitted
by the various state insurance departments.
Consolidation
The consolidated financial statements include the amounts of
Triad Guaranty Inc., Triad and Triads wholly-owned
subsidiaries, Triad Guaranty Assurance Corporation
(TGAC) and Triad Re Insurance Corporation
(Triad Re). All significant intercompany accounts
and transactions have been eliminated.
Use of
Estimates
The preparation of the consolidated financial statements in
conformity with GAAP requires management to make estimates and
assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results
could differ from those estimates.
Investments
All fixed maturity and equity securities are classified as
available-for-sale
and are carried at fair value. Unrealized gains and losses on
available-for-sale
securities, net of tax, are reported as a separate component of
accumulated other comprehensive income. Fair value generally
represents quoted market value prices for securities traded in
the public market or prices analytically determined using bid or
closing prices for securities not traded in the public
marketplace. Realized investment gains or losses are determined
on a specific identification basis. The Company evaluates its
investments regularly to determine whether there are declines in
value that are other than temporary. When the Company determines
that a security has experienced an
other-than-temporary
impairment, the impairment loss is recognized in the period as a
realized investment loss.
Other investments represent investments in equity securities for
which there is no readily determinable market value and are
stated at fair value. Other investments are reviewed regularly
to determine if there are declines in value that are other than
temporary. When an impairment is determined to be other than
temporary, the impairment loss is recognized as a realized
investment loss.
Short-term investments are defined as short-term, highly liquid
investments both readily convertible to known amounts of cash
and having maturities of twelve months or less upon acquisition
by the Company and are not used to fund operational cash flows
of the Company.
Cash
and Cash Equivalents
The Company considers cash equivalents to be short-term, highly
liquid investments with original maturities of three months or
less that are used to fund operational cash flow needs.
70
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Real
Estate Acquired in Claim Settlement
Real estate is sometimes acquired in the settlement of claims as
part of the Companys effort to mitigate losses. The real
estate is carried at lower of cost or net realizable value.
Gains or losses from the holding or disposition of real estate
acquired in claim settlement are recorded in net losses and loss
adjustment expenses. At December 31, 2006 and 2005, the
Company held 68 and 48 properties, respectively, that it
acquired in settlement of claims.
Deferred
Policy Acquisition Costs
The costs of acquiring new business, principally sales
compensation and certain policy underwriting and issue costs,
which vary with and are primarily related to the production of
new business, are deferred. Amortization of such policy
acquisition costs is charged to expense in proportion to
estimated gross profit recognized over the estimated policy life.
The Company reviews the persistency of policies in force and
makes appropriate adjustments to the amortization of deferred
policy acquisition costs to reflect policy cancellations. In
addition, the recoverability of deferred costs is tested by
calculating an estimated future gross profit on the existing
book of business and comparing that to the unamortized deferred
policy acquisition asset balance. If this comparison indicates a
premium deficiency, any unamortized acquisition cost to the
extent of that deficiency is charged to expense.
Property
and Equipment
Property and equipment is recorded at cost and is depreciated
principally on a straight-line basis over the estimated useful
lives, generally three to five years, of the depreciable assets.
Property and equipment primarily consists of computer hardware,
software, furniture, and equipment.
Loss
and Loss Adjustment Expense Reserves
Reserves are provided for the estimated costs of settling claims
on loans reported in default and loans in default that are in
the process of being reported to the Company. Consistent with
industry accounting practices, the Company does not establish
loss reserves for future claims on insured loans that are not
currently in default. Amounts for salvage recoverable are
considered in the determination of the reserve estimates. Loss
reserves are established by management using a process that
incorporates various components in a model that gives effect to
current economic conditions and segments defaults by a variety
of criteria. The criteria, include, among others, policy year,
lender, geography and the number of months and number of times
the policy has been in default, as well as whether the defaulted
loan was underwritten through our flow distribution channel or
as part of a structured bulk transaction.
Frequency and severity are the two most significant assumptions
in the establishment of our loss reserves. Frequency is used to
estimate the ultimate number of paid claims associated with the
current defaulted loans. The frequency estimate assumes that
long-term historical experience, taking into consideration
criteria such as those described in the preceding paragraph, and
adjusted for current economic conditions that the Company
believes will significantly impact the long-term loss
development, provides a reasonable basis for forecasting the
number of claims that will be paid. Severity is the estimate of
the dollar amount per claim that will be paid. The severity
factors are estimates of the percent of the risk in force that
will be paid. The severity factors used are based on an analysis
of the severity rates of recently paid claims, applied to the
risk in force of the loans currently in default. The frequency
and severity factors are updated quarterly.
The estimation of loss reserves requires assumptions as to
future events, and there are inherent risks and uncertainties
involved in making these assumptions. Economic conditions that
have affected the development of loss reserves in the past may
not necessarily affect development patterns in the future in
either a similar manner or degree. As adjustments to these
liabilities become necessary, such adjustments are reflected in
current operations.
71
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Reinsurance
Certain premiums and losses are assumed from and ceded to other
insurance companies under various reinsurance agreements.
Reinsurance premiums, loss reimbursement, and reserves related
to reinsurance business are accounted for on a basis consistent
with that used in accounting for the original policies issued
and the terms of the reinsurance contracts. The Company may
receive a ceding commission in connection with ceded
reinsurance. If so, the ceding commission is earned on a monthly
pro rata basis in the same manner as the premium and is recorded
as a reduction of other operating expenses.
Income
Taxes
The Company uses the asset and liability method of accounting
for income taxes. Under the asset and liability method, deferred
tax assets and deferred tax liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the
enactment date.
Federal tax law permits mortgage guaranty insurance companies to
deduct from taxable income, subject to certain limitations, the
amounts added to contingency loss reserves. Generally, the
amounts so deducted must be included in taxable income in the
tenth subsequent year. This deduction is allowed only to the
extent that non-interest bearing United States Mortgage Guaranty
Tax and Loss Bonds are purchased and held in an amount equal to
the tax benefit attributable to such deduction. The Company
accounts for these purchases as a prepayment of federal income
taxes. Current income tax expense is primarily associated with
the addition to taxable income in the current year of the
contingency reserve deduction from ten years prior.
Income
Recognition
The Company writes policies that are guaranteed renewable
contracts at the policyholders option on single premium,
annual premium, and monthly premium bases. The Company does not
have the option to re-underwrite these contracts. Premiums
written on a monthly basis are earned in the month coverage is
provided. Premiums written on annual policies are earned on a
monthly pro rata basis. Single premium policies covering more
than one year are amortized over the estimated policy life in
accordance with the expiration of risk.
Cancellation of a policy generally results in the unearned
portion of the premium paid being refunded to the policyholder.
However, many of the annual paying policies are paid by the
lender and are non-refundable. The cancellation of one of these
policies would impact earned premium through the release of the
unearned premium reserve at the time of the cancellation. The
amounts earned through the cancellation of annual paying
policies are not significant to earned premium.
Significant
Customers
During 2006, one customer accounted for 17% of total revenues
and two other customers each individually accounted for 11% of
total revenues. In 2005, two of these same customers accounted
for approximately 20% and 14% of total revenue. In 2004, these
same two customers accounted for approximately 16% and 14% of
the Companys revenue.
Share-Based
Compensation
Prior to January 1, 2006, the Company accounted for stock
option grants and grants of restricted stock under its 1993
Long-Term Stock Incentive Plan (the Plan), which is
more fully described in Note 11, using the intrinsic value
method prescribed in Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees
72
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
(APB 25), as permitted by Statement of
Financial Accounting Standards No. 123
(SFAS 123). In accordance with APB 25,
compensation expense was recognized for grants of restricted
stock, but not for grants of stock options. In December 2004,
the Financial Accounting Standards Board (FASB)
issued SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS 123(R)). SFAS 123(R)
requires compensation expense relating to share-based payment
transactions to be recognized in financial statements. The
Company adopted SFAS 123(R) effective January 1, 2006,
utilizing the modified prospective application as defined in
that statement. Under that transition method, compensation
expense recognized in the year ended 2006 includes:
a) compensation expense for all share-based payments
granted prior to, but not yet vested as of January 1, 2006
based on the grant-date fair value estimated in accordance with
the original provisions of SFAS 123, and
b) compensation expense for all share-based payments
granted subsequent to January 1, 2006, based on the
grant-date fair value estimated in accordance with the
provisions of SFAS 123(R). Results for prior periods have
not been restated.
The following table shows the effect of adopting
SFAS 123(R) in the Companys financial statements for
the year ended December 31, 2006 (in thousands, except per
share information):
|
|
|
|
|
Income before income taxes
|
|
$
|
(1,159
|
)
|
Net income
|
|
$
|
(753
|
)
|
Earnings per share
basic
|
|
$
|
(0.05
|
)
|
Earnings per share
diluted
|
|
$
|
(0.05
|
)
|
Prior to the adoption of SFAS 123(R), the Company presented
all tax benefits of deductions resulting from share-based
compensation as operating cash flows in the Statement of Cash
Flows. SFAS 123(R) requires the cash flows resulting from
the tax benefits of tax deductions in excess of the compensation
expense recognized for those share-based payments to be
classified as financing cash flows. This amount was $286,000 for
the year ended December 31, 2006.
The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value
recognition provisions of SFAS 123 to options granted in
all periods presented. For purposes of this pro forma
disclosure, the value of the options is estimated using a
Black-Scholes option pricing model and amortized to expense over
the options vesting periods:
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands, except earnings per share information)
|
|
|
Net income as reported
|
|
$
|
56,813
|
|
|
$
|
58,417
|
|
Net income pro forma
|
|
$
|
56,155
|
|
|
$
|
57,915
|
|
Earnings per share as
reported:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
3.87
|
|
|
$
|
4.04
|
|
Diluted
|
|
$
|
3.84
|
|
|
$
|
3.98
|
|
Earnings per share pro
forma:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
3.82
|
|
|
$
|
4.01
|
|
Diluted
|
|
$
|
3.79
|
|
|
$
|
3.94
|
|
Foreign
Currency Translation
Assets denominated in
non-U.S. dollar
currencies are translated into U.S. dollar equivalents
using exchange rates at December 31. Revenues and expenses
are translated at weighted-average exchange rates for the period
in which they occurred. Gains and losses on currency
re-measurement represent the revaluation of assets and
liabilities denominated in non-functional currency to the
functional currency, the U.S. dollar and are recorded in net
realized investment gains.
73
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Earnings
Per Share
Basic and diluted earnings per share are based on the
weighted-average daily number of shares outstanding. For diluted
earnings per share, the denominator includes the dilutive effect
on the weighted-average shares outstanding of employee stock
options and nonvested restricted stock. There are no other
reconciling items between the denominator used in basic earnings
per share and diluted earnings per share. There are no
reconciling items between the numerator used in basic earnings
per share and diluted earnings per share. At December 31,
2006, 2005 and 2004, options to purchase approximately 35,000,
107,000 and 4,000 shares, respectively, of the
Companys stock were excluded from the calculation of
earnings per share because they were antidilutive.
Comprehensive
Income
The only element of other comprehensive income applicable to the
Company is the change in unrealized gains and losses on
securities classified as
available-for-sale,
which is displayed in the following table, along with related
tax effects:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Unrealized gains (losses) arising
during the period, before taxes
|
|
$
|
2,988
|
|
|
$
|
(3,213
|
)
|
|
$
|
3,624
|
|
Income tax (expense) benefit
|
|
|
(1,046
|
)
|
|
|
1,124
|
|
|
|
(1,268
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) arising
during the period, net of taxes
|
|
|
1,942
|
|
|
|
(2,089
|
)
|
|
|
2,356
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less reclassification adjustment:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains realized in net income
|
|
|
1,584
|
|
|
|
36
|
|
|
|
504
|
|
Income tax expense
|
|
|
(554
|
)
|
|
|
(13
|
)
|
|
|
(176
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for
gains realized in net income
|
|
|
1,030
|
|
|
|
23
|
|
|
|
328
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss)
|
|
$
|
912
|
|
|
$
|
(2,112
|
)
|
|
$
|
2,028
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recent
Accounting Pronouncements
In June 2006, the FASB issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109
(FIN 48), which clarifies the accounting for
uncertainty in income taxes. FIN 48 prescribes a
recognition threshold and measurement attribute for the
recognition and measurement of a tax position taken or expected
to be taken in a tax return. The interpretation also provides
guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and
transition. FIN 48 is effective for the Company beginning
January 1, 2007 and is not expected to have a material
impact on the Companys financial position or results of
operations.
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements (SFAS 157),
which defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. SFAS 157
is effective for the Company beginning January 1, 2008 and
is not expected to have a material impact on the Companys
financial position or results of operations.
In September 2006, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Year Misstatements in Current Year Financial
Statements (SAB 108), which provides
guidance on the consideration of the financial statement impacts
of uncorrected prior year misstatements when quantifying a
current year misstatement. SAB 108 was effective for the
Companys 2006 financial statements and did not have a
material impact on the Companys financial position or
results of operations.
In February 2007, the FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities Including an Amendment of FASB Statement
No. 115. (SFAS 159), which
allows companies to choose to measure certain financial assets
and liabilities at fair value that are not currently required to
be measured
74
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
at fair value. SFAS 159 also establishes presentation and
disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes
for similar types of assets and liabilities. SFAS 159 is
effective for the Company beginning January 1, 2008. The
Company is currently evaluating the potential impact of adoption
of SFAS 159.
Reclassifications
During 2006, the Company reclassified unearned ceding
commissions payable from that caption in the consolidated
balance sheet to accrued expenses and other liabilities.
Accordingly, $4,000 and $200,000 as of December 31, 2005
and 2004, respectively, was reclassified to accrued expenses and
other liabilities to conform to the current year presentation,
with conforming reclassifications in the statement of cash flows.
During 2005, the Company reclassified overnight investment sweep
bank accounts from short-term investments to cash and cash
equivalents. Accordingly, $3.6 million and
$14.0 million as of December 31, 2004 and 2003,
respectively, was reclassified from short-term investments to
cash and cash equivalents to conform to the current year
presentation, with conforming reclassifications in the statement
of cash flows.
The cost or amortized cost, gross unrealized gains and losses,
and the fair value of investments at December 31, 2006 and
2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
|
|
|
|
Cost or
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
|
Available-for-sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government
|
|
$
|
12,119
|
|
|
$
|
4
|
|
|
$
|
(281
|
)
|
|
$
|
11,842
|
|
State and municipal
|
|
|
541,389
|
|
|
|
17,306
|
|
|
|
(564
|
)
|
|
|
558,131
|
|
Corporate
|
|
|
15,438
|
|
|
|
1,138
|
|
|
|
(4
|
)
|
|
|
16,572
|
|
Mortgage-backed
|
|
|
46
|
|
|
|
3
|
|
|
|
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturity securities
|
|
|
568,992
|
|
|
|
18,451
|
|
|
|
(849
|
)
|
|
|
586,594
|
|
Equity securities
|
|
|
9,530
|
|
|
|
954
|
|
|
|
(67
|
)
|
|
|
10,417
|
|
Other investments
|
|
|
5,000
|
|
|
|
|
|
|
|
|
|
|
|
5,000
|
|
Short-term investments
|
|
|
5,301
|
|
|
|
|
|
|
|
|
|
|
|
5,301
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
588,823
|
|
|
$
|
19,405
|
|
|
$
|
(916
|
)
|
|
$
|
607,312
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
75
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005
|
|
|
|
Cost or
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
|
Available-for-sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Government
|
|
$
|
12,348
|
|
|
$
|
16
|
|
|
$
|
(240
|
)
|
|
$
|
12,124
|
|
State and municipal
|
|
|
486,014
|
|
|
|
14,993
|
|
|
|
(980
|
)
|
|
|
500,027
|
|
Corporate
|
|
|
19,719
|
|
|
|
2,211
|
|
|
|
(75
|
)
|
|
|
21,855
|
|
Mortgage-backed
|
|
|
56
|
|
|
|
2
|
|
|
|
|
|
|
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturity securities
|
|
|
518,137
|
|
|
|
17,222
|
|
|
|
(1,295
|
)
|
|
|
534,064
|
|
Equity securities
|
|
|
7,001
|
|
|
|
1,284
|
|
|
|
(126
|
)
|
|
|
8,159
|
|
Short-term investments
|
|
|
4,796
|
|
|
|
|
|
|
|
|
|
|
|
4,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
529,934
|
|
|
$
|
18,506
|
|
|
$
|
(1,421
|
)
|
|
$
|
547,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2006 and 2005, the Company had 174 and 81
securities with gross unrealized losses, respectively. The
following tables show the gross unrealized losses and fair
value, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss
position at December 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
|
|
|
|
Less Than 12 Months
|
|
|
12 Months or More
|
|
|
Total
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
Description of Securities
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
|
|
(In thousands)
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Government
|
|
$
|
|
|
|
$
|
|
|
|
$
|
10,968
|
|
|
$
|
(281
|
)
|
|
$
|
10,968
|
|
|
$
|
(281
|
)
|
State and municipal
|
|
|
31,094
|
|
|
|
(159
|
)
|
|
|
20,632
|
|
|
|
(405
|
)
|
|
|
51,726
|
|
|
|
(564
|
)
|
Corporate
|
|
|
392
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
392
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
31,486
|
|
|
|
(163
|
)
|
|
|
31,600
|
|
|
|
(686
|
)
|
|
|
63,086
|
|
|
|
(849
|
)
|
Equity securities
|
|
|
658
|
|
|
|
(56
|
)
|
|
|
205
|
|
|
|
(11
|
)
|
|
|
863
|
|
|
|
(67
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired
securities
|
|
$
|
32,144
|
|
|
$
|
(219
|
)
|
|
$
|
31,805
|
|
|
$
|
(697
|
)
|
|
$
|
63,949
|
|
|
$
|
(916
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
76
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005
|
|
|
|
Less Than 12 Months
|
|
|
12 Months or More
|
|
|
Total
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
Description of Securities
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
|
|
(In thousands)
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Government
|
|
$
|
8,376
|
|
|
$
|
(123
|
)
|
|
$
|
2,883
|
|
|
$
|
(117
|
)
|
|
$
|
11,259
|
|
|
$
|
(240
|
)
|
State and municipal
|
|
|
57,969
|
|
|
|
(718
|
)
|
|
|
9,572
|
|
|
|
(262
|
)
|
|
|
67,541
|
|
|
|
(980
|
)
|
Corporate
|
|
|
731
|
|
|
|
(75
|
)
|
|
|
|
|
|
|
|
|
|
|
731
|
|
|
|
(75
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
67,076
|
|
|
|
(916
|
)
|
|
|
12,455
|
|
|
|
(379
|
)
|
|
|
79,531
|
|
|
|
(1,295
|
)
|
Equity securities
|
|
|
1,105
|
|
|
|
(19
|
)
|
|
|
1,347
|
|
|
|
(107
|
)
|
|
|
2,452
|
|
|
|
(126
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired
securities
|
|
$
|
68,181
|
|
|
$
|
(935
|
)
|
|
$
|
13,802
|
|
|
$
|
(486
|
)
|
|
$
|
81,983
|
|
|
$
|
(1,421
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company reviews its investments quarterly to identify and
evaluate whether any investments have indications of possible
impairment and whether any impairments are other than temporary.
Factors considered in determining whether a loss is other than
temporary include the length of time and extent to which fair
value has been less than the cost basis, the financial condition
and near-term prospects of the issuer, and the Companys
intent and ability to hold the investment for a period of time
sufficient to allow for recovery in market value. The Company
believes at this point in time that the positive evidence far
outweighs the negative evidence and all of the unrealized losses
shown above are temporary. Those gross unrealized losses at
December 31, 2006 related to fixed maturities that have
been in a continuous loss position for 12 months or more
are primarily the result of changes in interest rates. None of
the fixed maturity securities with unrealized losses have ever
missed or been delinquent on a scheduled principal or interest
payment. During 2006 and 2005, the Company wrote down securities
by $375,000 and $170,000, respectively, to reflect
other-than-temporary
declines in fair value.
The amortized cost and estimated fair value of investments in
fixed maturity securities, at December 31, 2006, are
summarized by stated maturity as follows:
|
|
|
|
|
|
|
|
|
|
|
Available-for-Sale
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
Maturity:
|
|
|
|
|
|
|
|
|
One year or less
|
|
$
|
27,566
|
|
|
$
|
28,040
|
|
After one year through five years
|
|
|
146,279
|
|
|
|
151,569
|
|
After five years through ten years
|
|
|
297,005
|
|
|
|
305,559
|
|
After ten years
|
|
|
98,096
|
|
|
|
101,377
|
|
Mortgage-backed securities
|
|
|
46
|
|
|
|
49
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
568,992
|
|
|
$
|
586,594
|
|
|
|
|
|
|
|
|
|
|
77
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The details of net realized investment gains including
other-than-temporary
impairments are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Securities
available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
$
|
913
|
|
|
$
|
25
|
|
|
$
|
626
|
|
Gross realized losses
|
|
|
(222
|
)
|
|
|
(305
|
)
|
|
|
(146
|
)
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
|
1,113
|
|
|
|
396
|
|
|
|
416
|
|
Gross realized losses
|
|
|
(207
|
)
|
|
|
(80
|
)
|
|
|
(435
|
)
|
Foreign currency gross realized
losses
|
|
|
(13
|
)
|
|
|
|
|
|
|
|
|
Covered call options:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
|
|
|
|
|
|
|
|
|
43
|
|
Gross realized losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gains
|
|
$
|
1,584
|
|
|
$
|
36
|
|
|
$
|
504
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized gains on fixed maturity securities increased
(decreased) by $1,675,000, $(2,762,000) and $3,477,000 in 2006,
2005, and 2004, respectively; the corresponding amounts for
equity securities were $(271,000), $(488,000), and $(356,000).
Major categories of the Companys net investment income are
summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
26,061
|
|
|
$
|
22,956
|
|
|
$
|
19,829
|
|
Preferred stocks
|
|
|
313
|
|
|
|
334
|
|
|
|
385
|
|
Common stocks
|
|
|
98
|
|
|
|
173
|
|
|
|
176
|
|
Cash, cash equivalents and
short-term investments
|
|
|
1,013
|
|
|
|
422
|
|
|
|
135
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
27,485
|
|
|
|
23,885
|
|
|
|
20,525
|
|
Expenses
|
|
|
(789
|
)
|
|
|
(887
|
)
|
|
|
(771
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
26,696
|
|
|
$
|
22,998
|
|
|
$
|
19,754
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2006 and 2005, investments with an
amortized cost of $6,631,000 and $6,432,000, respectively, were
on deposit with various state insurance departments to satisfy
regulatory requirements.
78
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
3.
|
Deferred
Policy Acquisition Costs
|
An analysis of deferred policy acquisition costs is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Balance at beginning of year
|
|
$
|
33,684
|
|
|
$
|
32,453
|
|
|
$
|
29,363
|
|
Acquisition costs deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales compensation
|
|
|
7,072
|
|
|
|
6,296
|
|
|
|
7,340
|
|
Underwriting and issue expenses
|
|
|
10,655
|
|
|
|
9,837
|
|
|
|
10,006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,727
|
|
|
|
16,133
|
|
|
|
17,346
|
|
Amortization of acquisition
expenses
|
|
|
16,268
|
|
|
|
14,902
|
|
|
|
14,256
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase
|
|
|
1,459
|
|
|
|
1,231
|
|
|
|
3,090
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
$
|
35,143
|
|
|
$
|
33,684
|
|
|
$
|
32,453
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4.
|
Reserve
for Losses and Loss Adjustment Expenses
|
Activity for the reserve for losses and loss adjustment expenses
for 2006, 2005, and 2004 is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Reserve for losses and loss
adjustment expenses at January 1, net of reinsurance
recoverables
|
|
$
|
51,073
|
|
|
$
|
34,040
|
|
|
$
|
27,183
|
|
Incurred losses and loss
adjustment expenses net of reinsurance recoveries (principally
in respect of default notices received in):
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
70,141
|
|
|
|
43,215
|
|
|
|
25,942
|
|
Deficiency on prior years
|
|
|
24,086
|
|
|
|
23,640
|
|
|
|
9,922
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total incurred losses and loss
adjustment expenses
|
|
|
94,227
|
|
|
|
66,855
|
|
|
|
35,864
|
|
Loss and loss adjustment expense
payments net of reinsurance recoveries (principally in respect
of default notices received in):
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
7,865
|
|
|
|
3,734
|
|
|
|
2,033
|
|
Prior years
|
|
|
53,084
|
|
|
|
46,088
|
|
|
|
26,974
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loss and loss adjustment
expense payments
|
|
|
60,949
|
|
|
|
49,822
|
|
|
|
29,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for losses and loss
adjustment expenses at December 31, net of reinsurance
recoverables of $1, $1, and $2 in 2006, 2005, and 2004,
respectively
|
|
$
|
84,351
|
|
|
$
|
51,073
|
|
|
$
|
34,040
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The foregoing reconciliation shows deficiencies in the reserve
for losses and loss adjustment expenses at December 31,
2005, 2004 and 2003. The deficiency recognized in 2006 on the
December 31, 2005 reserve was due to increased severity and
frequency factors applied to 2005 defaults based upon trends
observed in claims paid during 2006 primarily reflecting a
decline in the housing markets. Deficiencies recognized in 2005
and 2004 on the respective December 31, 2004 and 2003
reserve were due to increases in frequency factors driven by
changes in the composition of the default inventory, including
more pending claims than assumed originally in the reserving
model. Pending and ultimately paid claims increased in 2005 and
2004 over the Companys estimates due to the assumptions
regarding the seasoning of the business and the impact of the
significant refinancing in 2003 and 2004.
79
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The Company leases certain office facilities, autos, and
equipment under operating leases. Rental expense for all leases
was $2,102,000, $2,058,000, and $2,061,000, for 2006, 2005 and
2004, respectively. Future minimum payments under noncancellable
operating leases at December 31, 2006, are as follows (in
thousands):
|
|
|
|
|
2007
|
|
|
2,267
|
|
2008
|
|
|
2,144
|
|
2009
|
|
|
1,653
|
|
2010
|
|
|
1,466
|
|
2011
|
|
|
1,471
|
|
Thereafter
|
|
|
1,377
|
|
|
|
|
|
|
|
|
$
|
10,378
|
|
|
|
|
|
|
The Company leases facilities for its corporate headquarters
under an operating lease that is to expire in 2012. The Company
has options to renew this lease for up to ten additional years
at the fair market rental rate at the time of the renewal.
Income tax expense differed from the amounts computed by
applying the Federal statutory income tax rate to income before
taxes as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Income tax computed at statutory
rate
|
|
$
|
31,612
|
|
|
$
|
27,267
|
|
|
$
|
28,662
|
|
(Decrease) increase in taxes
resulting from:
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax-exempt interest
|
|
|
(8,330
|
)
|
|
|
(7,199
|
)
|
|
|
(6,048
|
)
|
Other
|
|
|
1,402
|
|
|
|
1,025
|
|
|
|
860
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
$
|
24,684
|
|
|
$
|
21,093
|
|
|
$
|
23,474
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
80
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The tax effects of temporary differences that give rise to
significant portions of deferred tax assets and deferred tax
liabilities at December 31, 2006 and 2005, are presented
below:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Deferred tax
liabilities
|
|
|
|
|
|
|
|
|
Contingency loss reserve deduction
|
|
$
|
160,103
|
|
|
$
|
137,512
|
|
Deferred policy acquisition costs
|
|
|
12,300
|
|
|
|
11,789
|
|
Unrealized investment gain
|
|
|
6,471
|
|
|
|
5,980
|
|
Other
|
|
|
2,646
|
|
|
|
2,260
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
181,520
|
|
|
|
157,541
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
Unearned premiums
|
|
|
2,835
|
|
|
|
1,026
|
|
Losses and loss adjustment expenses
|
|
|
1,640
|
|
|
|
1,017
|
|
Other
|
|
|
562
|
|
|
|
309
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
5,037
|
|
|
|
2,352
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax liability
|
|
$
|
176,483
|
|
|
$
|
155,189
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2006, Triad had purchased $5,539,000 of Tax
and Loss Bonds in excess of its current obligations.
|
|
7.
|
Insurance
in Force, Dividend Restriction, and Statutory Results
|
At December 31, 2006, approximately 58% of Triads
direct risk in force was concentrated in 10 states, with
approximately 14% in California, 11% in Florida, 7% in Texas, 5%
in Arizona, 4% each in Illinois, North Carolina and Georgia, and
3% each in Colorado, Virginia, and New Jersey. While Triad
continues to diversify its risk in force geographically, a
prolonged economic deterioration in its high concentration areas
could result in higher incurred losses and loss adjustment
expenses.
Insurance regulations limit the writing of mortgage guaranty
insurance to an aggregate amount of insured risk no greater than
twenty-five times the total of statutory capital and surplus and
the statutory contingency reserve. The amount of net risk for
insurance in force at December 31, 2006 and 2005 as
presented below, was computed by applying the various percentage
settlement options to the insurance in force amounts, adjusted
by risk ceded under reinsurance agreements, any applicable
aggregate stop-loss limits and deductibles. Triads ratio
is as follows:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands, except ratio)
|
|
|
Net risk
|
|
$
|
8,612,912
|
|
|
$
|
7,312,697
|
|
|
|
|
|
|
|
|
|
|
Statutory capital and surplus
|
|
$
|
168,439
|
|
|
$
|
131,582
|
|
Contingency reserve
|
|
|
521,836
|
|
|
|
447,826
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
690,275
|
|
|
$
|
579,408
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital
ratio
|
|
|
12.5 to 1
|
|
|
|
12.6 to 1
|
|
|
|
|
|
|
|
|
|
|
Triad and its wholly-owned subsidiaries, TGAC and Triad Re, are
each required under their respective domiciliary states
insurance code to maintain a minimum level of statutory capital
and surplus. Triad, an Illinois domiciled insurer, is required
under the Illinois Insurance Code (the Code) to
maintain minimum capital and surplus of $5,000,000.
81
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The Code permits dividends to be paid only out of earned surplus
and also requires prior approval of extraordinary dividends. An
extraordinary dividend is any dividend or distribution of cash
or other property, the fair market value of which, together with
that of other dividends or distributions made within a period of
twelve consecutive months, exceeds the greater of (a) ten
percent of statutory surplus as regards policyholders or
(b) statutory net income for the calendar year preceding
the date of the dividend. Net income as determined in accordance
with statutory accounting practices was $88,303,000,
$77,083,000, and $78,202,000, for the years ended
December 31, 2006, 2005 and 2004, respectively. At
December 31, 2006, the amount of the Companys equity
that can be paid out in dividends to the stockholders is
$84,723,000, which is the earned surplus of Triad on a statutory
basis.
|
|
8.
|
Related
Party Transactions
|
The Company pays companies affiliated through common ownership
for investment and other expenses. The total expense incurred
for such items was $78,000, $307,000 and $869,000 in 2006, 2005
and 2004, respectively. The decline in the expense incurred in
2006 and 2005 from 2004 represents the outsourcing of a
significant amount of the investment services to a third party.
Most of the Companys employees are eligible to participate
in its 401(k) Profit Sharing Plan. Under the plan, employees
elect to defer a portion of their wages, with the Company
matching deferrals at the rate of 50% of the first 8% of the
employees salary deferred. The Companys expense
associated with the plan totaled $529,000, $476,000, and
$463,000 for the years ended December 31, 2006, 2005 and
2004, respectively.
Certain premiums and losses are assumed from and ceded to other
insurance companies under various reinsurance agreements. The
ceding agreements principally provide Triad with increased
capacity to write business and achieve a more favorable
geographic dispersion of risk.
The effects of reinsurance for the years ended December 31,
2006, 2005 and 2004 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Earned premiums:
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
257,006
|
|
|
$
|
209,708
|
|
|
$
|
176,383
|
|
Assumed
|
|
|
1
|
|
|
|
1
|
|
|
|
1
|
|
Ceded
|
|
|
(46,151
|
)
|
|
|
(40,712
|
)
|
|
|
(35,392
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
$
|
210,856
|
|
|
$
|
168,997
|
|
|
$
|
140,992
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss adjustment
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
94,229
|
|
|
$
|
66,852
|
|
|
$
|
35,876
|
|
Assumed
|
|
|
(3
|
)
|
|
|
4
|
|
|
|
(14
|
)
|
Ceded
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment
expenses
|
|
$
|
94,227
|
|
|
$
|
66,855
|
|
|
$
|
35,864
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company cedes business to captive reinsurance subsidiaries
or affiliates of certain mortgage lenders (captives)
primarily under excess of loss reinsurance agreements.
Reinsurance recoverables on loss reserves and unearned premiums
ceded to these captives are backed by trust funds or letters of
credit.
82
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
At December 31, 2006, the Company maintained $100,000,000
of excess of loss reinsurance through non-affiliated reinsurers.
The excess of loss reinsurance agreements are designed to
protect the Company in the event of a catastrophic level of
losses.
Reinsurance contracts do not relieve Triad from its obligations
to policyholders. Failure of the reinsurer to honor its
obligation could result in losses to Triad; consequently,
allowances are established for amounts deemed uncollectible.
Triad evaluates the financial condition of its reinsurers and
monitors credit risk arising from similar geographic regions,
activities, or economic characteristics of its reinsurers to
minimize its exposure to significant losses from reinsurer
insolvency.
|
|
11.
|
Long-Term
Stock Incentive Plan
|
In May 2006, the Companys shareholders approved the 2006
Long-Term Stock Incentive Plan (the Plan). Under the
Plan, certain directors, officers, and key employees are
eligible to receive various share-based compensation awards.
Stock options, restricted stock and phantom stock rights may be
awarded under the Plan for a fixed number of shares with a
requirement for stock options granted to have an exercise price
equal to or greater than the fair value of the shares at the
date of grant. Generally, most awards vest over three years.
Options granted under the Plan expire no later than ten years
following the date of grant. In May 2006, the Companys
shareholders also approved the termination as to future awards
of the 1993 Long-Term Stock Incentive Plan, which was structured
similar to the 2006 Long-Term Stock Incentive Plan. Upon
termination, 86,024 shares available for issuance under the
1993 Long-Term Stock Incentive Plan were merged into the Plan.
The number of shares authorized to be granted or issued through
equity awards under the Plan is 1,091,400. As of
December 31, 2006, 1,649,637 shares were reserved
(including 690,370 shares granted as part of the 1993
Long-Term Stock Incentive Plan that have not been exercised or
vested) and 1,084,925 shares were available for issuance
under the Plan. For the year ended December 31, 2006, the
Company recognized gross compensation expense of $3,476,000
along with a related tax benefit of $1,217,000 related to
share-based compensation. In addition, the Company capitalized
compensation expense related to share-based compensation of
$566,000 as part of deferred acquisition costs for the year
ended December 31, 2006.
A summary of option activity under the Plan for the year ended
December 31, 2006 is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Average Exercise
|
|
|
Aggregate
|
|
|
Remaining
|
|
|
|
Number of Shares
|
|
|
Price
|
|
|
Intrinsic Value
|
|
|
Contractual Term
|
|
|
|
|
|
|
(In thousands)
|
|
|
Outstanding, January 1, 2006
|
|
|
588,780
|
|
|
$
|
37.21
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
15,594
|
|
|
|
44.79
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
35,142
|
|
|
|
21.28
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
4,520
|
|
|
|
43.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2006
|
|
|
564,712
|
|
|
|
38.36
|
|
|
$
|
9,379
|
|
|
|
4.6 years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable, December 31, 2006
|
|
|
432,603
|
|
|
|
37.19
|
|
|
$
|
7,684
|
|
|
|
3.4 years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of stock options is estimated on the date of
grant using a Black-Scholes pricing model. The weighted-average
assumptions used for options granted during the years ended
December 31, 2006, 2005 and 2004 are noted in the following
table. The expected volatilities are based on volatility of the
Companys stock over the most recent historical period
corresponding to the expected term of the options. The Company
also uses historical data to estimate option exercise and
employee terminations within the model; separate groups of
employees with
83
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
similar historical exercise and termination histories are
considered separately for valuation purposes. The risk-free
rates for the periods corresponding to the expected terms of the
options are based on U.S. Treasury rates in effect on the
dates of grant.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Expected volatility
|
|
|
33.7
|
%
|
|
|
34.0
|
%
|
|
|
40.0
|
%
|
Expected dividend yield
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Expected term
|
|
|
5.0 years
|
|
|
|
7.7 years
|
|
|
|
7.0 years
|
|
Risk-free rate
|
|
|
4.5
|
%
|
|
|
4.1
|
%
|
|
|
3.6
|
%
|
The weighted-average grant-date fair value of options granted
during the years ended December 31, 2006, 2005 and 2004 was
$16.81, $19.79 and $25.55, respectively. The total intrinsic
value of options exercised during the years ended
December 31, 2006, 2005 and 2004 was approximately
$0.9 million, $5.0 million and $5.7 million,
respectively.
A summary of restricted stock and phantom stock rights activity
under the Plan for the year ended December 31, 2006 is
presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average
|
|
|
|
Number of Shares
|
|
|
Grant-Date Fair Value
|
|
|
Nonvested, January 1, 2006
|
|
|
101,415
|
|
|
$
|
46.93
|
|
Granted
|
|
|
84,025
|
|
|
|
45.74
|
|
Vested
|
|
|
34,264
|
|
|
|
47.09
|
|
Canceled
|
|
|
37,235
|
|
|
|
44.14
|
|
|
|
|
|
|
|
|
|
|
Nonvested, December 31, 2006
|
|
|
113,941
|
|
|
|
46.41
|
|
|
|
|
|
|
|
|
|
|
The fair value of restricted stock and phantom stock rights are
determined based on the closing price of the Companys
shares on the grant date. The weighted-average grant-date fair
value of restricted stock and phantom stock rights granted
during the years ended December 31, 2006, 2005 and 2004 was
$45.74, $47.45 and $53.88, respectively.
As of December 31, 2006, there was $4.7 million of
unrecognized compensation expense related to nonvested stock
options, restricted stock, and phantom stock rights granted
under the Plan. That expense is expected to be recognized over a
weighted-average period of 1.8 years. The total fair value
of stock options, restricted stock and phantom stock rights
vested during the years ended December 31, 2006, 2005 and
2004 was $2.0 million, $2.2 million and
$1.9 million, respectively.
The Company issues new shares upon exercise of stock options and
phantom stock rights.
In 1998, the Company completed a $35,000,000 private offering of
notes due January 15, 2028. Proceeds from the offering, net
of debt issue costs, totaled $34,453,000. The notes, which
represent unsecured obligations of the Company, bear interest at
a rate of 7.9% per annum and are non-callable.
84
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
13.
|
Fair
Value of Financial Instruments
|
The carrying values and fair values of financial instruments as
of December 31, 2006 and 2005 are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
Carrying
|
|
|
Fair
|
|
|
Carrying
|
|
|
Fair
|
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
Financial Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities
available-for-sale
|
|
$
|
586,594
|
|
|
$
|
586,594
|
|
|
$
|
534,064
|
|
|
$
|
534,064
|
|
Equity securities
available-for-sale
|
|
|
10,417
|
|
|
|
10,417
|
|
|
|
8,159
|
|
|
|
8,159
|
|
Other investments
|
|
|
5,000
|
|
|
|
5,000
|
|
|
|
|
|
|
|
|
|
Financial Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
|
34,510
|
|
|
|
39,231
|
|
|
|
34,501
|
|
|
|
40,514
|
|
The fair values of cash, cash equivalents and short-term
investments approximate their carrying values due to their
short-term maturity or availability.
The fair values of fixed maturity securities and equity
securities have been determined using quoted market prices for
securities traded in the public market or prices using bid or
closing prices for securities not traded in the public
marketplace.
Other investments represent investments in equity securities for
which there is no readily determinable market value. The fair
values of other investments approximate their cost.
The fair value of the Companys long-term debt is estimated
using discounted cash flow analysis based on the Companys
current incremental borrowing rates for similar types of
borrowing arrangements.
A lawsuit was filed against the Company in January 2004 in the
ordinary course of the Companys business alleging
violations of the Fair Credit Reporting Act. The Company is
vigorously defending the lawsuit. In the opinion of management,
the ultimate resolution of this pending litigation will not have
a material adverse effect on the financial position or results
of operations of the Company.
85
TRIAD
GUARANTY INC.
NOTES TO
CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
15.
|
Unaudited
Quarterly Financial Data
|
The following is a summary of the unaudited quarterly results of
operations for the years ended December 31, 2006 and 2005.
The sum of the quarterly basic earnings per share may not equal
the amount for the year as the basis for calculating average
outstanding number of shares differs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006 Quarter
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
Year
|
|
|
|
(In thousands, except per share data)
|
|
|
Net premiums written
|
|
$
|
48,342
|
|
|
$
|
49,358
|
|
|
$
|
53,903
|
|
|
$
|
58,963
|
|
|
$
|
210,566
|
|
Change in unearned premiums
|
|
|
(452
|
)
|
|
|
1,309
|
|
|
|
174
|
|
|
|
(741
|
)
|
|
|
290
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
|
47,890
|
|
|
|
50,667
|
|
|
|
54,077
|
|
|
|
58,222
|
|
|
|
210,856
|
|
Net investment income
|
|
|
6,222
|
|
|
|
6,535
|
|
|
|
6,761
|
|
|
|
7,178
|
|
|
|
26,696
|
|
Net losses incurred
|
|
|
16,351
|
|
|
|
17,271
|
|
|
|
19,305
|
|
|
|
41,300
|
|
|
|
94,227
|
|
Underwriting and other expenses
|
|
|
13,068
|
|
|
|
13,308
|
|
|
|
14,081
|
|
|
|
14,141
|
|
|
|
54,598
|
|
Net income
|
|
|
18,553
|
|
|
|
19,587
|
|
|
|
19,392
|
|
|
|
8,103
|
|
|
|
65,635
|
|
Basic earnings per share
|
|
|
1.26
|
|
|
|
1.33
|
|
|
|
1.31
|
|
|
|
0.55
|
|
|
|
4.44
|
|
Diluted earnings per share
|
|
|
1.25
|
|
|
|
1.31
|
|
|
|
1.30
|
|
|
|
0.54
|
|
|
|
4.40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 Quarter
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
Year
|
|
|
|
(In thousands, except per share data)
|
|
|
Net premiums written
|
|
$
|
38,711
|
|
|
$
|
40,611
|
|
|
$
|
42,973
|
|
|
$
|
44,321
|
|
|
$
|
166,616
|
|
Change in unearned premiums
|
|
|
66
|
|
|
|
510
|
|
|
|
1,155
|
|
|
|
650
|
|
|
|
2,381
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
|
38,777
|
|
|
|
41,121
|
|
|
|
44,128
|
|
|
|
44,971
|
|
|
|
168,997
|
|
Net investment income
|
|
|
5,415
|
|
|
|
5,743
|
|
|
|
5,896
|
|
|
|
5,944
|
|
|
|
22,998
|
|
Net losses incurred
|
|
|
10,630
|
|
|
|
17,288
|
|
|
|
16,958
|
|
|
|
21,979
|
|
|
|
66,855
|
|
Underwriting and other expenses
|
|
|
11,567
|
|
|
|
11,405
|
|
|
|
11,902
|
|
|
|
12,411
|
|
|
|
47,285
|
|
Net income
|
|
|
15,760
|
|
|
|
13,199
|
|
|
|
15,294
|
|
|
|
12,560
|
|
|
|
56,813
|
|
Basic earnings per share
|
|
|
1.08
|
|
|
|
0.90
|
|
|
|
1.04
|
|
|
|
0.85
|
|
|
|
3.87
|
|
Diluted earnings per share
|
|
|
1.07
|
|
|
|
0.89
|
|
|
|
1.03
|
|
|
|
0.85
|
|
|
|
3.84
|
|
86
SCHEDULE I
SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN
RELATED PARTIES
TRIAD GUARANTY INC.
December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount at
|
|
|
|
Cost or
|
|
|
|
|
|
Which Shown
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
in Balance
|
|
Type of Investment
|
|
Cost
|
|
|
Value
|
|
|
Sheet
|
|
|
|
(In thousands)
|
|
|
Fixed maturity securities,
available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
Bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Government obligations
|
|
$
|
12,119
|
|
|
$
|
11,842
|
|
|
$
|
11,842
|
|
Mortgage-backed securities
|
|
|
46
|
|
|
|
49
|
|
|
|
49
|
|
State and municipal bonds
|
|
|
541,389
|
|
|
|
558,131
|
|
|
|
558,131
|
|
Corporate bonds
|
|
|
15,438
|
|
|
|
16,572
|
|
|
|
16,572
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
568,992
|
|
|
|
586,594
|
|
|
|
586,594
|
|
Equity securities,
available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stocks
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank, trust, and insurance
|
|
|
613
|
|
|
|
739
|
|
|
|
739
|
|
Public utilities
|
|
|
146
|
|
|
|
173
|
|
|
|
173
|
|
Industrial and miscellaneous
|
|
|
4,027
|
|
|
|
4,630
|
|
|
|
4,630
|
|
Preferred stock
|
|
|
4,744
|
|
|
|
4,875
|
|
|
|
4,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
9,530
|
|
|
|
10,417
|
|
|
|
10,417
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other investments
|
|
|
5,000
|
|
|
|
5,000
|
|
|
|
5,000
|
|
Short-term investments
|
|
|
5,301
|
|
|
|
5,301
|
|
|
|
5,301
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments other than
investments in related parties
|
|
$
|
588,823
|
|
|
$
|
607,312
|
|
|
$
|
607,312
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
87
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
TRIAD GUARANTY INC.
(Parent Company)
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
ASSETS:
|
Fixed maturities,
available-for-sale
|
|
$
|
30,021
|
|
|
$
|
32,250
|
|
Equity securities,
available-for-sale
|
|
|
251
|
|
|
|
252
|
|
Notes receivable from subsidiary
|
|
|
25,000
|
|
|
|
25,000
|
|
Investment in subsidiary
|
|
|
547,220
|
|
|
|
478,310
|
|
Short-term investments
|
|
|
213
|
|
|
|
681
|
|
Other invested assets
|
|
|
5,000
|
|
|
|
|
|
Cash
|
|
|
1,880
|
|
|
|
1,996
|
|
Accrued investment income
|
|
|
1,513
|
|
|
|
1,532
|
|
Income taxes recoverable
|
|
|
37
|
|
|
|
176
|
|
Other assets
|
|
|
|
|
|
|
95
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
611,135
|
|
|
$
|
540,292
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND
STOCKHOLDERS EQUITY:
|
Liabilities:
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
$
|
34,510
|
|
|
$
|
34,501
|
|
Accrued interest on long-term debt
|
|
|
1,275
|
|
|
|
1,275
|
|
Deferred income taxes
|
|
|
5,102
|
|
|
|
5,305
|
|
Accrued expenses and other
liabilities
|
|
|
24
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
40,911
|
|
|
|
41,101
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
Common stock
|
|
|
149
|
|
|
|
148
|
|
Additional paid-in capital
|
|
|
104,981
|
|
|
|
103,657
|
|
Accumulated other comprehensive
income
|
|
|
12,018
|
|
|
|
11,106
|
|
Deferred compensation
|
|
|
|
|
|
|
(3,161
|
)
|
Retained earnings
|
|
|
453,076
|
|
|
|
387,441
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
570,224
|
|
|
|
499,191
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders equity
|
|
$
|
611,135
|
|
|
$
|
540,292
|
|
|
|
|
|
|
|
|
|
|
See supplementary notes to condensed financial statements.
88
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF INCOME
TRIAD GUARANTY INC.
(Parent Company)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
3,712
|
|
|
$
|
3,510
|
|
|
$
|
3,251
|
|
Realized investment gains (losses)
|
|
|
(185
|
)
|
|
|
(87
|
)
|
|
|
142
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,527
|
|
|
|
3,423
|
|
|
|
3,393
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest on long-term debt
|
|
|
2,774
|
|
|
|
2,772
|
|
|
|
2,772
|
|
Operating expenses
|
|
|
3,489
|
|
|
|
1,783
|
|
|
|
1,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,263
|
|
|
|
4,555
|
|
|
|
4,002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before federal income taxes
and equity in undistributed income of subsidiary
|
|
|
(2,736
|
)
|
|
|
(1,132
|
)
|
|
|
(609
|
)
|
Income tax expense (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
176
|
|
|
|
|
|
|
|
28
|
|
Deferred
|
|
|
(676
|
)
|
|
|
(505
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(500
|
)
|
|
|
(505
|
)
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before equity in
undistributed income of subsidiary
|
|
|
(2,236
|
)
|
|
|
(627
|
)
|
|
|
(637
|
)
|
Equity in undistributed income of
subsidiary
|
|
|
67,871
|
|
|
|
57,440
|
|
|
|
59,054
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
65,635
|
|
|
$
|
56,813
|
|
|
$
|
58,417
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See supplementary notes to condensed financial statements.
89
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
TRIAD GUARANTY INC.
(Parent Company)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In thousands)
|
|
|
Operating Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
65,635
|
|
|
$
|
56,813
|
|
|
$
|
58,417
|
|
Adjustments to reconcile net
income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in undistributed income of
subsidiary
|
|
|
(67,871
|
)
|
|
|
(57,440
|
)
|
|
|
(59,054
|
)
|
Accrued investment income
|
|
|
19
|
|
|
|
(50
|
)
|
|
|
(174
|
)
|
Other assets
|
|
|
95
|
|
|
|
1,156
|
|
|
|
(823
|
)
|
Deferred income taxes
|
|
|
(676
|
)
|
|
|
(505
|
)
|
|
|
|
|
Current taxes
|
|
|
139
|
|
|
|
963
|
|
|
|
(1,139
|
)
|
Accretion of discount on
investments
|
|
|
3
|
|
|
|
2
|
|
|
|
(61
|
)
|
Amortization of deferred
compensation
|
|
|
3,476
|
|
|
|
1,788
|
|
|
|
1,232
|
|
Amortization of debt issue costs
|
|
|
9
|
|
|
|
8
|
|
|
|
7
|
|
Realized investment (gains) losses
on securities
|
|
|
185
|
|
|
|
87
|
|
|
|
(142
|
)
|
Other liabilities
|
|
|
4
|
|
|
|
(50
|
)
|
|
|
70
|
|
Other operating activities
|
|
|
16
|
|
|
|
2,049
|
|
|
|
3,595
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
1,034
|
|
|
|
4,821
|
|
|
|
1,928
|
|
Investing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases
|
|
|
(9,079
|
)
|
|
|
(8,795
|
)
|
|
|
(10,246
|
)
|
Sales and maturities
|
|
|
11,428
|
|
|
|
641
|
|
|
|
3,319
|
|
Equity Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
|
|
|
|
163
|
|
|
|
|
|
Purchases of other assets
|
|
|
(5,000
|
)
|
|
|
|
|
|
|
|
|
Change in short-term investments
|
|
|
468
|
|
|
|
161
|
|
|
|
1,722
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(2,183
|
)
|
|
|
(7,830
|
)
|
|
|
(5,205
|
)
|
Financing Activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Excess tax benefits related to
share based payments
|
|
|
286
|
|
|
|
|
|
|
|
|
|
Proceeds from exercise of stock
options
|
|
|
747
|
|
|
|
3,269
|
|
|
|
3,741
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing
activities
|
|
|
1,033
|
|
|
|
3,269
|
|
|
|
3,741
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in cash
|
|
|
(116
|
)
|
|
|
260
|
|
|
|
464
|
|
Cash at beginning of year
|
|
|
1,996
|
|
|
|
1,736
|
|
|
|
1,272
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash at end of year
|
|
$
|
1,880
|
|
|
$
|
1,996
|
|
|
$
|
1,736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See supplementary notes to condensed financial statements.
90
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TRIAD GUARANTY INC.
(Parent Company)
SUPPLEMENTARY NOTES
|
|
1.
|
Basis of
Presentation and Significant Accounting Policies
|
In the parent company financial statements, the Companys
investment in its subsidiaries is stated at cost plus equity in
undistributed earnings of the subsidiaries. The Companys
share of net income of its subsidiaries is included in income
using the equity method. The accompanying Parent Company
financial statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated
Financial Statements included as part of this Form 10-K.
Triad Guaranty Inc. (the Company) is a holding
company which, through its wholly-owned subsidiary, Triad
Guaranty Insurance Corporation (Triad), provides
private mortgage insurance coverage in the United States to
mortgage lenders to protect the lender against loss from
defaults on mortgage loans.
The cost or amortized cost and the fair value of investments,
other than the investment in its subsidiary held by the parent
company, is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
At December 31, 2006
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
$
|
500
|
|
|
$
|
11
|
|
|
$
|
|
|
|
$
|
511
|
|
Municipal
|
|
|
28,286
|
|
|
|
1,232
|
|
|
|
(8
|
)
|
|
|
29,510
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
28,786
|
|
|
|
1,243
|
|
|
|
(8
|
)
|
|
|
30,021
|
|
Equity securities
|
|
|
250
|
|
|
|
1
|
|
|
|
|
|
|
|
251
|
|
Other investments
|
|
|
5,000
|
|
|
|
|
|
|
|
|
|
|
|
5,000
|
|
Short-term investments
|
|
|
213
|
|
|
|
|
|
|
|
|
|
|
|
213
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
34,249
|
|
|
$
|
1,244
|
|
|
$
|
(8
|
)
|
|
$
|
35,485
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
91
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TRIAD GUARANTY INC.
(Parent Company)
SUPPLEMENTARY NOTES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
At December 31, 2005
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
$
|
499
|
|
|
$
|
21
|
|
|
$
|
|
|
|
$
|
520
|
|
U.S. Government
|
|
|
250
|
|
|
|
|
|
|
|
9
|
|
|
|
241
|
|
Municipal
|
|
|
30,560
|
|
|
|
1,044
|
|
|
|
115
|
|
|
|
31,489
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
31,309
|
|
|
|
1,065
|
|
|
|
124
|
|
|
|
32,250
|
|
Equity securities
|
|
|
250
|
|
|
|
2
|
|
|
|
|
|
|
|
252
|
|
Short-term investments
|
|
|
681
|
|
|
|
|
|
|
|
|
|
|
|
681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
32,240
|
|
|
$
|
1,067
|
|
|
$
|
124
|
|
|
$
|
33,183
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Major categories of the parent companys investment income
are summarized as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
Income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
1,396
|
|
|
$
|
1,309
|
|
|
$
|
1,017
|
|
Equity securities
|
|
|
18
|
|
|
|
32
|
|
|
|
36
|
|
Cash and short-term investments
|
|
|
82
|
|
|
|
36
|
|
|
|
6
|
|
Note receivable from subsidiary
|
|
|
2,240
|
|
|
|
2,231
|
|
|
|
2,225
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,736
|
|
|
|
3,608
|
|
|
|
3,284
|
|
Expenses
|
|
|
24
|
|
|
|
98
|
|
|
|
33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
3,712
|
|
|
$
|
3,510
|
|
|
$
|
3,251
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 1998, the Company completed a $35,000,000 private offering of
notes due January 15, 2028. Proceeds from the offering, net
of debt issue costs, totaled $34,453,000. The notes, which
represent unsecured obligations of the Company, bear interest at
a rate of 7.9% per annum and are non-callable.
92
SCHEDULE IV
REINSURANCE
TRIAD GUARANTY INC.
MORTGAGE INSURANCE PREMIUM EARNED
Years Ended December 31, 2006, 2005 and 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ceded To
|
|
|
Assumed
|
|
|
|
|
|
Percentage of
|
|
|
|
Gross
|
|
|
Other
|
|
|
From Other
|
|
|
Net
|
|
|
Amount Assumed
|
|
|
|
Amount
|
|
|
Companies
|
|
|
Companies
|
|
|
Amount
|
|
|
to Net
|
|
|
|
(In thousands)
|
|
|
2006
|
|
$
|
257,006
|
|
|
$
|
46,151
|
|
|
$
|
1
|
|
|
$
|
210,856
|
|
|
|
0.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
$
|
209,708
|
|
|
$
|
40,712
|
|
|
$
|
1
|
|
|
$
|
168,997
|
|
|
|
0.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
$
|
176,383
|
|
|
$
|
35,392
|
|
|
$
|
1
|
|
|
$
|
140,992
|
|
|
|
0.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
93