We have closed all of our remote underwriting offices. We exited the lease for our facility in Toronto, Canada in the third quarter of 2008 and we liquidated our Canadian subsidiary in the fourth quarter of 2008.
Certain of the statements contained in this release are “forward-looking statements” and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include estimates and assumptions related to economic, competitive, regulatory, operational and legislative developments. These forward-looking statements are subject to change, uncertainty and circumstances that are, in many instances, beyond our control and they have been made based upon our current 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 a number of factors, including our ability to operate our business in run-off, the possibility of general economic and business conditions that are different than anticipated, legislative, regulatory, and other similar developments, changes in interest rates, employment rates, the housing market, the mortgage industry and the stock market, as well as the relevant factors described under “Risk Factors” and in the “Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995” section below with respect to forward-looking statements contained herein. Forward-looking statements are based upon our current expectations and beliefs concerning future events and we undertake no obligation to update or revise any forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements are made.
We have historically provided Primary and Modified Pool mortgage guaranty insurance coverage on U.S. residential mortgage loans. We classify insurance as Primary when we are in the first loss position and the loan-to-value amount, or 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 has been delivered through the flow channel, which is defined as loans originated by lenders and submitted to us on a loan-by-loan basis. We have also historically provided 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 has been delivered through the structured bulk channel. Our insurance remains effective until one of the following
the conditions of the housing, mortgage and capital markets that have a direct impact on default rates, mitigation efforts, cure rates and ultimately the amount of claims paid;
Restricted TGIC from making any payments or entering into any transaction that involves the transfer of assets to, or liabilities from, any affiliated parties without the prior approval of the Division;
Required TGIC to obtain prior written approval from the Division before entering into certain transactions with unaffiliated parties;
Required TGIC to furnish to the Division certain reports, agreements, actuarial opinions and information on an ongoing basis at specified times.
We submitted a corrective plan to the Division as required under the Corrective Order. The corrective plan we submitted included, among other items, a five-year statutory financial projection for TGIC and a detailed description of our planned course of action to address our current financial condition. The financial statements that form the basis of our corrective plan were prepared in accordance with Statutory Accounting Principles (“SAP”) set forth in the Illinois Insurance Code. SAP differs from GAAP, which are followed to prepare the financial statements presented in this annual report on Form 10-K. We received approval of the corrective plan from the Division in October 2008.
Failure to comply with the provisions of the Corrective Order or any other violation of the Illinois Insurance Code may result in the imposition of fines or penalties or subject TGIC to further legal proceedings, including receivership proceedings for the conservation, rehabilitation or liquidation of TGIC. See Item 1A, “Risk Factors” for more information.
Our recurring losses from operations and resulting decline in policyholders’ surplus as calculated in accordance with SAP increases the likelihood that TGIC will be placed into conservatorship or liquidated and raises substantial doubt about our ability to continue as a going concern. Our consolidated financial statements that are presented in this annual report on Form 10-K do not include any adjustments that reflect the financial risks of TGIC entering receivership proceedings and assume that we will continue as a going concern. We expect losses from
operations to continue and our ability to continue as a going concern is dependent on the successful development, approval, and implementation of a revised corrective plan. See Item 1A, “Risk Factors” for more information.
At December 31, 2008, the Company reported a deficit in assets of $136.7 million compared to a deficit in assets of $28.4 million at September 30, 2008 and stockholders’ equity of $498.9 million at December 31, 2007. A deficit in assets occurs when recorded liabilities exceed recorded assets and is not necessarily a measure of insolvency. The deficit in assets is primarily the result of an increase in loss reserves of over $800 million since December 31, 2007. In addition, we have paid in excess of $230 million of claims during the last 12 months. Although we have reported a deficit in assets at December 31, 2008, we had approximately $935 million of cash and invested assets at December 31, 2008 compared to $910 million at December 31, 2007. We expect to continue to report a deficit in assets in future periods. While we do not expect the deficit in assets to have a direct impact on our operations, it could adversely impact our continued listing on The NASDAQ Stock Market.
Triad maintains a $95 million Excess-of-Loss reinsurance treaty that is currently in arbitration. The arbitration hearing began in 2008 and we expect to have a decision in the second quarter of 2009. As the matter is in dispute as a gain contingency, we have not recorded any benefit from this reinsurance treaty in our GAAP financial statements. However, in consultation with the Division, we recorded in our statutory financial statements for the year ended December 31, 2008 the net benefit of the reinsurance treaty of $51.5 million, which included the $95 million benefit and an accrual for the present value of the future 10-year premium expense due the reinsurer, reduced by a required reserve reflecting the dispute and aging of the recoverables.
The Housing and Economic Recovery Act of 2008 also includes the HOPE for Homeowners Act, which created a new, temporary, voluntary program within the Federal Housing Administration (“FHA”) to back FHA-insured mortgages to distressed borrowers. The new mortgages offered by FHA-approved lenders will refinance distressed loans at a significant discount for owner-occupants at risk of losing their homes to foreclosure. In exchange, homeowners will share future appreciation with the FHA.
In February 2009, the Federal government unveiled The Homeowner Affordability and Stability Plan (“HASP”), which is designed to replace the SMP and reduce the number of foreclosures. HASP, which was detailed in March 2009, includes the Home Affordable Modification Program (“HMP”) which provides incentives to borrowers, servicers, and lenders to modify loans with the modifications jointly paid for by lenders and the U.S. government. HASP also includes the Home Affordable Refinance Program which provides refinance opportunities to certain borrowers who have conforming mortgage loans owned or guaranteed by the GSEs. The borrowers targeted for this refinance opportunity are those who have experienced significant depreciation in the value of their home, thereby making refinancing difficult or prohibitive given current underwriting standards in the marketplace.
Certain members of the Obama administration have discussed providing TARP funds to private mortgage insurers. No assurance can be given that TARP funds would be provided to mortgage insurers or, if funds were provided, that they would be provided to us or that they would be offered under terms acceptable or beneficial to our stockholders.
As of the date of this annual report on Form 10-K, we are unable to predict the impact that these recent government initiatives and the conservatorship of Fannie Mae and Freddie Mac will have on our future results of operations and prospects.
Incurred losses and loss adjustment expenses (“LAE”) increased by $550 million during 2008 and is primarily responsible for the substantial increase in our net loss. The incurred losses in 2008 were composed of an increase in
the reserve for losses and LAE of $828 million and direct paid losses and LAE of $245 million, offset partially by an increase in reinsurance recoverables of $151 million.
The adverse development of our 2006 and 2007 books of business, which, on average, have significantly higher default rates than our other books of business and also have a higher average risk per policy than our other books of business;
Our Primary bulk business written in 2006 and 2007, which has shown a significant amount of early payment defaults and has a significant amount of high LTV loans; and
Our 2006 and 2007 Modified Pool business, which also has exhibited a significant amount of early payment defaults.
Gross paid losses for 2008 were $238 million compared to $101 million for 2007, an increase of 135%. The average paid loss was approximately $54,000 in 2008 compared to $37,000 in 2007. The increase in the average paid loss is primarily the result of a higher percentage of claims from the more recent vintage years and from the distressed markets, both of which reflect larger loan balances, as well as a decline in our ability to mitigate losses. During the third and fourth quarters of 2008, we experienced a moderation in claim paid activity due to a number of factors including state and lender foreclosure moratoriums, delays by the servicers, continued efforts on our part to investigate policies for fraud, misrepresentation or other underwriting violations, as well as an increase in the number of policies rescinded.
The following table provides a summary of new insurance written for the years ended December 31, 2008 and 2007:
Primary insurance persistency improved to 86.6% at December 31, 2008 compared to 81.4% at December 31, 2007. Modified pool insurance persistency improved to 88.3% at December 31, 2008 compared to 82.6% at December 31, 2007. We believe the increase in our persistency reflects the general inability of borrowers to refinance or sell their homes due to stricter underwriting guidelines by lenders, as well as the nationwide decline in home prices. We anticipate that persistency rates will be maintained near these levels for 2009. However, mortgage interest rates are at historically low levels and the majority of our insurance in force has associated interest rates greater than the prevailing rates. Recent government and private industry initiatives were developed, in part, to promote liquidity in the mortgage markets. Given the interest rate environment and these initiatives, persistency could fall in 2009, which could have a significant adverse impact on our future earned premiums.
The percentage of business with a loan-to-value (LTV) greater than 95%;
The percentage of interest only loans and adjustable rate mortgages (ARMs), particularly ARMs with potential negative amortization;
Given the lack of production during 2008 and the high level of persistency, the risk composition of our portfolio has remained relatively constant. Our portfolio contains significant exposure to Alt-A loans, loans with the potential for negative amortization (“PNAMs”), as well as interest only loans. An inherent risk in both PNAMs and interest only loans is the scheduled milestone in which the borrower must begin making amortizing payments. These payments can be substantially greater than the minimum payments required before the milestone is met. An additional risk to PNAMs is the payment being made may be less than the amount of interest due, creating negative amortization on the outstanding principal of the loan. These features add uncertainty and potential risk. Due in part to recent market conditions, the Alt-A loans, PNAM loans, and interest only loans have, as a group, performed significantly worse than the remaining prime fixed rate loans through December 31, 2008.
The premium rates we charge vary depending on the perceived risk of a loan and generally cannot be changed after issuance of coverage. We do not believe that the premium rates charged for business originated in 2005, 2006 and 2007, and specifically for high risk products including PNAMs and Alt-A loans, will generate premium revenue sufficient to cover future losses.
The following table shows direct risk in force as of December 31, 2008 and December 31, 2007 by year of loan origination. Business originated in 2006 and 2007 continues to comprise the majority of our risk in force. This is due to the significant amounts of production during these two years as well as the amount of refinancing that took place in 2002 through 2005. In general, policies originated during these years have significantly higher amounts of average risk per policy than policies originated prior to 2006. Furthermore, policies originated during these vintage years have also exhibited higher default rates than preceding vintage years. For additional information regarding these vintage years, see “Losses and Expenses,” below.
Net investment income grew primarily due to the growth in average invested assets. Average invested assets at cost or amortized cost grew by 21.4% in 2008 as a result of the investment of positive operating cash flows, which included $116.0 million from the redemption of Tax and Loss Bonds. The book yield on our investment portfolio was 4.62% at December 31, 2008 compared to 4.56% at December 31, 2007. Realized investment losses were $26.6 million during 2008 compared to a loss of $3.0 million for 2007, primarily due to an increase in other-than-temporary impairment losses. For a further discussion, see “Investment Portfolio”.
The following table provides details on both the amount and the number of paid claims of both Primary and Modified Pool insurance prior to the effect of ceded paid claims for the years ended December 31, 2008 and 2007:
The increase in paid severity was also influenced by our reduced ability to mitigate claims. Beginning in late 2006, we began to experience a significant reduction in our ability to reduce the severity of our claims paid through the sale of properties. Subsequent declines in home prices across almost all markets, with significant declines in the distressed markets, has continued to negatively impact our ability to mitigate losses through the sale of properties. We expect our ability to mitigate losses will continue to be adversely affected by the continued pressure on home prices combined with the limited availability of credit in the U.S. financial markets.
The number of paid claims during both the third and fourth quarters of 2008 were lower than the number of paid claims during the second quarter of 2008, although the inventory of filed claims has continued to increase. The slowdown in the second half of 2008 was due to a number of factors, including lender and GSE foreclosure moratoriums, delays by the servicers due to a large increase in the number of defaults, our ongoing effort to identify fraud, misrepresentation or other underwriting violations in policies which are currently in default, as well as increased rescission activity.
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, 2008 and 2007. The data below excludes the effects of reinsurance.
The above table does not account for reserves ceded to the lender sponsored captive reinsurers. The amount recoverable under captive reinsurance contracts, net of liabilities where the right of offset exists, is shown as an asset on the balance sheet and amounted to approximately $157 million and $7 million at December 31, 2008 and 2007, respectively.
The large increase in reserves in 2008 primarily reflects the increase in the number of defaults, a decline in the cure rate of defaults, as well as the changing composition of our default inventory, with higher concentrations in distressed market states and recent policy years. Our reserving model incorporates management’s judgment regarding the impact of the current housing and economic environment on our estimate of the ultimate claims we will pay on loans currently in default. To reflect the significant adverse changes in the economy, including declining home prices and our reduced ability to mitigate claims, we have increased the severity factor utilized in the calculation of the reserve.
We have experienced an increasing number of defaults that contained underwriting violations in the original application for insurance. Generally, our master policies provide that we are not liable to pay a claim for loss when this occurs. We are currently reviewing the majority of the claims for losses and defaults that occur soon after loan origination, especially with respect to the 2006 and 2007 vintage years, to determine whether the limitations on our
liability contained in our master policies are applicable. Beginning in the third quarter of 2007, we incorporated an adjustment in the frequency factor utilized in the calculation of our provision for losses to account for expected rescissions. The expected rescission factor, for specific sub-sections of our portfolio, increased in each quarter of 2008. This increase in the number of policies that have been rescinded, combined with the large increase in number of policies under review for possible violations of our master policies, resulted in a decline in the frequency factor at December 31, 2008 from that used at December 31, 2007, which mitigated the reserve increase.
To illustrate the impact of the changes in the frequency and severity factors utilized in the reserve model, the following table details the amount of risk in default and the reserve balance as a percentage of risk in default at December 31, 2008 and December 31, 2007.
Reflects gross case reserves, which excludes IBNR and ceded reserves and the benefit from Modified Pool structures, as a percent of risk in default for total Primary delinquent loans and total Modified Pool delinquent loans.
The percentage of total loans in default increased to 11.68% as of December 31, 2008 from 4.44% at December 31, 2007, an overall increase of 163% during 2008. 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. The percentage of loans in default, or default rate, has increased considerably during 2008. The default rate is affected by the number of policies in default as well as the number of policies in force. As we are in run-off and are no longer issuing commitments for mortgage insurance, we expect the number of policies in force to continue to decrease which will have an adverse effect on the default rate. We currently expect the overall default rate as well as the number of loans in default to increase in 2009, and the increase may be greater than that experienced in 2008.
As part of our overall risk management strategy, we have entered into excess of loss captive reinsurance agreements with several of our lender customers. As detailed under “Business - Reinsurance” in Part I, Item 1 of this report, we retain the first loss position on the first aggregate layer of risk and reinsure a second finite layer with the captive reinsurer. Certain captives have exceeded the first loss layer in incurred losses, which resulted in the ceding of reserves and paid losses related to specific book years. We recorded a net of $157 million of ceded reserve from these captive arrangements at December 31, 2008 and ceded $497,000 of paid claims during 2008. If the current default and paid claim trends continue, we expect to cede additional reserves and paid losses to the captive reinsurers in 2009.
We wrote off the remaining deferred policy acquisition costs (“DAC”) asset balance of $34.8 million during the first quarter of 2008 as estimated gross loss in the remaining portfolio no longer supported the asset value.
On July 15, 2008, we ceased issuing commitments for insurance written and are operating our business in run-off. Going forward, our production will consist of certificates issued from commitments for mortgage insurance that were entered into prior to July 15, 2008. As such, we do not have any significant customers on whom we rely for new business.
Total assets were $1.1 billion at both December 31, 2008 and December 31, 2007. For the year ended December 31, 2008, total assets reflect the liquidation of certain assets in connection with the repayment of the $80.0 million credit facility and the write-off of the remaining $34.8 million of DAC as well as an increase of $145.0 million of ceded reinsurance recoverable, primarily related to loss reserves ceded to captive reinsurers. Total liabilities increased substantially to $1.3 billion at December 31, 2008 from $634.0 million at December 31, 2007 primarily reflecting the $827.9 million increase in loss and LAE reserves. This increase was partially offset by the repayment of the $80.0 million credit facility in the first quarter of 2008 and a decline in deferred income taxes of $123.3 million related to the reversal of previously established deferred taxes.
Our goal for managing our investment portfolio is to optimize investment returns, provide liquidity when necessary, preserve capital and adhere to regulatory requirements. We have established a formal investment policy that describes our overall quality and diversification objectives and limits. Historically, the majority of our investment portfolio had been comprised of tax-preferred state and municipal fixed income securities. Given the operating losses reported since the third quarter of 2007, we currently do not anticipate the realization of tax benefits normally associated with state and municipal securities. As a result, we made the decision in the second quarter of 2008 to restructure the investment portfolio into taxable publicly-traded securities, primarily corporate debt obligations, asset-backed securities, and mortgage-backed securities. Furthermore, as we anticipate negative cash flow from operations in 2009 due to the expected increase in claims paid, we expect the proceeds from the maturity and sale of securities will be required to fund the shortfall. In connection with the restructuring of our investment portfolio, we shortened the portfolio duration to better match the maturities with our anticipated cash needs. At December 31, 2008, we had $159 million of municipal securities remaining in our portfolio. In the current market there are significant risks involved in attempting to liquidate the remaining tax-preferred portfolio. These risks include execution risk in the selling and buying of securities, additional credit risk moving from primarily insured, highly rated municipal bonds to lower rated corporate bonds, and uncertainty surrounding mortgage-backed and asset-backed securities.
Our investment policy and strategies are subject to further change depending upon regulatory, economic and market conditions as well as our existing financial condition and operating requirements, including our tax position. We classify our entire investment portfolio as available for sale. This classification allows us the flexibility to dispose of securities in order to meet our investment objectives and operating requirements. All investments are carried on our balance sheet at fair value.
The following table shows the results of our investment portfolio for the last two years:
Credit risk is inherent in an investment portfolio. 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.
We evaluate the credit risk of a security by analyzing the underlying credit qualities of the security. The following table indicates the credit quality of our fixed maturity portfolio with and without the benefit of the credit enhancements as provided by financial guaranty insurers at December 31, 2008:
At December 31, 2008, our state and municipal bond portfolio amounted to $159.4 million, with approximately $131.9 million containing credit enhancements from financial guaranty insurers. The following table indicates the approximate exposure to and percentage of our credit enhanced state and municipal bond portfolio by financial guaranty insurer:
During 2009 and continuing into 2010, we expect to report negative cash flow from operations as we anticipate the payment of claims and expenses will be greater than net premium and investment income received. We anticipate that the cash necessary to meet the negative operating cash flow in 2009 and 2010 will be funded by the scheduled maturities of invested assets and, if needed, sales of other assets in our investment portfolio. Items that could have an impact on cash flow in 2009 and 2010 include the outcome of the arbitration of the $95 million Excess-of-Loss reinsurance treaty and the reimbursement of claims paid by the captive reinsurers.
As described under “Investment Portfolio,” we are in the process of repositioning our investment portfolio to convert from a primarily tax-preferred portfolio to a taxable portfolio. Furthermore, maturities within our fixed income investment portfolio are being structured to have such funds available to meet operating cash needs or provide options to reinvest those funds. See “Investment Portfolio” for more information concerning the repositioning. Our business does not routinely require significant amounts of capital expenditures. Although some capital expenditures are required to keep systems operating effectively and efficiently during run-off, we anticipate that future capital expenditures will be less than in previous years.
At December 31, 2008, the Company reported a deficit in assets of $136.7 million compared to stockholders’ equity of $498.9 million at December 31, 2007. A deficit in assets occurs when recorded liabilities exceed recorded assets. The deficit in assets is the result of six straight quarters of losses totaling $737.9 million. The largest portion of our losses is the result of an increase in loss and loss adjustment expense reserves of $1.1 billion since June 30, 2007, the last quarter for which we reported a profit. In addition, we have paid in excess of $300 million of claims during these last six quarters, an amount greater than the total claims paid during the first 18 years of the Company’s existence. At December 31, 2008, we had approximately $935 million of cash and invested assets, approximately $234 million more than at June 30, 2007. We reported $147.1 million of cash flow from operations for 2008, with $116.0 million derived from the redemption of Tax and Loss Bonds that are not expected to be an ongoing source of cash. We expect to continue to report a deficit in assets in future periods. While we do not expect the deficit in assets to have a direct impact on our operations, it could adversely impact our continued listing on The NASDAQ Stock Market. While we reported a deficit in assets at December 31, 2008 for GAAP purposes, we are still reporting positive policyholders’ surplus as calculated under statutory accounting principles.
The parent company has limited sources of cash flow. The $35 million outstanding long-term debt is the obligation of the parent company and not of Triad. Debt service amounts to $2.8 million per year and is paid by the parent company. The primary source of funds for the parent company debt service has historically been the interest paid on the $25 million surplus note by Triad, which has provided $2.2 million on an annual basis. We do not expect this source of cash to be available for the foreseeable future. At December 31, 2008, the parent company had cash and invested assets of approximately $10.7 million. While we currently believe that the cash resources on hand at the parent company will be sufficient to cover the required debt service for 2009 on the $35 million long-term debt, we cannot provide any assurance that this or any future debt service payments will be made and the ultimate ability
Triad has historically reimbursed the parent company for a majority of its operating cash expenses under a management agreement. As part of the Corrective Order, we are required to submit to the Division a request for reimbursement of these expenses on a quarterly basis. These parent company cash expenses range from approximately $250,000 to $600,000 per quarter depending on certain activities and include legal, director, accounting, and consulting fees. There can be no assurance these quarterly expenditures will not increase in the future. If the Division prohibits or limits the reimbursement by Triad of the parent company’s operating expenses, the cash resources of the parent company will be adversely affected.
In 2007, the Company established a Canadian subsidiary for the purpose of exploring the opportunity to provide mortgage insurance in Canada. During the first quarter of 2008, in response to the continued stress in the U.S. mortgage markets, the Company discontinued the effort in Canada and repatriated most of the funds back to the U.S. parent company. The Canadian subsidiary was liquidated during the fourth quarter of 2008 and all funds have now been returned to the parent company. Of the approximately $45.0 million of cash originally invested, we received approximately $44.1 million back from Canada, which included a net realized gain from foreign currency translation of $3.4 million.
Triad cedes business to captive reinsurance affiliates of certain mortgage lenders, primarily under excess of loss reinsurance agreements. Generally, reinsurance recoverables on loss reserves and unearned premiums ceded to these captives are backed by trust accounts where Triad is the sole beneficiary. When ceded loss reserves exceed the trust balances, we address the counter-party credit risk of the reinsurance recoverable on a case-by-case basis and provide for a provision for uncollectible accounts where appropriate. At December 31, 2008, total trust balances were approximately $258.0 million compared to $201.5 million at December 31, 2007.
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, 2008 and December 31, 2007:
In connection with the decision to transition our business into run-off, we notified the rating agencies that we were terminating all agreements with them regarding the issuance of ratings on the Company. As a result, the rating agencies have since withdrawn their ratings for the Company and for our subsidiaries, including Triad. All three rating agencies currently have a negative outlook on the U.S. private mortgage insurance industry.
We had no material off-balance sheet arrangements at December 31, 2008.
We lease office facilities, automobiles, and office equipment under operating leases with minimum lease commitments that range from one to five years. We had no capitalized leases or material purchase commitments at December 31, 2008.
Loss reserves represent 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. For the purpose of this table, we estimated that 34% of the existing reserves will result in claim payments in the next year and the remaining 66% will be paid in the following two years in equal amounts. The payment period is based on historical claim payment trends adjusted somewhat for recent developments affecting the payment of claims. The establishment of loss reserves is subject to inherent uncertainty and requires significant judgment by management. Furthermore, the current operating environment and recent government initiatives have made it even more difficult to estimate loss reserves and the payment period.
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 but 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 segments defaults by a variety of criteria. The criteria include, among others, policy year, lender, geography and the number of months 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. Beginning in 2007, we incorporated in the calculation of loss reserves the probability that a policy may be rescinded for underwriting violations.
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. Furthermore, the current conditions of the economy and the mortgage market are substantially different than those we have witnessed before and, as such, we believe our estimates are susceptible to a larger degree of variation than those established in previous financial statements. To provide a measure of the sensitivity on pretax income and
During 2008, we experienced a much higher level of rescission activity than in previous years. This activity was concentrated in policies originated in 2006 and 2007. We have also identified concentrations with specific lenders and by delivery channel. Beginning in late 2007, we began to incorporate a factor in our computation of loss reserves to account for expected rescissions. In estimating this factor, we consider whether the policy is under review, if the policy has been recommended for rescission, how many payments the borrower made on the mortgage, whether the policy was delivered through the flow channel or bulk channel, as well as who was the originating lender. The effect of the factor is to reduce the loss reserve by reflecting the probability that we may rescind coverage on a certificate. The inclusion of this factor in our calculation of loss reserves reduced incurred losses by $203.9 million at December 31, 2008.
We also account for the impact of expected rescissions on our future premium revenue by establishing an accrual for expected premium refunds. In establishing this accrual, we consider the probability a policy will be rescinded, which is consistent with the factor used in the calculation of loss reserves. The establishment of this liability reduced premium revenue in 2008 by $17.1 million.
A substantial amount of judgment is used in calculating the impact of rescissions and we have limited historical experience in calculating this impact. Our recent experience with rescissions is not necessarily indicative of the future trends. Furthermore, our ability to rescind a policy may be adversely impacted by the insured disputing our rights and prevailing in court or arbitration. Any increase or decrease in rescission factors would impact our reserves in the period in which they are adopted.
Given our recurring losses from operations and the significant doubt regarding our ability to continue as a going concern, we may no longer have the ability to hold impaired assets for a sufficient time to recover their value. As a result, we recognized an impairment loss on all securities that were in an unrealized loss position at December 31, 2008. Previously, we reviewed our investments quarterly to identify and evaluate whether any investments had indications of possible impairment and whether any impairments were 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 our intent and ability to hold the investment for a period of time sufficient to allow for recovery in market value. For a further discussion of the valuation of our investment portfolio and the methodology we use to identify potential impairments, see “Investment Portfolio” above.
A premium deficiency is recognized when the present value of the embedded estimated future loss from the existing insurance portfolio is greater than the existing net reserves. Computations of premium deficiency reserves requires the use of significant judgments and estimates to determine the present value of future premiums and present value of expected losses and expenses on our business. The present value of future premiums relies on, among other things, assumptions about persistency and repayment patterns on underlying loans. The present value of expected losses and expenses depends on assumptions relating to severity of claims and claim rates on current defaults, and expected defaults in future periods.
the possibility that the Division may take various actions regarding Triad if it does not approve our revised financial and operating plan, including placing Triad into receivership proceedings, which would effectively eliminate all remaining stockholder value;
the ability of the parent company to pay the debt service with funds obtained from Triad, whether in the form of dividends, payments on the surplus note or otherwise, will require the approval of the Division, and it is unlikely that such approval will be sought or, if sought, will be obtained in the foreseeable future;
our financial condition and performance in run-off could be affected by legislation adopted in the future, if any, impacting the mortgage industry, the GSEs specifically, or the financial services industry in general;
a significant decline in interest rates coupled with an increase in available credit could increase refinancings and decrease the persistency of renewal premiums and the quality of our insurance in force;
any impediment to our ability to rescind coverage on insurance policies, which would be detrimental to our success in run-off;
if we are unable to satisfy its continued listing requirements, we may be delisted from The NASDAQ Stock Market.