(2) Calculated on a GAAP basis using provision for losses to calculate the loss ratio and policy acquisition costs and other operating expenses, excluding merger expenses, to calculate the expense ratio as a percentage of net premiums earned.
For the year ended December 31, 2007, other risk written was $604.0 million, compared to $900.0 million for 2006 and $9.0 billion for 2005. A large portion of the other risk written for the year ended December 31, 2007 was insurance on NIMS written during the first half of 2007. Included in the $9.0 billion of other risk written for the year ended December 31, 2005, is $7.3 billion of other risk written in the form of credit default swaps written as AAA tranches of mortgage-backed securities in Germany and Denmark. Opportunities for structured transactions depend on a number of macroeconomic factors, and thus, the volume of structured transactions we enter into can vary significantly from year to year.
The largest single customer of our mortgage insurance segment (including branches and affiliates of such customer), measured by primary new insurance written, accounted for 19.4% of primary new insurance written for 2007 compared to 18.6% for 2006 and 10.6% for 2005.
We closely monitor our financial guaranty obligations and we use an internal classification process to identify and track troubled credits. We classify credits as “intensified surveillance credits” when we determine that continued performance is questionable and, in the absence of a positive change, may result in a claim. At December 31, 2007, 2006 and 2005, the financial guaranty segment had the following exposure on credits classified as intensified surveillance credits:
The following table summarizes certain of our contractual obligations and commitments as of December 31, 2007, and the future periods in which such obligations are expected to be settled in cash. Following the table are “Other Contractual Obligations and Commitments” of the registrant that do not fall within the categories specified by the SEC for tabular disclosure. Although the majority of our loss reserves do not represent contractual obligations and commitments under the SEC definition, they are included in the table because they represent management’s estimate of the claims that we will be required to pay on our mortgage insurance and financial guaranty contracts. The table also reflects the timing of principal and interest payments on outstanding debt and other borrowings. Additional details regarding these obligations are provided in the narrative following the table and in the Notes to Consolidated Financial Statements as referenced in the table:
Radian Group and Radian Mortgage Insurance Inc. (formerly known as CMAC of Arizona), a subsidiary of Radian Guaranty Inc., are parties to a guaranty agreement in which Radian Group has agreed for the benefit of Radian Mortgage Insurance Inc.’s creditors to make funds available on demand for the full and complete payment of all due but unpaid liabilities.
The following table shows the gross unrealized losses and fair value of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007.
We are currently under examination by the Internal Revenue Service (“IRS”) for the 2000 through 2004 tax years. The IRS opposes the recognition of certain tax losses and deductions that were generated through our investment in a portfolio of residual interests in Real Estate Mortgage Investment Conduits (“REMICs”) and has proposed adjustments denying the associated tax benefits of these items. We will contest all such proposed adjustments relating to the IRS’s opposition of the tax benefits in question and are working with tax counsel in our defense efforts. When an examination has not been settled at the local examination division level, the IRS will usually issue a “30-day” letter which contains details of the proposed adjustments and the taxpayer’s rights to appeal. Upon receipt of the IRS’s 30-day letter, we may make a payment with the U.S. Department of the Treasury to avoid the accrual of the above-market-rate interest associated with our estimate of the potentially unsettled adjustment. We anticipate receiving the 30-day letter and making the payment on account at some point during the first two quarters of 2008 and the cash requirement for this payment is anticipated to be approximately $75.0 to $80.0 million. Any ultimate overpayment associated with the payment on account would be recovered through a formal claim for refund process.
Our insurance subsidiaries are permitted to allocate capital resources within certain insurance department and rating agency guidelines by making direct investments. In March 2006, Radian Guaranty contributed approximately $500 million in capital to Radian Insurance to support the additional risk that had been, and was expected to be, written in that entity, mostly through non-traditional products, such as domestic or international credit default swaps.
On April 18, 2007, the Financial Accounting Standards Board (“FASB”) issued an exposure draft, “Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60” (“Exposure Draft”). The Exposure Draft clarifies how SFAS No. 60 applies to financial guaranty insurance contracts and provides guidance with respect to the timing of claim liability recognition, premium recognition and the related amortization of deferred policy acquisition costs, specifically for financial guaranty contracts issued by insurance companies that are not accounted for as derivative contracts under SFAS No. 133. The goal of the proposed statement is to reduce diversity in accounting by financial guaranty insurers, thereby enabling users to better understand and more readily compare insurers’ financial statements. Final guidance from the FASB regarding accounting for financial guaranty insurance is expected to be issued in 2008. If the Exposure Draft is issued as proposed, the effect on the consolidated financial statements, particularly with respect to revenue recognition and claims liability, could be material.
We have audited the accompanying consolidated balance sheet of Radian Group Inc. and subsidiaries (the “Company”) as of December 31, 2006, and the related consolidated statements of income, changes in common stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2006. Our audits also included the financial statement schedules as of December 31, 2006 and for each of the two years in the period ended December 31, 2006 listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits. We did not audit the financial statements of Sherman Financial Group LLC (an equity method investee) as of December 31, 2006, which statements reflect earnings constituting 15% of consolidated pretax income for the year ended December 31, 2006. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Sherman Financial Group LLC, is based solely on the report of the other auditors.
(4) Each Fitch rating for our mortgage insurance subsidiaries is currently Ratings Watch Negative
The provisions of Statement of Financial Accounting Standards No. 60, (“SFAS No. 60”), “Accounting and Reporting by Insurance Enterprises,” specifically exclude mortgage insurance from its guidance relating to the earning of insurance premiums. Mortgage insurance premiums written on an annual and multi-year basis are initially recorded as unearned premiums and earned over the policy term, and premiums written on a monthly basis are earned over the period that coverage is provided. Annual premiums are amortized on a monthly, straight-line basis. Multi-year premiums are amortized over the terms of the contracts in relation to the anticipated claim payment pattern based on historical industry experience. Ceded premiums written are initially set up as prepaid reinsurance and are amortized in a manner consistent with how direct premiums are earned. Premiums on certain structured transactions are recognized over the period that coverage is provided.
2005 Recapture. Effective June 1, 2004, we merged the two main operating subsidiaries of EFSG, Radian Asset Assurance Inc. (“Radian Asset Assurance”) and Radian Reinsurance Inc., thereby combining the financial guaranty reinsurance business formerly conducted by Radian Reinsurance Inc. with the direct financial guaranty business conducted by Radian Asset Assurance. In May 2004, immediately prior to this merger, Moody’s Investor Service (“Moody’s”) downgraded the insurance financial strength rating of Radian Reinsurance from Aa2 to Aa3. As a result of this downgrade, two of the primary insurer customers of our financial guaranty reinsurance business had the right to recapture previously written business ceded to our financial guaranty reinsurance business. One of these customers agreed, without cost to or concessions by us, to waive its recapture rights. Effective February 28, 2005, the remaining primary insurer customer with recapture rights recaptured approximately $7.4 billion of par in force that it had ceded to us, including $54.7 million of net premiums written, $4.5 million of which already had been treated as earned under GAAP and was required to be recorded as an immediate reduction of net premiums earned at the time of the recapture. Also in connection with the recapture in the first quarter of 2005, we were reimbursed for policy acquisition costs of approximately $17.1 million for which the carrying value under GAAP was $18.8 million. This required us to write off policy acquisition costs of $1.7 million. The aggregate result was a reduction in pre-tax income of $6.2 million, or approximately $0.04 per share after tax.
Interpretation No. 46(R) (“FIN No. 46R”). The variability that is considered in applying FIN No. 46R affects the determination of (i) whether the entity is a variable interest entity, (ii) which interests are variable interests in the entity and (iii) which party, if any, is the primary beneficiary of the variable interest entity. That variability will affect any calculation of expected losses and expected residual returns, if such a calculation is necessary. FSP FIN No. 46(R)-6 became effective July 1, 2006. The adoption of this FSP did not have a material impact on our consolidated financial statements. We continue to monitor our variable interest entities for possible consolidation.
Certain prior period balances have been reclassified to conform to the current period presentation. Because the derivative liabilities became material in 2007, we have presented such amounts separately from derivative assets in the consolidated balance sheets. As a result, $31.7 million of derivative liabilities previously included as an offset to derivative assets at December 31, 2006, has been reclassified to derivative liabilities.
permit the issuer to settle the securities at a price less than the par value of the investment. Because we have the ability and intent to hold these investments until a full recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2007.
Provisional losses recoverable under these quota share treaties were $12.5 million at December 31, 2006. The 2006 provisional losses recoverable represent amounts due to us under the variable quota-share treaty entered in 1997. These recoverable amounts covered the books of business originated by Radian Guaranty in those years. In 2007, the reinsurer reimbursed us for the remaining underwriting-year excess coverage due under
During 2007, 2006 and 2005, our incurred losses and LAE in our financial guaranty insurance business for prior years were reduced by $28.4 million, $6.8 million and $15.9 million, respectively, mainly related to favorable loss development in our trade credit reinsurance business reserved for in prior years.
Our unallocated non-specific loss reserve at December 31, 2007, was $49.2 million. The range between the unallocated non-specific reserves that would have resulted from applying the highest and lowest default factors
On December 13, 2006, we entered into a $400 million unsecured revolving credit facility that is scheduled to expire on December 13, 2011. This facility includes an additional $100 million uncommitted line that we may exercise at our option, subject to our obtaining necessary commitments from lenders. On August 15, 2007, we drew down $200 million in principal amount under this facility. The amounts drawn down bear interest at a rate equal to LIBOR plus 20 basis points (which resets periodically) as specified by the credit facility and was 5.14% at December 31, 2007. At December 31, 2007, the outstanding balance under this facility was $200 million, with $200 million remaining available under the facility.
We adopted FIN No. 48 on January 1, 2007. The cumulative effect of applying the provisions of FIN No. 48 was a $21 million decrease in retained earnings. Prior to the implementation of FIN No. 48, we maintained reserves for contingent tax liabilities, which totaled approximately $20 million as of December 31, 2006. As of December 31, 2007, we have approximately $38.9 million of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Our policy for the recognition of interest and penalties associated with uncertain tax positions is to record such items as a component of our income tax provision. The table below details the cumulative effect of applying the provisions of FIN No. 48 as of December 31, 2007.
Radian Asset Assurance’s ability to pay dividends is restricted by certain provisions of the insurance laws of New York. Under the New York insurance laws, Radian Asset Assurance may only declare or distribute dividends from earned surplus. Unless the company has prior approval from the New York Superintendent of Insurance, the company can only pay a dividend, which when totaled with all other dividends declared or distributed by it during the preceding twelve months, is the lesser of 10% of its surplus to policyholders as shown by its last statement on file with the Superintendent of Insurance, or 100% of adjusted net investment income. At December 31, 2007, Radian Asset Assurance had $113.7 million available for dividends that could be paid in 2008 without prior approval.
(b) In accordance with New York insurance law, financial guaranty insurance companies are required to establish a contingency reserve in the amount prescribed by legislation. Such legislation requires that, for financial guaranty policies each insurer must establish a contingency reserve equal to the greater of 50% of premiums written or a stated percentage of the principal guaranteed, ratably over 15-20 years dependent upon the category of obligation insured. Reinsurers are required to establish a contingency reserve equal to their proportionate share of the reserve established by the primary insurer. Also under STAT, case reserves are required to be established in the year in which the default occurred. We establish non-specific reserves under GAAP as described in Note 2.
The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123R to stock-based employee compensation prior to 2006 (in thousands, except per-share amounts).
As of December 31, 2007 and 2006, unrecognized compensation expense related to the unvested portion of all of our stock-based awards was approximately $49.8 million and $31.0 million, respectively. Absent a change of control under the Plan, this cost is expected to be recognized over a weighted average period of approximately 2.2 years.
permit the board to make discretionary, pro rata (based on eligible pay) cash allocations to each eligible participant’s account, with vesting upon completion of three years of service with Radian; and
The selected long-term rate on assets (6.00%) was principally based on the allocation of the Pension Plan’s assets (approximately 60% equities and 40% fixed-income investments) coupled with the actual expected returns provided by our investment advisor by asset type. This assumption is a long-term assumption that has been in place for many years. We have periodically reviewed our assumptions against various capital market simulations to assure that our assumptions remain reasonable. We believe that a 6.00% long-term return assumption remains reasonable in calculating pension expense.
We believe we will be able to obtain satisfactory lease renewal terms, as necessary, with respect to all of our facilities. We believe our existing properties are well utilized, suitable and adequate for our present circumstances.
Unearned Premiums-In the mortgage insurance business, because the majority of the premiums received are cash-basis, the fair value is assumed to equal the book value. The fair value of unearned premiums in the financial guaranty insurance business, net of prepaid reinsurance premiums, is based on the estimated cost of entering into a cession of the entire portfolio with third-party reinsurers under current market conditions, adjusted for commissions based on current market rates.
As a result of our net loss in 2007, 4,606,454 shares of our common stock issued under our stock-based compensation plans were not included in the calculation of diluted earnings per share because they were anti-dilutive. At December 31, 2006 and 2005, there were 1,176,250 common shares underlying options and 268,878 common shares underlying options, respectively, excluded from the net income per share calculation because the options were anti-dilutive.