|Edgar Online, Inc.|
Through our subsidiaries MGIC and MIC, we are the leading provider of private mortgage insurance in
the United States, as measured by insurance in force, to the home mortgage lending industry. As used below, "we" and "our" refer to MGIC Investment Corporation'sconsolidated operations. The discussion below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2011. We refer to this Discussion as the "10-K MD&A." In the discussion below, we classify, in accordance with industry practice, as "full documentation" loans approved by GSE and other automated underwriting systems under "doc waiver" programs that do not require verification of borrower income. For additional information about such loans, see footnote (3) to the composition of primary default inventory table under "Results of Consolidated Operations-Losses-Losses incurred" below. The discussion of our business in this document generally does not apply to our Australian operations which have historically been immaterial. The results of our operations in Australiaare included in the consolidated results disclosed. For additional information about our Australian operations, see our risk factor titled "Our Australian operations may suffer significant losses" and "Overview-Australia" in our 10-K MD&A.
Forward Looking and Other Statements
As discussed under "Forward Looking Statements and Risk Factors" below, actual results may differ materially from the results contemplated by forward looking statements. We are not undertaking any obligation to update any forward looking statements or other statements we may make in the following discussion or elsewhere in this document even though these statements may be affected by events or circumstances occurring after the forward looking statements or other statements were made. Therefore no reader of this document should rely on these statements being current as of any time other than the time at which this document was filed with the
Securities and Exchange Commission.
At this time, we are facing the following particularly significant challenges:
· Whether we may continue to write insurance on new residential mortgage loans
due to actions our regulators or the GSEs could take based upon our capital
position or based upon their projections of future deterioration in our capital position. This challenge is discussed under "Capital" below. 53
· Whether we will prevail in legal proceedings challenging whether our
rescissions were proper or if we enter into material resolution arrangements.
For additional information about this challenge and other potentially
significant challenges that we face, see "Rescissions" below as well as our
risk factors titled "Our losses could increase if rescission rates decrease
faster than we are projecting, we do not prevail in proceedings challenging
whether our rescissions were proper or we enter into material resolution
arrangements," "We are defendants in private and government litigation and are
subject to the risk of additional private litigation, government litigation
and regulatory proceedings in the future" and "Resolution of our dispute with
these matters would negatively impact our capital position. See discussion of
this challenge under "Capital" below. · Whether private mortgage insurance will remain a significant credit enhancement alternative for low down payment single family mortgages. A
definition of "qualified residential mortgages" ("QRM") that significantly
impacts the volume of low down payment mortgages available to be insured or a
possible restructuring or change in the charters of the GSEs could
significantly affect our business. This challenge is discussed under
"Qualified Residential Mortgages" and "GSE Reform" below. For another factor
that could decrease the demand for mortgage insurance see our risk factor
titled "The implementation of the Basel III capital accord, or other changes
to our customers' capital requirements, may discourage the use of mortgage
insurance." Capital Insurance regulators The insurance laws of 16 jurisdictions, including
Wisconsin, our domiciliary state, require a mortgage insurer to maintain a minimum amount of statutory capital relative to the risk in force (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the "Capital Requirements." New insurance written in the jurisdictions that have Capital Requirements represented approximately 50% of new insurance written in 2011 and the first nine months of 2012. While formulations of minimum capital vary among jurisdictions, the most common formulation allows for a maximum risk-to-capital ratio of 25 to 1. A risk-to-capital ratio will increase if the percentage decrease in capital exceeds the percentage decrease in insured risk. Therefore, as capital decreases, the same dollar decrease in capital will cause a greater percentage decrease in capital and a greater increase in the risk-to-capital ratio. Wisconsindoes not regulate capital by using a risk-to-capital measure but instead requires a minimum policyholder position ("MPP"). The "policyholder position" of a mortgage insurer is its net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums. At September 30, 2012, MGIC's preliminary risk-to-capital ratio was 31.5 to 1, exceeding the maximum allowed by many jurisdictions, and its preliminary policyholder position was $344 millionbelow the required MPP of $1.3 billion. We expect MGIC's risk-to-capital ratio to increase and to continue to exceed 25 to 1. At September 30, 2012, the preliminary risk-to-capital ratio of our combined insurance operations (which includes reinsurance affiliates) was 34.1 to 1. A higher risk-to-capital ratio on a combined basis may indicate that, in order for MGIC or MIC to continue to utilize reinsurance arrangements with its subsidiaries or subsidiaries of our holding company, additional capital contributions to the reinsurance affiliates could be needed. These reinsurance arrangements permit MGIC and MIC to write insurance with a higher coverage percentage than they could on their own under certain state-specific requirements. 54
Under Statement of Statutory Accounting Principles No. 101 ("SSAP No. 101"), which became effective
January 1, 2012, MGIC received no benefit to statutory capital at June 30, 2012for deferred tax assets because MGIC's risk-to-capital ratio exceeded 25 to 1 before considering those assets. The exclusion of deferred tax assets at June 30, 2012, negatively impacted our statutory capital. Under a permitted practice effective September 30, 2012and until further notice, the Office of the Commissioner of Insurance of the State of Wisconsin("OCI") has approved MGIC to report its net deferred tax asset as an admitted asset in an amount not to exceed 10% of surplus as regards policyholders, notwithstanding contrary provisions of SSAP No. 101. At September 30, 2012, pursuant to the permitted practice, deferred tax assets of $90 millionwere included in statutory capital. Although MGIC does not meet the Capital Requirements of Wisconsin, the OCI has waived them until December 31, 2013. In place of the Capital Requirements, the OCI Order containing the waiver of Capital Requirements (the "OCI Order") provides that MGIC can write new business as long as it maintains regulatory capital that the OCI determines is reasonably in excess of a level that would constitute a financially hazardous condition. The OCI Order requires MGIC Investment Corporation, beginning January 1, 2012and continuing through the earlier of December 31, 2013and the termination of the OCI Order (the "Covered Period"), to make cash equity contributions to MGIC as may be necessary so that its "Liquid Assets" are at least $1 billion(this portion of the OCI Order is referred to as the "Keepwell Provision"). "Liquid Assets," which include those of MGIC as well as those held in certain of our subsidiaries, excluding MIC and its reinsurance affiliates, are the sum of (i) the aggregate cash and cash equivalents, (ii) fair market value of investments and (iii) assets held in trusts supporting the obligations of captive mortgage reinsurers to MGIC. As of September 30, 2012, "Liquid Assets" were approximately $5.1 billion. Although we do not expect that MGIC's Liquid Assets will fall below $1 billionduring the Covered Period, we do expect the amount of Liquid Assets to continue to decline materially after September 30, 2012and through the end of the Covered Period as MGIC's claim payments and other uses of cash continue to exceed cash generated from operations. For more information about factors that could negatively impact MGIC's Liquid Assets, see our risk factors titled "We are defendants in private and government litigation and are subject to the risk of additional private litigation, government litigation and regulatory proceedings in the future," "We have reported net losses for the last five years, expect to continue to report annual net losses, and cannot assure you when we will return to profitability" and "Resolution of our dispute with the Internal Revenue Servicecould adversely affect us ." MGIC applied for waivers in the other jurisdictions with Capital Requirements and, at this time, has active waivers from eight of them, two of which allow a maximum risk-to-capital ratio that we expect to exceed in the fourth quarter of 2012. Four jurisdictions have either denied our request for waivers, have laws that do not allow for waivers or have granted waivers allowing risk-to-capital ratios that MGIC has exceeded. We are awaiting a response from three other jurisdictions, some of which may deny our request. As part of our longstanding plan to write new business in MIC, a direct subsidiary of MGIC, and pursuant to the OCI Order, MGIC has made capital contributions to MIC, with $200 millioncontributed in January 2012. As of September 30, 2012, MIC had statutory capital of $443 million. In the third quarter of 2012, we began writing new mortgage insurance in MIC on the same policy terms as MGIC, in those jurisdictions where we did not have active waivers of Capital Requirements for MGIC. In the third quarter of 2012, MIC's new insurance written was $587 million, which includes business from certain jurisdictions for which new insurance is again being written in MGIC after it received the necessary waivers, but excludes business in certain jurisdictions in which we expect MIC to write new insurance in the fourth quarter of 2012, after MGIC exceeds the risk-to-capital ratio limit included in the jurisdictions' waivers. With the $443 millionof statutory capital in MIC, we have the capacity to write 100% of our new insurance written in MIC for at least five years at current quality and volume levels of new insurance written if we obtained GSE approval to do so. We are currently writing new mortgage insurance in MIC in Florida, Idaho, New Jersey, New York, Ohio, Puerto Ricoand Texas. MIC is licensed to write business in all jurisdictions and, subject to the conditions and restrictions discussed below, has received the necessary approvals from Fannie Mae and Freddie Mac (the "GSEs") and the OCI to write business in all of the jurisdictions that have not waived their Capital Requirements for MGIC. 55
Under an agreement in place with Fannie Mae, MIC will be eligible to write mortgage insurance through
December 31, 2013, only in those jurisdictions (other than Wisconsin) in which MGIC cannot write new insurance due to MGIC's failure to meet Capital Requirements and to obtain a waiver of them. The agreement with Fannie Mae, including certain conditions and restrictions to its continued effectiveness, is summarized more fully in, and included as an exhibit to, our Form 8-K filed with the Securities and Exchange Commission(the "SEC") on January 24, 2012. Such conditions include the continued effectiveness of the OCI Order and the continued applicability of the Keepwell Provision of the OCI Order. Under a letter dated January 23, 2012, Freddie Mac approved MIC to write business only in certain jurisdictions where MGIC does not meet the Capital Requirements and does not obtain waivers of them. The January 23, 2012approval from Freddie Mac, including certain conditions and restrictions to its continued effectiveness, is summarized more fully in, and included as an exhibit to, our Form 8-K filed with the SECon January 24, 2012. Such conditions, which remain in effect, include requirements that while MIC is writing new business under the Freddie Mac approval, MIC may not exceed a risk-to-capital ratio of 20:1 (at September 30, 2012, MIC's preliminary risk-to-capital ratio was 0.3 to 1), MGIC and MIC comply with all terms and conditions of the OCI Order, the OCI Order remain effective, and that MIC provide MGIC access to the capital of MIC in an amount necessary for MGIC to maintain sufficient liquidity to satisfy its obligations under insurance policies issued by MGIC. As requested by the OCI, we have notified Freddie Mac that the OCI has objected to this last requirement and others contained in the Freddie Mac approval because those requirements do not recognize the OCI's statutory authority and obligations. In this regard, see the third condition to the September 28, 2012Freddie Mac letter referred to in the next paragraph. Under a letter dated August 1, 2012, as amended by a letter dated September 28, 2012(collectively, the "September Freddie Mac Letter"), Freddie Mac expanded the jurisdictions in which MIC is approved to cover all of the 15 jurisdictions besides Wisconsinthat have Capital Requirements when MGIC is not able to write new business in a jurisdiction because MGIC would not meet those Requirements, after considering any waiver that may be granted. The approval in the September Freddie Mac Letter is subject to the following conditions: (1) a $100 millioncapital contribution to MGIC by our holding company be made on or before December 1, 2012(the "Contribution Condition"); (2) substantial agreement to a settlement of our dispute with Freddie Mac regarding the interpretation of certain pool policies be reached on or before October 31, 2012(such condition is the "Settlement Condition"; for more information about this dispute, see Note 5 "Litigation and Contingencies"); and (3) agreement by the OCI by December 31, 2012that MIC's capital will be available to MGIC to support MGIC's policyholder obligations without segregation of those obligations (the "OCI Condition"). The approval in the September Freddie Mac Letter may be withdrawn at any time, ends December 31, 2013and is also subject to compliance with the conditions and restrictions in Freddie Mac's January 23, 2012letter. This approval is only summarized above; the September Freddie Mac Letter was included as an exhibit to our Form 8-K filed with the SECon October 2, 2012. The Settlement Condition has been met, and with the exception of drafting issues that we consider minor, MGIC and Freddie Mac have agreed on the terms and text of a definitive settlement agreement, subject to approval by the Boards of Directors of MGIC and Freddie Mac and by the FHFA. Under the settlement agreement, MGIC is to pay Freddie Mac $267.5 millionin satisfaction of any further obligations under the policies in dispute, of which $100 millionis to be paid upon effectiveness of the settlement and the remaining $167.5 millionis to be paid in 48 equal monthly installments thereafter. The settlement will become effective if and when the definitive settlement agreement is signed by all parties, including the FHFA. MGIC does not intend to sign the settlement agreement unless MIC is approved by Freddie Mac and Fannie Mae, for a period that MGIC and the GSEs need to agree on, to write business in jurisdictions in which MGIC cannot due to failure to meet the Capital Requirements (the "Further MIC Approvals"). If the Further MIC Approvals are obtained, and there is a satisfactory resolution of the OCI Condition (which is completely beyond our control), we are willing to satisfy the Contribution Condition and MGIC is willing to sign the settlement agreement. While we are hopeful of making further progress regarding the settlement, there are substantial risks the settlement will not be concluded. We have not made any loss provision for a settlement and are unable to predict if and when a signed and effective settlement will be reached. Effectiveness of the settlement would negatively impact our statutory capital and materially worsen the current non-compliance with Capital Requirements. Absent a settlement, such an effect could also occur from changed circumstances that lead us to conclude a loss is probable in litigation. 56
If one GSE does not approve MIC in all jurisdictions that have not waived their Capital Requirements for MGIC, MIC may be able to write insurance on loans that will be sold to the other GSE or retained by private investors. However, because lenders may not know which GSE will purchase their loans until mortgage insurance has been procured, lenders may be unwilling to procure mortgage insurance from MIC. Furthermore, if we are unable to write business on a nationwide basis utilizing a combination of MGIC and MIC, lenders may be unwilling to procure insurance from us anywhere. In addition, the terms of the September Freddie Mac Letter may discourage some lenders from selecting MGIC or MIC as a mortgage insurer. Insurance departments, in their sole discretion, may modify, terminate or extend their waivers of Capital Requirements. If an insurance department other than the OCI modifies or terminates its waiver, or if it fails to grant a waiver or renew its waiver after expiration, depending on the circumstances, MGIC could be prevented from writing new business in that particular jurisdiction. Also, depending on the level of losses that MGIC experiences in the future, it is possible that regulatory action by one or more jurisdictions, including those that do not have specific Capital Requirements, may prevent MGIC from continuing to write new insurance in some or all of the jurisdictions in which MIC is not eligible to insure loans purchased or guaranteed by Fannie Mae or Freddie Mac. If this were to occur, we would need to seek the GSEs' approval to allow MIC to write business in those jurisdictions.
The OCI, in its sole discretion, may modify, terminate or extend its waiver of Capital Requirements, although any modification or extension of the Keepwell Provision requires our written consent. If the OCI modifies or terminates its waiver, or if it fails to renew its waiver upon expiration, depending on the circumstances, MGIC could be prevented from writing new business in all jurisdictions if MGIC does not comply with the Capital Requirements. If MGIC were prevented from writing new business in all jurisdictions, our insurance operations in MGIC would be in run-off (meaning no new loans would be insured but loans previously insured would continue to be covered, with premiums continuing to be received and losses continuing to be paid on those loans) until MGIC either met the Capital Requirements or obtained a necessary waiver to allow it to once again write new business. Furthermore, if the OCI revokes or fails to renew MGIC's waiver, MIC's ability to write new business would be severely limited because the GSEs' approval of MIC is conditioned upon the continued effectiveness of the OCI Order. We cannot assure you that the OCI or any other jurisdiction that has granted a waiver of its Capital Requirements will not modify or revoke the waiver, or will renew the waiver when it expires; that the GSEs will approve MIC to write new business in all jurisdictions in which MGIC is unable to do so; or that MGIC could obtain the additional capital necessary to comply with the Capital Requirements. At present the amount of additional capital we would need to comply with the Capital Requirements would be substantial. See our risk factor titled "Your ownership in our company may be diluted by additional capital that we raise or if the holders of our outstanding convertible debt convert that debt into shares of our common stock." For more information about factors that could negatively impact MGIC's compliance with Capital Requirements, which depending on the severity of adverse outcomes could exacerbate materially the current non-compliance with Capital Requirements, see our risk factors titled "We are defendants in private and government litigation and are subject to the risk of additional private litigation, government litigation and regulatory proceedings in the future," "We have reported net losses for the last five years, expect to continue to report annual net losses, and cannot assure you when we will return to profitability" and "Resolution of our dispute with the
Internal Revenue Servicecould adversely affect us ." As discussed above, we have not accrued an estimated loss in our financial statements to reflect the satisfaction of the Settlement Condition. In addition, as discussed below, in accordance with Accounting Standards Codification ("ASC") 450-20, we have not accrued an estimated loss in our financial statements to reflect possible adverse developments in other litigation or other dispute resolution proceedings. An accrual, if required and depending on the amount, could exacerbate materially MGIC's current non-compliance with Capital Requirements. In addition to the factors listed above, our statutory capital and compliance with Capital Requirements could be negatively affected by an unfunded pension liability. An unfunded pension liability for statutory capital purposes may result from increases in pension benefit obligations due to a lower discount rate assumption or decreases to the fair value of pension plan assets due to poor asset performance, as well as changes in certain other actuarial assumptions. Since mid-2011, two of our competitors, Republic Mortgage Insurance Company("RMIC") and PMI Mortgage Insurance Co.("PMI"), ceased writing new insurance commitments, were placed under the supervision of the insurance departments of their respective domiciliary states and are subject to partial claim payment plans, with the remaining claim amounts deferred. (PMI's parent company subsequently filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code.) In addition, in 2008, Triad Guaranty Insurance Corporationceased writing new business and entered into voluntary run-off. It is also subject to a partial payment plan ordered by its domiciliary state.
MGIC's failure to meet the Capital Requirements to insure new business does not necessarily mean that MGIC does not have sufficient resources to pay claims on its insurance liabilities. While we believe that MGIC has sufficient claims paying resources to meet its claim obligations on its insurance in force on a timely basis, even though it does not meet Capital Requirements, we cannot assure you that the events that led to MGIC failing to meet Capital Requirements would not also result in it not having sufficient claims paying resources. Furthermore, our estimates of MGIC's claims paying resources and claim obligations are based on various assumptions. These assumptions include the timing of the receipt of claims on loans in our delinquency inventory and future claims that we anticipate will ultimately be received, our anticipated rescission activity, future housing values and future unemployment rates. These assumptions are subject to inherent uncertainty and require judgment by management. Current conditions in the domestic economy make the assumptions about when anticipated claims will be received, housing values, and unemployment rates highly volatile in the sense that there is a wide range of reasonably possible outcomes. Our anticipated rescission activity is also subject to inherent uncertainty due to the difficulty of predicting the amount of claims that will be rescinded and the outcome of any legal proceedings or settlement discussions related to rescissions that we make, including those with Countrywide. (For more information about the Countrywide legal proceedings, see Note 5 - "Litigation and Contingencies" and our risk factor titled "We are defendants in private and government litigation and are subject to the risk of additional private litigation, government litigation and regulatory proceedings in the future.") GSEs The GSEs have approved MGIC as an eligible mortgage insurer, under remediation plans, even though our insurer financial strength (IFS) rating is below the published GSE minimum. The GSEs may change the requirements under our remediation plans or fail to renew, when they expire, their approvals of MIC as an eligible insurer. These possibilities could result from changes imposed on the GSEs by their regulator or due to an actual or GSE-projected deterioration in our capital position. For additional information about this challenge see our risk factors titled "We may not continue to meet the GSEs' mortgage insurer eligibility requirements," "Regulatory capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis" and "We have reported losses for the last five years, expect to continue to report annual net losses, and cannot assure you when we will return to profitability."
Before paying a claim, we can review the loan file to determine whether we are required, under the applicable insurance policy, to pay the claim or whether we are entitled to reduce the amount of the claim. For example, all of our insurance policies provide that we can reduce or deny a claim if the servicer did not comply with its obligation to mitigate our loss by performing reasonable loss mitigation efforts or diligently pursuing a foreclosure or bankruptcy relief in a timely manner. We also do not cover losses resulting from property damage that has not been repaired.
In addition, subject to rescission caps in certain of our
Wall Streetbulk transactions, all of our insurance policies allow us to rescind coverage under certain circumstances. Because we can review the loan origination documents and information as part of our normal processing when a claim is submitted to us, rescissions occur on a loan by loan basis most often after we have received a claim. Prior to 2008, rescissions of coverage on loans for which claims have been submitted to us were not a material portion of our claims resolved during a year. However, beginning in 2008, our rescission of coverage on loans has materially mitigated our paid losses. In each of 2009 and 2010, rescissions mitigated our paid losses by approximately $1.2 billion; in 2011, rescissions mitigated our paid losses by approximately $0.6 billion; and in the first nine months of 2012, rescissions mitigated our paid losses by approximately $0.2 billion(in each case, the figure includes amounts that would have either resulted in a claim payment or been charged to a deductible under a bulk or pool policy, and may have been charged to a captive reinsurer). In recent quarters, 8% to 13% of claims received in a quarter have been resolved by rescissions, down from the peak of approximately 28% in the first half of 2009. As discussed in Note 5 - "Litigation and Contingencies" and noted in our risk factor titled "We are defendants in private and government litigation and are subject to the risk of additional private litigation, government litigation and regulatory proceedings in the future," we are in mediation in an effort to resolve our dispute with Countrywide. In connection with that mediation, we have voluntarily suspended rescissions of coverage related to loans that we believe could be included in a potential resolution. As of September 30, 2012, coverage on approximately 1,700 loans, representing total potential claim payments of approximately $125 million, that we had determined was rescindable was affected by our decision to suspend such rescissions. Substantially all of these potential rescissions relate to claims received beginning in the first quarter of 2011 or later and, had we not suspended rescissions, most of these rescissions would have been processed in the first nine months of 2012. In addition, as of September 30, 2012, approximately 350 rescissions, representing total potential claim payments of approximately $23 million, were affected by our decision to suspend rescissions for customers other than Countrywide. Although the loans with suspended rescissions are included in our delinquency inventory, for purposes of determining our reserve amounts, it is assumed that coverage on these loans will be rescinded. The decision to suspend these potential rescissions does not represent the only reason for the recent decline in the percentage of claims that have been resolved through rescissions and we continue to expect that our rescissions will continue to decline. Our loss reserving methodology incorporates the effect that rescission activity is expected to have on the losses we will pay on our delinquent inventory. Historically, the number of rescissions that we have reversed has been immaterial. We do not utilize an explicit rescission rate in our reserving methodology, but rather our reserving methodology incorporates the effects rescission activity has had on our historical claim rate and claim severities. A variance between ultimate actual rescission rates and these estimates could materially affect our losses incurred. Our estimation process does not include a direct correlation between claim rates and severities to projected rescission activity or other economic conditions such as changes in unemployment rates, interest rates or housing values. Our experience is that analysis of that nature would not produce reliable results, as the change in one condition cannot be isolated to determine its sole effect on our ultimate paid losses as our ultimate paid losses are also influenced at the same time by other economic conditions. The estimation of the impact of rescissions on incurred losses, as shown in the table below, must be considered together with the various other factors impacting incurred losses and not in isolation. At September 30, 2012, we had 148,885 loans in our primary delinquency inventory; a significant portion of these loans will cure their delinquency or be rescinded and will not involve paid claims. 60
The table below represents our estimate of the impact rescissions have had on reducing our loss reserves, paid losses and losses incurred.
Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (In billions) Estimated rescission reduction - beginning reserve $ 0.6 $ 0.9
$ 0.7 $ 1.3
Estimated rescission reduction - losses incurred - - - - Rescission reduction - paid claims 0.1 0.1 0.2 0.5 Amounts that may have been applied to a deductible - - - - Net rescission reduction - paid claims 0.1 0.1 0.2 0.5 Estimated rescission reduction - ending reserve (1) $ 0.5 $ 0.8 $ 0.5 $ 0.8 (1) As noted in Note 5 - "Litigation and Contingencies" we are in mediation in an effort to resolve our dispute with Countrywide. In connection with that mediation, we have voluntarily suspended rescissions of coverage related to loans that we believe could be included in a potential resolution. As of
September 30, 2012, coverage on approximately 1,700 loans, representing total potential claim payments of approximately $125 million, that we had determined was rescindable was affected by our decision to suspend such rescissions. Substantially all of these potential rescissions relate to claims received beginning in the first quarter of 2011 or later and, had we not suspended rescissions, most of these rescissions would have been processed in the first nine months of 2012. In addition, as of September 30, 2012, approximately 350 rescissions, representing total potential claim payments of approximately $23 million, were affected by our decision to suspend rescissions for customers other than Countrywide. Although the loans with suspended rescissions are included in our delinquency inventory, for purposes of determining our reserve amounts, it is assumed that coverage on these loans will be rescinded, and thus are included in the estimated $0.5 millionestimated rescission reduction to ending reserves at September 30, 2012. The decision to suspend these potential rescissions does not represent the only reason for the recent decline in the percentage of claims that have been resolved through rescissions and we continue to expect that our rescissions will continue to decline.
The liability associated with our estimate of premiums to be refunded on expected future rescissions is accrued for separately. At
September 30, 2012and December 31, 2011the estimate of this liability totaled $49 millionand $58 million, respectively. Separate components of this liability are included in "Other liabilities" and "Premium deficiency reserve" on our consolidated balance sheet. Changes in the liability affect premiums written and earned and change in premium deficiency reserve. If the insured disputes our right to rescind coverage, the outcome of the dispute ultimately would be determined by legal proceedings. Under our policies, legal proceedings disputing our right to rescind coverage may be brought up to three years after the lender has obtained title to the property (typically through a foreclosure) or the property was sold in a sale that we approved, whichever is applicable, although in a few jurisdictions there is a longer time to bring such an action. For the majority of our rescissions since the beginning of 2009 that are not subject to a settlement agreement, this period in which a dispute may be brought has not ended. We consider a rescission resolved for financial reporting purposes even though legal proceedings have been initiated and are ongoing. Although it is reasonably possible that, when the proceedings are completed, there will be a determination that we were not entitled to rescind in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. Under ASC 450-20, an estimated loss from such proceedings is accrued for only if we determine that the loss is probable and can be reasonably estimated. Therefore, when establishing our loss reserves, we do not include additional loss reserves that would reflect an adverse outcome from ongoing legal proceedings, including those with Countrywide. For more information about these legal proceedings, see Note 5 - "Litigation and Contingencies" and our risk factor titled "We are defendants in private and government litigation and are subject to the risk of additional private litigation, government litigation and regulatory proceedings in the future." 61
In addition to the proceedings involving Countrywide, we are involved in legal proceedings with respect to rescissions that we do not consider to be collectively material in amount. Although it is reasonably possible that, when these discussions or proceedings are completed, there will be a conclusion or determination that we were not entitled to rescind in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. In 2010, we entered into a settlement agreement with a lender-customer regarding our rescission practices. In
April 2011, Freddie Mac advised its servicers that they must obtain its prior approval for rescission settlements and Fannie Mae advised its servicers that they are prohibited from entering into such settlements. In addition, in April 2011, Fannie Mae notified us that we must obtain its prior approval to enter into certain settlements. We continue to discuss with other lender-customers their objections to material rescissions and have reached settlement terms with several of our significant lender-customers. In connection with some of these settlement discussions, we have suspended rescissions related to loans that we believe could be included in potential settlements. As of September 30, 2012, approximately 350 rescissions, representing total potential claim payments of approximately $23 million, were affected by our decision to suspend rescissions for customers other than Countrywide. Any definitive agreement with these customers would be subject to GSE approval under announcements they made last year. Both GSEs approved our proposed settlement agreement with one customer. We considered the terms of the proposed agreement when establishing our loss reserves at September 30, 2012. This agreement did not have a significant impact on our established loss reserves. Neither GSE has approved our other settlement agreements, which were structured in a different manner than the one that was approved by the GSEs, and the terms of these other agreements were not considered when establishing our loss reserves at September 30, 2012. We have also reached settlement agreements that do not require GSE approval, but they have not been material in the aggregate.
Qualified Residential Mortgages
The financial reform legislation that was passed in
July 2010(the "Dodd-Frank Act" or "Dodd-Frank") requires a securitizer to retain at least 5% of the risk associated with mortgage loans that are securitized, and in some cases the retained risk may be allocated between the securitizer and the lender that originated the loan. This risk retention requirement does not apply to mortgage loans that are Qualified Residential Mortgages ("QRMs") or that are insured by the FHA or another federal agency. In March 2011, federal regulators requested public comments on a proposed risk retention rule that includes a definition of QRM. The proposed definition of QRM contains many underwriting requirements, including a maximum loan-to-value ratio ("LTV") of 80% on a home purchase transaction, a prohibition on seller contributions toward a borrower's down payment or closing costs, and certain limits on a borrower's debt-to-income ratio. The LTV is to be calculated without including mortgage insurance. The following table shows the percentage of our new risk written by LTV for 2011 and the first nine months of 2012.
Percentage of new risk written YTD Full Year September 30, 2012 2011 LTV: 80% and under 0% 0% 80.1% - 85% 6% 6% 85.1 - 90% 36% 41% 90.1 - 95% 54% 50% 95.1 - 97% 4% 3% > 97% 0% 0% The regulators also requested public comments regarding an alternative QRM definition, the underwriting requirements of which would allow loans with a maximum LTV of 90% and higher debt-to-income ratios than allowed under the proposed QRM definition, and that may consider mortgage insurance in determining whether the LTV requirement is met. We estimate that approximately 22% of our new risk written in 2011 and 21% in the first nine months of 2012 was on loans that would have met the alternative QRM definition. The regulators also requested that the public comments include information that may be used to assess whether mortgage insurance reduces the risk of default. We submitted a comment letter, including studies to the effect that mortgage insurance reduces the risk of default. The public comment period for the proposed rule expired on
August 1, 2011. At this time we do not know when a final rule will be issued, although the final rule is not expected until, at the earliest, 2013. Under the proposed rule, because of the capital support provided by the U.S. Government, the GSEs satisfy the Dodd-Frank risk-retention requirements while they are in conservatorship. Therefore, under the proposed rule, lenders that originate loans that are sold to the GSEs while they are in conservatorship would not be required to retain risk associated with those loans. Depending on, among other things, (a) the final definition of QRM and its requirements for LTV, seller contribution and debt-to-income ratio, (b) to what extent, if any, the presence of mortgage insurance would allow for a higher LTV in the definition of QRM, and (c) whether lenders choose mortgage insurance for non-QRM loans, the amount of new insurance that we write may be materially adversely affected. For other factors that could decrease the demand for mortgage insurance, see our risk factor titled "If the volume of low down payment home mortgage originations declines, the amount of insurance that we write could decline, which would reduce our revenues" and "The implementation of the Basel III capital accord, or other changes to our customers' capital requirements, may discourage the use of mortgage insurance."
September 2008, the Federal Housing Finance Agency("FHFA") was appointed as the conservator of the GSEs. As their conservator, FHFA has the authority to control and direct the operations of the GSEs. The appointment of FHFA as conservator, the increasing role that the federal government has assumed in the residential mortgage market, our industry's inability, due to capital constraints, to write sufficient business to meet the needs of the GSEs or other factors may increase the likelihood that the business practices of the GSEs change in ways that may have a material adverse effect on us. In addition, these factors may increase the likelihood that the charters of the GSEs are changed by new federal legislation. The Dodd-Frank Act required the U.S. Department of the Treasuryto report its recommendations regarding options for ending the conservatorship of the GSEs. This report was released on February 11, 2011and while it does not provide any definitive timeline for GSE reform, it does recommend using a combination of federal housing policy changes to wind down the GSEs, shrink the government's footprint in housing finance, and help bring private capital back to the mortgage market. Members of Congresshave since introduced several bills intended to scale back the GSEs. As a result of the matters referred to above, it is uncertain what role the GSEs, FHA and private capital, including private mortgage insurance, will play in the domestic residential housing finance system in the future or the impact of any such changes on our business. In addition, the timing of the impact on our business is uncertain. Any changes would require Congressional action to implement and it is difficult to estimate when Congressional action would be final and how long any associated phase-in period may last. The GSEs have different loan purchase programs that allow different levels of mortgage insurance coverage. Under the "charter coverage" program, on certain loans lenders may choose a mortgage insurance coverage percentage that is less than the GSEs' "standard coverage" and only the minimum required by the GSEs' charters, with the GSEs paying a lower price for such loans. In 2011 and the first nine months of 2012, nearly all of our volume was on loans with GSE standard coverage. We charge higher premium rates for higher coverage percentages. To the extent lenders selling loans to GSEs in the future choose charter coverage for loans that we insure, our revenues would be reduced and we could experience other adverse effects. Both of the GSEs have guidelines on terms under which they can conduct business with mortgage insurers, such as MGIC, with financial strength ratings below Aa3/AA-. (MGIC's financial strength rating from Moody's Investors Service is B2, and is on review for further downgrade, and from Standard & Poor's Rating Services is B-, with a negative outlook.) For information about how these guidelines could affect us, see "Capital - GSEs" above and our risk factor titled "We may not continue to meet the GSEs' mortgage insurer eligibility requirements."
Loan Modification and Other Similar Programs
Beginning in the fourth quarter of 2008, the federal government, including through the
Federal Deposit Insurance Corporationand the GSEs, and several lenders have adopted programs to modify loans to make them more affordable to borrowers with the goal of reducing the number of foreclosures. During 2010, 2011 and the first nine months of 2012, we were notified of modifications that cured delinquencies that had they become paid claims would have resulted in approximately $3.2 billion, $1.8 billionand $895 million, respectively, of estimated claim payments. As noted below, we cannot predict with a high degree of confidence what the ultimate re-default rate will be. Although the recent re-default rate on these modifications has been lower, for internal reporting purposes, we assume approximately 50% of those modifications will ultimately re-default, and those re-defaults may result in future claim payments. Because modifications cure the defaults with respect to the previously defaulted loans, our loss reserves do not account for potential re-defaults unless at the time the reserve is established, the re-default has already occurred. Based on information that is provided to us, most of the modifications resulted in reduced payments from interest rate and/or amortization period adjustments; less than 5% resulted in principal forgiveness.
One loan modification program is the Home Affordable Modification Program ("HAMP"). Some of HAMP's eligibility criteria relate to the borrower's current income and non-mortgage debt payments. Because the GSEs and servicers do not share such information with us, we cannot determine with certainty the number of loans in our delinquent inventory that are eligible to participate in HAMP. We believe that it could take several months from the time a borrower has made all of the payments during HAMP's three month "trial modification" period for the loan to be reported to us as a cured delinquency. We rely on information provided to us by the GSEs and servicers. We do not receive all of the information from such sources that is required to determine with certainty the number of loans that are participating in, or have successfully completed, HAMP. We are aware of approximately 9,600 loans in our primary delinquent inventory at
September 30, 2012for which the HAMP trial period has begun and which trial periods have not been reported to us as completed or cancelled. Through September 30, 2012approximately 43,100 delinquent primary loans have cured their delinquency after entering HAMP and are not in default. In 2011 and the first nine months of 2012, approximately 18% and 16%, respectively, of our primary cures were the result of a modification, with HAMP accounting for approximately 70% and 73% of those modifications, respectively. By comparison, in 2010, approximately 27% of our primary cures were the result of a modification, with HAMP accounting for approximately 60% of those modifications. We believe that we have realized the majority of the benefits from HAMP because the number of loans insured by us that we are aware are entering HAMP trial modification periods has decreased significantly over time. Recent announcements by the U.S. Treasury have extended the end date of the HAMP program through 2013, expanded the eligibility criteria of HAMP and increased lenders' incentives to modify loans through principal forgiveness. Approximately 66% of the loans in our primary delinquent inventory are guaranteed by the GSEs. The GSEs have informed us that they already use expanded criteria (beyond the HAMP guidelines) for determining eligibility for loan modification and currently do not offer principal forgiveness. Therefore, we currently expect new loan modifications will continue to only modestly mitigate our losses in 2012. In 2009, the GSEs began offering the Home Affordable Refinance Program ("HARP"). HARP allows borrowers who are not delinquent but who may not otherwise be able to refinance their loans under the current GSE underwriting standards, to refinance their loans. We allow the HARP refinances on loans that we insure, regardless of whether the loan meets our current underwriting standards, and we account for the refinance as a loan modification (even where there is a new lender) rather than new insurance written. To incent lenders to allow more current borrowers to refinance their loans, in October 2011, the GSEs and their regulator, FHFA, announced an expansion of HARP. The expansion includes, among other changes, releasing certain representations in certain circumstances benefitting the GSEs. We have agreed to allow these additional HARP refinances, including releasing the insured in certain circumstances from certain rescission rights we would have under our policy. While an expansion of HARP may result in fewer delinquent loans and claims in the future, our ability to rescind coverage will be limited in certain circumstances. We are unable to predict what net impact these changes may have on our incurred or paid losses. The effect on us of loan modifications depends on how many modified loans subsequently re-default, which in turn can be affected by changes in housing values. Re-defaults can result in losses for us that could be greater than we would have paid had the loan not been modified. At this point, we cannot predict with a high degree of confidence what the ultimate re-default rate will be. In addition, because we do not have information in our database for all of the parameters used to determine which loans are eligible for modification programs, our estimates of the number of loans qualifying for modification programs are inherently uncertain. If legislation is enacted to permit a portion of a borrower's mortgage loan balance to be reduced in bankruptcy and if the borrower re-defaults after such reduction, then the amount we would be responsible to cover would be calculated after adding back the reduction. Unless a lender has obtained our prior approval, if a borrower's mortgage loan balance is reduced outside the bankruptcy context, including in association with a loan modification, and if the borrower re-defaults after such reduction, then under the terms of our policy the amount we would be responsible to cover would be calculated net of the reduction.
Eligibility under certain loan modification programs can also adversely affect us by creating an incentive for borrowers who are able to make their mortgage payments to become delinquent in an attempt to obtain the benefits of a modification. New notices of delinquency increase our incurred losses. In response to the significant increase in the number of foreclosures that began in 2009, various government entities and private parties have from time to time enacted foreclosure (or equivalent) moratoriums and suspensions (which we collectively refer to as moratoriums). In
October 2010, a number of mortgage servicers temporarily halted some or all of the foreclosures they were processing after discovering deficiencies in their foreclosure processes and those of their service providers. In response to the deficiencies, some states changed their foreclosure laws to require additional review and verification of the accuracy of foreclosure filings. Some states also added requirements to the foreclosure process, including mediation processes and requirements to file new affidavits. Certain state courts have issued rulings calling into question the validity of some existing foreclosure practices. These actions halted or significantly delayed foreclosures. Furthermore five of the nation's largest mortgage servicers agreed to implement new servicing and foreclosure practices as part of a settlement announced in February 2012, with the federal government and the attorneys general of 49 states. Past moratoriums or delays were designed to afford time to determine whether loans could be modified and did not stop the accrual of interest or affect other expenses on a loan, and we cannot predict whether any future moratorium or lengthened timeframes would do so. Therefore, unless a loan is cured during a moratorium or delay, at the completion of a foreclosure, additional interest and expenses may be due to the lender from the borrower. In some circumstances, our paid claim amount may include some additional interest and expenses. For moratoriums or delays resulting from investigations into servicers and other parties' actions in foreclosure proceedings, our willingness to pay additional interest and expenses may be different, subject to the terms of our mortgage insurance policies. The various moratoriums and extended timeframes may temporarily delay our receipt of claims and may increase the length of time a loan remains in our delinquent loan inventory. We do not know what effect improprieties that may have occurred in a particular foreclosure have on the validity of that foreclosure, once it was completed and the property transferred to the lender. Under our policy, in general, completion of a foreclosure is a condition precedent to the filing of a claim. Beginning in 2011 and from time to time, various courts have ruled that servicers did not provide sufficient evidence that they were the holders of the mortgages and therefore they lacked authority to foreclose. Some courts in other jurisdictions have considered similar issues and reached similar conclusions, but other courts have reached different conclusions. These decisions have not had a direct impact on our claims processes or rescissions.
Factors Affecting Our Results
Our results of operations are affected by:
· Premiums written and earned
Premiums written and earned in a year are influenced by:
· New insurance written, which increases insurance in force, and is the
aggregate principal amount of the mortgages that are insured during a period.
Many factors affect new insurance written, including the volume of low down
payment home mortgage originations and competition to provide credit
enhancement on those mortgages, including competition from the FHA, other
mortgage insurers, GSE programs that may reduce or eliminate the demand for
mortgage insurance and other alternatives to mortgage insurance. In addition,
new insurance written can be influenced by a lender's assessment of the
financial strength of our insurance operations and the matters in Freddie
New insurance written does not include loans previously insured by us which
are modified, such as loans modified under the Home Affordable Refinance
Program. · Cancellations, which reduce insurance in force. Cancellations due to
refinancings are affected by the level of current mortgage interest rates
compared to the mortgage coupon rates throughout the in force book.
Refinancings are also affected by current home values compared to values when
the loans in the in force book became insured and the terms on which mortgage
credit is available. Cancellations also include rescissions, which require us
to return any premiums received related to the rescinded policy, and policies
cancelled due to claim payment, which require us to return any premium
received from the date of default. Finally, cancellations are affected by home
price appreciation, which can give homeowners the right to cancel the mortgage
insurance on their loans.
· Premium rates, which are affected by the risk characteristics of the loans
insured and the percentage of coverage on the loans. · Premiums ceded to reinsurance subsidiaries of certain mortgage lenders ("captives") and risk sharing arrangements with the GSEs. Premiums are generated by the insurance that is in force during all or a portion of the period. A change in the average insurance in force in the current period compared to an earlier period is a factor that will increase (when the average in force is higher) or reduce (when it is lower) premiums written and earned in the current period, although this effect may be enhanced (or mitigated) by differences in the average premium rate between the two periods as well as by premiums that are returned or expected to be returned in connection with claim payments and rescissions, and premiums ceded to captives or the GSEs. Also, new insurance written and cancellations during a period will generally have a greater effect on premiums written and earned in subsequent periods than in the period in which these events occur. · Investment income Our investment portfolio is comprised almost entirely of investment grade fixed income securities. The principal factors that influence investment income are the size of the portfolio and its yield. As measured by amortized cost (which excludes changes in fair market value, such as from changes in interest rates), the size of the investment portfolio is mainly a function of cash generated from (or used in) operations, such as net premiums received, investment earnings, net claim payments and expenses, less cash provided by (or used for) non-operating activities, such as debt or stock issuances or repurchases or dividend payments. Realized gains and losses are a function of the difference between the amount received on the sale of a security and the security's amortized cost, as well as any "other than temporary" impairments recognized in earnings. The amount received on the sale of fixed income securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale. 67
· Losses incurred Losses incurred are the current expense that reflects estimated payments that will ultimately be made as a result of delinquencies on insured loans. As explained under "Critical Accounting Policies" in our 10-K MD&A, except in the case of a premium deficiency reserve, we recognize an estimate of this expense only for delinquent loans. Losses incurred are generally affected by:
· The state of the economy, including unemployment, and housing values, each of
which affects the likelihood that loans will become delinquent and whether
loans that are delinquent cure their delinquency. The level of new
delinquencies has historically followed a seasonal pattern, with new
delinquencies in the first part of the year lower than new delinquencies in
the latter part of the year, though this pattern can be affected by the state
of the economy and local housing markets. · The product mix of the in force book, with loans having higher risk characteristics generally resulting in higher delinquencies and claims. · The size of loans insured, with higher average loan amounts tending to increase losses incurred.
· The percentage of coverage on insured loans, with deeper average coverage
tending to increase incurred losses.
· Changes in housing values, which affect our ability to mitigate our losses
through sales of properties with delinquent mortgages as well as borrower
willingness to continue to make mortgage payments when the value of the home
is below the mortgage balance.
· The rate at which we rescind policies. Our estimated loss reserves reflect
mitigation from rescissions of policies and denials of claims. We collectively
refer to such rescissions and denials as "rescissions" and variations of this
· The distribution of claims over the life of a book. Historically, the first
two years after loans are originated are a period of relatively low claims,
with claims increasing substantially for several years subsequent and then
declining, although persistency (percentage of insurance remaining in force
from one year prior), the condition of the economy, including unemployment and
housing prices, and other factors can affect this pattern. For example, a weak
economy or housing price declines can lead to claims from older books
increasing, continuing at stable levels or experiencing a lower rate of
decline. See further information under "Mortgage Insurance Earnings and Cash Flow Cycle" below. 68
· Changes in premium deficiency reserve Each quarter, we re-estimate the premium deficiency reserve on the remaining
Wall Streetbulk insurance in force. The premium deficiency reserve primarily changes from quarter to quarter as a result of two factors. First, it changes as the actual premiums, losses and expenses that were previously estimated are recognized. Each period such items are reflected in our financial statements as earned premium, losses incurred and expenses. The difference between the amount and timing of actual earned premiums, losses incurred and expenses and our previous estimates used to establish the premium deficiency reserve has an effect (either positive or negative) on that period's results. Second, the premium deficiency reserve changes as our assumptions relating to the present value of expected future premiums, losses and expenses on the remaining Wall Streetbulk insurance in force change. Changes to these assumptions also have an effect on that period's results.
· Underwriting and other expenses
The majority of our operating expenses are fixed, with some variability due to contract underwriting volume. Contract underwriting generates fee income included in "Other revenue."
· Interest expense
Interest expense reflects the interest associated with our outstanding debt obligations. The principal amount of our long-term debt obligations at
September 30, 2012is comprised of $100.1 millionof 5.375% Senior Notes due in November 2015, $345 millionof 5% Convertible Senior Notes due in 2017 and $389.5 millionof 9% Convertible Junior Subordinated Debentures due in 2063 (interest on these debentures accrues and compounds even if we defer the payment of interest), as discussed in Note 3 - "Debt" to our consolidated financial statements and under "Liquidity and Capital Resources" below. At September 30, 2012, the convertible debentures are reflected as a liability on our consolidated balance sheet at the current amortized value of $370.2 million, with the unamortized discount reflected in equity.
Mortgage Insurance Earnings and Cash Flow Cycle
In our industry, a "book" is the group of loans insured in a particular calendar year. In general, the majority of any underwriting profit (premium revenue minus losses) that a book generates occurs in the early years of the book, with the largest portion of any underwriting profit realized in the first year following the year the book was written. Subsequent years of a book generally result in modest underwriting profit or underwriting losses. This pattern of results typically occurs because relatively few of the claims that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments), and increasing losses.
Summary of 2012 Third Quarter Results
Our results of operations for the third quarter of 2012 were principally affected by the factors referred to below.
· Net premiums written and earned
Net premiums written during the third quarter of 2012 increased when compared to the same period in 2011 due to a decrease in premium refunds related to rescissions and paid claims (when a claim is paid we return any premium received since the date of default) as well as the continued decline of premiums ceded to captives. Also, in the third quarter of 2011 there was a termination of a reinsurance agreement that resulted in a return of premium of approximately
$7 million. These items were partially offset by our lower average insurance in force. Net premiums earned during the third quarter of 2012 decreased when compared to the same period in 2011. The decrease was due to our lower average insurance in force, partially offset by a decrease in premium refunds related to rescissions and paid claims as well as the continued decline of premiums ceded to captives. · Investment income
Investment income in the third quarter of 2012 was lower when compared to the same period in 2011 due to a decrease in our average invested assets as we continue to meet our claim obligations as well as a decrease in our average investment yield.
· Realized gains (losses) and other-than-temporary impairments
Net realized gains for the third quarter of 2012 included
$6.2 millionin net realized gains on the sale of investments, compared to $11.4 millionin net gains on sales during the third quarter of 2011. There were no other-than-temporary impairments recognized in the third quarter of 2012, compared to $0.3 millionin other-than-temporary impairments recognized during the third quarter of 2011. The gross unrealized gains on our investment portfolio were approximately $136 millionat September 30, 2012. In October 2012, we realized $79 millionin gains on the sale of investments. The gross unrealized gains on our investment portfolio were approximately $55 millionat October 31, 2012. · Other revenue
Other revenue for the third quarter of 2012 increased compared to the third quarter of 2011 primarily due to an increase in contract underwriting fees.
· Losses incurred
Losses incurred for the third quarter of 2012 increased compared to the same period in 2011 primarily due to a redundancy in pool reserves experienced during the third quarter of 2011, offset by fewer new primary notices, net of cures. The estimated claim rate increased slightly and the estimated severity decreased slightly in each of the third quarters of 2012 and 2011. The primary default inventory decreased by 5,105 delinquencies in the third quarter of 2012, compared to a decrease of 3,558 in the third quarter of 2011. Losses incurred for the third quarter of 2012 decreased compared to the second quarter of 2012 primarily due to a smaller increase in the estimated claim rate compared to the second quarter of 2012. · Change in premium deficiency reserve 70
During the third quarter of 2012 the premium deficiency reserve on
Wall Streetbulk transactions declined from $93 million, as of June 30, 2012, to $84 millionas of September 30, 2012. The decrease in the premium deficiency reserve represents the net result of actual premiums, losses and expenses as well as a change in net assumptions for the period. The change in assumptions for the third quarter of 2012 is primarily related to higher estimated ultimate losses. The $84 millionpremium deficiency reserve as of September 30, 2012reflects the present value of expected future losses and expenses that exceeds the present value of expected future premium and already established loss reserves. · Underwriting and other expenses Underwriting and other expenses for the third quarter of 2012 decreased when compared to the same period in 2011. The decrease reflects our reductions in headcount. · Interest expense Interest expense for the third quarter of 2012 decreased slightly when compared to the same period in 2011. The decrease is primarily due to lower interest on our Senior Notes due to repayments and repurchases, partially offset by an increase in amortization on our junior debentures. · Provision for income taxes We had a benefit from income taxes of ($3.0)and ($26.1) millionin the third quarter of 2012 and 2011, respectively. The benefit from income taxes was reduced by $86.1 millionand $47.9 milliondue to the recognition of a valuation allowance for the three months ended September 30, 2012and 2011, respectively.