Combined statutory capital equals the sum of statutory capital of Essent Guaranty, Inc. plus Essent Guaranty of PA, Inc., after eliminating the impact of intercompany transactions. Statutory capital is computed based on accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the National Association of Insurance Commissioners Accounting Practices and Procedures Manual.
We are an established and growing private mortgage insurance company. Essent Guaranty, Inc., our wholly-owned insurance subsidiary which we refer to as "Essent Guaranty," is licensed to write coverage in all 50 states and the District of Columbia. The financial strength of Essent Guaranty is rated Baa1 with a stable outlook by Moody's Investors Service ("Moody's") and BBB+ with a stable outlook by S&P Global Ratings ("S&P"). On September 5, 2018, A.M. Best's Financial Strength Rating of A (Excellent) with a stable outlook was assigned to Essent Guaranty.
We also offer mortgage-related insurance and reinsurance through our wholly-owned Bermuda-based subsidiary, Essent Reinsurance Ltd., which we refer to as "Essent Re." As of December 31, 2018, Essent Re provided insurance or reinsurance relating to GSE risk share and other reinsurance transactions covering approximately $655.4 million of risk. Essent Re has also reinsured 25% of Essent Guaranty's GSE-eligible mortgage insurance NIW originated since July 1, 2014 under a quota share reinsurance agreement. The insurer financial strength rating of Essent Re is BBB+ with a stable outlook by S&P. On September 5, 2018, A.M. Best's Financial Strength Rating of A (Excellent) with a stable outlook was assigned to Essent Re.
It is likely that Federal legislation will be necessary to resolve the conservatorship of the GSEs, and such legislation could materially affect the role and charter of the GSEs and the operation of the housing finance system. In 2011, the U.S. Department of the Treasury recommended options for winding down the GSEs and using a combination of Federal housing policy changes to contract the government's footprint in housing finance and restore a larger role for private capital. Since 2011, members of Congress have introduced several bills intended to reform the secondary market and the role of the GSEs, although no comprehensive housing finance or GSE reform legislation has been enacted to date. In January 2018, the FHFA offered its own perspectives on housing finance reform in a communication to Congressional leaders, including a proposal to privatize the GSEs with an explicit guarantee from the U.S. Government for catastrophic losses on their mortgage-backed securities in return for fees paid into a reserve fund. See "Business-Regulation-Federal Mortgage-Related Laws and Regulations-Housing Finance Reform," "Risk Factors-Risks Relating to Our Business-Legislative or regulatory actions or decisions to change the role of the GSEs in the U.S. housing market generally, or changes to the charters of the GSEs with regard to the use of credit enhancements generally and private mortgage insurance specifically, could reduce our revenues or adversely affect our
profitability and returns," and "-Changes in the business practices of the GSEs, including actions or decisions to decrease or discontinue the use of mortgage insurance or changes in the GSEs' eligibility requirements for mortgage insurers, could reduce our revenues or adversely affect our profitability and returns."
Effective December 31, 2015, Fannie Mae and Freddie Mac, at the direction of the FHFA, implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. As of December 31, 2018, Essent Guaranty, our GSE-approved mortgage insurance company, was in compliance with the PMIERs.
We compete with the single-family mortgage insurance programs of the FHA, which is part of the Department of Housing and Urban Development. The most recent FHA report to Congress dated November 15, 2018 on the financial status of the FHA's Mutual Mortgage Insurance Fund, or MMIF, showed the capital reserve ratio of the MMIF at 2.76%, above the Congressionally mandated required minimum level of 2%. As a result of the financial improvements in the condition of the MMIF over the past few years and the stated desire to support the housing recovery, the FHA reduced its mortgage insurance premiums by 50 basis points in January 2015. See "Risk Factors-Risks Relating to Our Business-The amount of insurance we may be able to write could be adversely affected if lenders and investors select alternatives to private mortgage insurance."
NIW, which is the aggregate principal amount of the new mortgages that are insured during a period. Many factors affect NIW, including, among others, the volume of low down payment home mortgage originations and the competition to provide credit enhancement on those mortgages;
Cancellations of our insurance policies, which are impacted by payments on mortgages, home price appreciation, or refinancings, which in turn are affected by mortgage interest rates. Cancellations are also impacted by the levels of claim payments and rescissions;
The percentage of IIF that remains on our books after any 12-month period is defined as our persistency rate. Because our insurance premiums are earned over the life of a policy, higher persistency rates can have a significant impact on our profitability. The persistency rate on our portfolio was 84.9% at December 31, 2018. Generally, higher prepayment speeds lead to lower persistency.
Our investment portfolio was predominantly comprised of investment-grade fixed income securities and money market funds as of December 31, 2018. The principal factors that influence investment income are the size of the investment portfolio and the yield on individual securities. As measured by amortized cost (which excludes changes in fair market value, such as from changes in interest rates), the size of our investment portfolio is mainly a function of increases in capital and cash generated from or used in operations which is impacted by net premiums received, investment earnings, net claim payments and expenses. 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.
The provision for losses and loss adjustment expenses reflects the current expense that is recorded within a particular period to reflect actual and estimated loss payments that we believe will ultimately be made as a result of insured loans that are in default.
the level and amount of reinsurance coverage maintained with third parties;
During the third quarter of 2017, certain regions of the U.S. experienced hurricanes which have impacted our insured portfolio’s performance. Loans in default identified as hurricane-related defaults resulting from those storms totaled 2,288 as of December 31, 2017. In the year ended December 31, 2018, 2,150 of the 2,288 defaults previously identified as hurricane-related cured. Based on our experience to date and prior industry experience, we expect the ultimate number of hurricane-
Essent Group Ltd. and its wholly-owned subsidiary, Essent Re, are domiciled in Bermuda, which does not have a corporate income tax. Effective July 2014, Essent Re began to reinsure 25% of GSE-eligible new insurance written of Essent Guaranty, an affiliate. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae.
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. Subsequent years of a book generally result in modest underwriting profit or underwriting losses. This pattern generally 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 by increasing losses.
Our average net premium rate is dependent on a number of factors, including: (1) the risk characteristics and average coverage on the mortgages we insure; (2) the mix of monthly premiums compared to single premiums in our portfolio; (3) cancellations of non-refundable single premiums during the period; (4) changes to our pricing; and (5) premiums ceded under third-party reinsurance agreements. For the years ended December 31, 2018, 2017 and 2016, our average net premium rate was 0.50%, 0.53% and 0.57%, respectively. In 2018, Essent Guaranty entered into third-party reinsurance agreements, and in June 2018, we announced a reduction in pricing on our published rates effective for future NIW. We anticipate that the continued use of third-party reinsurance and the announced pricing reductions on future NIW will reduce our average net premium rate in future periods.
The risk-to-capital ratio has historically been used as a measure of capital adequacy in the U.S. mortgage insurance industry and is calculated as a ratio of net risk in force to statutory capital. Net risk in force represents total risk in force net of reinsurance ceded and net of exposures on policies for which loss reserves have been established. Statutory capital for our U.S.
As of December 31, 2018, our combined net risk in force for our U.S. insurance companies was $26.2 billion and our combined statutory capital was $1.9 billion, resulting in a risk-to-capital ratio of 13.9 to 1. The amount of capital required varies in each jurisdiction in which we operate; however, generally, the maximum permitted risk-to-capital ratio is 25.0 to 1. State insurance regulators are currently examining their respective capital rules to determine whether, in light of the financial crisis, changes are needed to more accurately assess mortgage insurers' ability to withstand stressful economic conditions. As a result, the capital metrics under which they assess and measure capital adequacy may change in the future. Independent of the state regulator and GSE capital requirements, management continually assesses the risk of our insurance portfolio and current market and economic conditions to determine the appropriate levels of capital to support our business.
ceded under third-party reinsurance agreements and a decrease in premiums earned on the cancellation of non-refundable single premium policies, along with changes in the mix of the mortgages we insure and changes in our pricing.
Net premiums written increased in the year ended December 31, 2018 by 20% over the prior year. The increase was due primarily to the increase in average IIF for the year ended December 31, 2018 as compared to the year ended December 31, 2017, partially offset by the increase in premiums ceded under third-party reinsurance agreements in the year ended December 31, 2018.
In the year ended December 31, 2018, unearned premiums increased by $35.8 million as a result of net premiums written on single premium policies of $114.9 million which was partially offset by $79.1 million of unearned premium that was recognized in earnings during the year. In the year ended December 31, 2017, unearned premiums increased by $40.1 million as a result of net premiums written on single premium policies of $114.3 million which was partially offset by $74.2 million of unearned premium that was recognized in earnings during the year. Included in unearned premium recognized was $17.7 million and $23.2 million related to policy cancellations for the year ended December 31, 2018 and 2017, respectively.
The increase in net investment income to $64.1 million for the year ended December 31, 2018 as compared to $40.2 million for the year ended December 31, 2017 was due to the increase in the weighted average balance of our investment portfolio and the increase in the pre-tax investment income yield. The average cash and investment portfolio balance increased to $2.6 billion during the year ended December 31, 2018 from $1.9 billion during the year ended December 31, 2017, primarily as a result of investing cash flows generated from operations and proceeds from the public offering of common shares completed in August 2017. The pre-tax investment income yield increased from 2.2% in the year ended December 31, 2017 to 2.6% in the year ended December 31, 2018 primarily due to an increase in market interest rates, an increase in the portion of our investment portfolio invested in spread and duration assets and higher yields on new investments. The pre-tax investment income yields are calculated based on amortized cost and exclude investment expenses. See "-Liquidity and Capital Resources" for further details of our investment portfolio.
The decrease in the number of defaults at December 31, 2018 compared to December 31, 2017 was primarily due to the previously identified hurricane-related defaults that have cured, partially offset by new defaults resulting from the increase in our IIF and policies in force and further seasoning of our insurance portfolio.
Our subsidiaries in the United States file a consolidated U.S. Federal income tax return. Our income tax expense was $79.3 million for the year ended December 31, 2018 compared to $18.8 million for the year ended December 31, 2017. Income tax expense for the year ended December 31, 2018 was calculated using an effective tax rate of 16.0% and includes $1.5 million of expense associated with accrual to return adjustments associated with the completion of the 2017 U.S. federal income tax return. For the year ended December 31, 2018, income tax expense was reduced by excess tax benefits associated with the vesting of common shares and common share units of $9.6 million. Income tax expense for the year ended December 31, 2017, was calculated using an effective tax rate of 26.9% and was reduced by $85.1 million of income tax benefits associated with the one-time impact of the reduced U.S. statutory corporate income tax rate on the company's net deferred tax liability position. Income tax expense for the year ended December 31, 2017 was also reduced by excess tax benefits associated with the vesting of common shares and common share units of $3.2 million. The tax effects associated with the vesting of common shares and common share units, the accrual to return adjustments associated with the completion of U.S. federal income tax returns and the income tax benefits associated with the one-time impact of the reduced U.S. statutory corporate income tax rate on the company's net deferred tax liability position are treated as discrete items in the reporting period in which they occur and are not considered in determining the annual effective tax rate. The decrease in the annual effective tax rate for 2018 reflects the reduction of the U.S. statutory corporate income tax rate from 35% to 21% and the portion of our consolidated earnings generated in Bermuda. Bermuda does not have a corporate income tax.
rather than as derivatives, and the decrease in Triad service fees associated with the reduction in the number of Triad's mortgage insurance policies in force. The fees earned from Triad will continue to decrease over time as Triad's existing policies are cancelled.
The increase in the number of defaults at December 31, 2017 compared to December 31, 2016 was primarily due to the increase in defaulted loans in the areas impacted by Hurricanes Harvey and Irma, as well as the increase in our IIF and policies in force, along with further seasoning of our insurance portfolio. In 2017, loans in default increased by a total of 3,026, including 2,288 defaults we identified as hurricane-related defaults.
The decrease in the average total reserve per default was primarily due to a lower total reserve per hurricane-related default. Based on prior industry experience, we expect the ultimate number of hurricane-related defaults that result in claims will be less than the default-to-claim experience of non-hurricane-related defaults. Accordingly, when establishing our loss reserves as of December 31, 2017, we applied a lower estimated claim rate to new default notices received in the fourth quarter of 2017 from the affected areas than the claim rate we apply to other notices in our default inventory. The reserve for losses and LAE on hurricane-related defaults was $11.1 million at December 31, 2017. Also contributing to the decrease in the average case reserve per default were changes in the composition (such as mark-to-market loan-to-value ratios, risk in force, and number of months past due) of the underlying loans in default and improvements in economic fundamentals.
During the year ended December 31, 2017, the provision for losses and LAE was $27.2 million, comprised of $38.2 million of current year losses partially offset by $10.9 million of favorable prior years' loss development. During the year ended December 31, 2016, the provision for losses and LAE was $15.5 million, comprised of $21.9 million of current year losses partially offset by $6.4 million of favorable prior years' loss development. In both periods, the favorable prior years' loss development was the result of a re-estimation of amounts ultimately to be paid on prior year defaults in the default inventory, including the impact of previously identified defaults that cured.
At December 31, 2017 and 2016, we concluded that it was more likely than not that our deferred tax assets would be
net premiums that we will receive from our existing IIF as well as policies that we write in the future;
On May 2, 2018, we amended the Credit Facility to increase the committed capacity by $125 million to $500 million, including the issuance of $100 million of additional term loans, the proceeds of which were used to pay down borrowings outstanding under the revolving component of the Credit Facility. See Note 7 to our consolidated financial statements.
While the Company and all of its subsidiaries are expected to have sufficient liquidity to meet all their expected obligations, additional capital may be required to meet any new capital requirements that are adopted by regulatory authorities or the GSEs, or to provide additional capital related to the growth of our risk in force in our mortgage insurance portfolio, or to fund new business initiatives including the insurance activities of Essent Re. We continually evaluate opportunities based upon market conditions to further increase our financial flexibility through the issuance of equity or debt, or other options including reinsurance or credit risk transfer transactions. There can be no guarantee that any such opportunities will be available on acceptable terms or at all.
Our U.S. insurance subsidiaries are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate and the GSEs. Under the insurance laws of the Commonwealth of Pennsylvania, the insurance subsidiaries may pay dividends during any twelve-month period in an amount equal to the greater of (i) 10% of the preceding year-end statutory policyholders' surplus or (ii) the preceding year's statutory net income. The Pennsylvania statute also requires that dividends and other distributions be paid out of positive unassigned surplus without prior approval. At December 31, 2018, Essent Guaranty, had unassigned surplus of approximately $166.8 million. During the year ended December 31, 2018, Essent Guaranty paid to its parent, Essent US Holdings, Inc. ("Essent Holdings"), a $40 million dividend which was used to repay the borrowings remaining under the revolving component of the Credit Facility. Essent Guaranty of PA, Inc. had unassigned surplus of approximately $10.3 million as of December 31, 2018. Essent Re is subject to certain dividend restrictions as prescribed by the Bermuda Monetary Authority and under certain agreements with counterparties. In connection with a quota share reinsurance agreement with Essent Guaranty, Essent Re has agreed to maintain a minimum total equity of $100 million. As of December 31, 2018, Essent Re had total equity of $798.6 million. In connection with its insurance and reinsurance activities, Essent Re is required to maintain assets in trusts for the benefit of its contractual counterparties. See Note 3 to our consolidated financial statements. At December 31, 2018, our insurance subsidiaries were in compliance with these rules, regulations and agreements.
Cash flow provided by operating activities totaled $625.3 million for the year ended December 31, 2018, as compared to $368.6 million for the year ended December 31, 2017 and $274.6 million for the year ended December 31, 2016. The increase in cash flow from operations of $256.7 million in 2018 was primarily a result of increases in premium collected and net investment income, and a net decrease in United States Mortgage Guaranty Tax and Loss Bonds (“T&L Bonds”), partially offset by increases in expenses paid. The increase in cash flow from operations of $94.0 million in 2017 was primarily a result of increases in premium collected and net investment income, partially offset by increases in expenses paid.
Cash flow used in investing activities totaled $546.9 million for the year ended December 31, 2018 and primarily related to investing cash flows from the business. Cash flow used in investing activities totaled $690.1 million for the year ended December 31, 2017 and $365.3 million for the year ended December 31, 2016 and primarily related to investing cash flows from the business, proceeds from the public offering of common shares in August 2017 and net increased borrowings under the Credit Facility in 2017 and 2016.
During the year ended December 31, 2018, Essent Holdings made capital contributions to Essent Guaranty of $15 million to support new and existing business and Essent Guaranty paid a dividend to Essent Holdings of $40 million which was used to repay the borrowings remaining under the revolving component of the Credit Facility. During the year ended December 31, 2017, Essent Holdings made capital contributions to Essent Guaranty of $125 million to support new and existing business.
For additional information regarding regulatory capital see Note 17 to our consolidated financial statements. Our combined statutory capital equals the sum of statutory capital of Essent Guaranty plus Essent Guaranty of PA, Inc., after eliminating the impact of intercompany transactions. The combined risk-to-capital ratio equals the sum of the net risk in force of Essent Guaranty and Essent Guaranty of PA, Inc. divided by combined statutory capital. The information above has been derived from the annual and quarterly statements of our insurance subsidiaries, which have been prepared in conformity with accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the National Association of Insurance Commissioners Accounting Practices and Procedures Manual. Such practices vary from accounting principles generally accepted in the United States.
Essent Re has entered into GSE and other risk share transactions, including insurance and reinsurance transactions with Freddie Mac and Fannie Mae. Essent Re also executed a quota share reinsurance transaction with Essent Guaranty to reinsure 25% of Essent Guaranty’s GSE-eligible NIW effective July 1, 2014. Essent Group Ltd. made no capital contributions to Essent Re during the years ended December 31, 2018 as compared to capital contributions of $165.0 million during the year ended December 31, 2017 to support new business. As of December 31, 2018, Essent Re had total stockholders’ equity of $798.6 million and net risk in force of $8.3 billion.
The insurer financial strength rating of Essent Guaranty, our principal mortgage insurance subsidiary, is Baa1 with a stable outlook by Moody's and BBB+ with a stable outlook by S&P. The insurer financial strength rating of Essent Re is BBB+ with a stable outlook by S&P. On September 5, 2018, A.M. Best assigned Financial Strength Ratings of A (Excellent) with a stable outlook to each of Essent Guaranty and Essent Re.
As of December 31, 2018, stockholders’ equity was $2.4 billion compared to $1.9 billion as of December 31, 2017. This increase was primarily due to net income generated in 2018, partially offset by an increase in accumulated other comprehensive loss related to an increase in our unrealized investment losses.
As of December 31, 2018, investments totaled $2.8 billion compared to $2.3 billion as of December 31, 2017. In addition, our total cash was $64.9 million as of December 31, 2018, compared to $43.5 million as of December 31, 2017. The increase in investments was primarily due to investing net cash flows from operations during the year ended December 31, 2018.
Certain of the above securities may include financial guaranty insurance or state enhancements. The above ratings include the effect of these credit enhancements, if applicable.
We lease office space in Pennsylvania, North Carolina, California and Bermuda under leases accounted for as operating leases. A portion of the space leased in North Carolina has been subleased to Triad; minimum lease payments shown above have not been reduced by minimum sublease rental income of $0.1 million due in 2019 under the non-cancelable sublease.
our intent to sell the security or whether it is more likely than not that we will be required to sell the security before recovery;
Under the current guidance a debt security impairment is deemed other-than-temporary if we either intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery or we do not expect to collect cash flows sufficient to recover the amortized cost basis of the security. During the years ended December 31, 2018, 2017 and 2016, the unrealized losses recorded in the investment portfolio principally resulted from fluctuations in market interest rates and credit spreads. Each issuer is current on its scheduled interest and principal payments. There were no other-than-temporary impairments in the year ended December 31, 2018. We recorded other-than-temporary impairments of $0.1 million and $0.1 million in the years ended December 31, 2017 and 2016, respectively, for securities in an unrealized loss position. The impairments resulted from our intent to sell these securities subsequent to the reporting date.
To the Board of Directors and Stockholders of Essent Group Ltd.
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Essent Guaranty reinsures 25% of GSE-eligible new insurance written to Essent Reinsurance Ltd. (“Essent Re”), an affiliated Bermuda domiciled Class 3A Insurer licensed pursuant to Section 4 of the Bermuda Insurance Act 1978 that provides insurance and reinsurance coverage of mortgage credit risk. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae. In 2016, Essent Re formed Essent Agency (Bermuda) Ltd., a wholly-owned subsidiary, which provides underwriting consulting services to third-party reinsurers. In accordance with certain state law requirements, Essent Guaranty also reinsures that portion of the risk that is in excess of 25% of the mortgage balance with respect to any loan insured, after consideration of other reinsurance, to Essent Guaranty of PA, Inc. (“Essent PA”), an affiliate domiciled in the state of Pennsylvania.
Our fixed maturity and short-term investments are classified as available for sale as we may sell securities from time to time to provide liquidity and in response to changes in the market. Debt and equity securities classified as available for sale are reported at fair value with unrealized gains and losses on these securities reported in other comprehensive income, net of deferred income taxes. See Note 16 for a description of the valuation methods for investments available for sale.
We defer certain personnel costs and premium tax expense directly related to the successful acquisition of new insurance policies and amortize these costs over the period the related estimated gross profits are recognized in order to match costs and revenues. We do not defer any underwriting costs associated with our contract underwriting services. Costs related to the
A significant portion of our premium revenue relates to master policies with certain lending institutions. For the year ended December 31, 2018, one lender represented approximately 11% of our total revenue. The loss of this customer could have a significant impact on our revenues and results of operations.
We are required to establish a premium deficiency reserve if the net present value of the expected future losses and expenses for a particular group of policies exceeds the net present value of expected future premium, anticipated investment
Derivative instruments, including embedded derivative instruments, are recognized at fair value in the consolidated balance sheets. The amount of monthly reinsurance premium ceded under one of our reinsurance contracts will fluctuate due to changes in one-month LIBOR and changes in money market rates. As the reinsurance premium will vary based on changes in these rates, we concluded that this reinsurance agreement contains an embedded derivative that is accounted for separately like a freestanding derivative.
Through June 30, 2016, insurance and certain reinsurance policies issued by Essent Re in connection with Freddie Mac's Agency Credit Insurance Structure ("ACIS") program were accounted for as derivatives under GAAP with the fair value of these policies reported as an asset or liability and changes in the fair value of these policies reported in earnings as a component of other income. During the quarter ended September 30, 2016, these contracts were amended and are accounted for as insurance contracts rather than as derivatives subsequent to their amendment. As of December 31, 2018 and 2017, the Company had no freestanding derivative instruments.
Deferred income tax assets and liabilities are determined using the asset and liability (or balance sheet) method. Under this method, we determine the net deferred tax asset or liability based on the tax effects of the temporary differences between the book and tax bases of the various assets and liabilities and give current recognition to changes in tax rates and laws. Changes in tax laws, rates, regulations and policies, or the final determination of tax audits or examinations, could materially affect our tax estimates. We evaluate the realizability of the deferred tax asset and recognize a valuation allowance if, based on the weight of all available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. When evaluating the realizability of the deferred tax asset, we consider estimates of expected future taxable income, existing and projected book/tax differences, carryback and carryforward periods, tax planning strategies available, and the general and industry specific economic outlook. This realizability analysis is inherently subjective, as it requires management to forecast changes in the mortgage market, as well as the related impact on mortgage insurance, and the competitive and general economic environment in future periods. Changes in the estimate of deferred tax asset realizability, if applicable, are included in income tax expense on the consolidated statements of comprehensive income.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326). This update is intended to provide financial statement users with more information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of an allowance for credit losses. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance rather than as a write-down of the amortized cost of the securities. The provisions of this update
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this update modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The provisions of this update are effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted for the removed disclosures. The Company is evaluating the impact the adoption of this ASU will have on the consolidated financial statements and related disclosures.
Gross gains and losses realized on the sale of investments available for sale were as follows:
The fair value of investments available for sale in an unrealized loss position and the related unrealized losses were as follows:
Effective November 1, 2018, Essent Guaranty entered into a reinsurance agreement with a panel of reinsurers that provides for up to $165.2 million of aggregate excess-of-loss coverage immediately above the coverage provided by Radnor Re. The aggregate excess of loss reinsurance coverage decreases over a ten-year period as the underlying covered mortgages amortize. Essent Guaranty has rights to terminate the reinsurance agreement, which includes an option to terminate after five years from issuance. If the reinsurance agreement is not terminated after five years from issuance, the reinsurance premium payable will increase by 50%.
The following table presents total assets of Radnor Re as well as our maximum exposure to loss associated with Radnor Re, representing the estimated net present value of investment earnings on the assets in the reinsurance trust, each as of December 31, 2018:
The assets of Radnor Re are the source of reinsurance claim payments to Essent Guaranty and provide capital relief under the PMIERs financial strength requirements (see Note 17). A decline in the assets available to pay claims would reduce the capital relief available to Essent Guaranty.
For the year ended December 31, 2018, $7.7 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There has been a $24.9 million favorable prior year development during the year ended December 31, 2018. Reserves remaining as of December 31, 2018 for prior years are $14.3 million as a result of re-estimation of unpaid losses and loss adjustment expenses. For the year ended December 31, 2017, $7.9 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There was a $10.9 million favorable prior year development during the year ended December 31, 2017. Reserves remaining as of December 31, 2017 for prior years were $9.3 million as a result of re-estimation of unpaid losses and loss adjustment expenses. In both periods, the favorable prior years' loss development was the result of a re-estimation of amounts ultimately to be paid on prior year defaults in the default inventory, including the impact of previously identified defaults that cured. Original estimates are increased or decreased as additional information becomes known regarding individual claims.
quarter of 2018, we reduced the reserves on hurricane-related defaults by $9.9 million based on the performance to date and our expectations of the amount of ultimate losses on the remaining delinquencies. The impact on our reserves in future periods will be dependent upon the performance of the hurricane-related defaults and our expectations for the amount of ultimate losses on these delinquencies.
The following table summarizes incurred loss and allocated loss adjustment expense development, IBNR plus expected development on reported defaults and the cumulative number of reported defaults. The information about incurred loss development for the years ended December 31, 2010 to 2017 is presented as supplementary information.
On May 2, 2018, the Credit Facility was amended to increase the committed capacity by $125 million to $500 million and to increase the uncommitted line by $25 million to $100 million. The revolving component of the Credit Facility was increased from $250 million to $275 million, and the Borrowers issued $100 million of additional term loans, resulting in $225 million of term loans outstanding. The proceeds of $100 million of additional term loans were used to pay down borrowings outstanding under the revolving component of the Credit Facility. The interest rate, contractual maturity and other terms of the Credit Facility are otherwise unchanged from those described above. As of December 31, 2018, the Company was in compliance with the covenants and $225 million had been borrowed under the Credit Facility with a weighted average interest rate of 4.43%. As of December 31, 2017, $250 million had been borrowed with a weighted average interest rate of 3.49%.
Under the terms of CUW Solutions' contract underwriting agreements with lenders and subject to contractual limitations on liability, we agree to indemnify certain lenders against losses incurred in the event that we make an error in determining whether loans processed meet specified underwriting criteria, to the extent that such error materially restricts or impairs the salability of such loan, results in a material reduction in the value of such loan or results in the lender repurchasing the loan. The indemnification may be in the form of monetary or other remedies. For the years ended December 31, 2018 and 2017, we paid $0.1 million and $0.2 million, respectively, related to remedies. As of December 31, 2018, management believes any potential claims for indemnification related to contract underwriting services through December 31, 2018 are not material to our consolidated financial position or results of operations.
In addition to the indemnifications discussed above, in the normal course of business, we enter into agreements or other relationships with third parties pursuant to which we may be obligated under specified circumstances to indemnify the counterparties with respect to certain matters. Our contractual indemnification obligations typically arise in the context of agreements entered into by us to, among other things, purchase or sell services, finance our business and business transactions, lease real property and license intellectual property. The agreements we enter into in the normal course of business generally
We lease office space for use in our operations under leases accounted for as operating leases. Total rent expense was $2.1 million, $2.1 million and $1.9 million for the years ended December 31, 2018, 2017 and 2016, respectively. The future minimum lease payments of non-cancelable operating leases are as follows at December 31, 2018:
Minimum lease payments shown above have not been reduced by minimum sublease rental income of $0.1 million due in 2019 under the non-cancelable sublease.
In August 2017, Essent Group completed the sale of 5.0 million common shares in a public offering at a price of $39.90 per share. The total net proceeds from this offering were approximately $197.7 million after deducting underwriting discounts, commissions and other offering expenses.
In May 2015, nonvested common shares were granted to an employee in connection with an employment agreement that are subject to time-based and performance-based vesting. The time-based share award vests in four equal installments on July 1, 2016, 2017, 2018 and 2019. The performance-based share award vests based upon our compounded annual book value per share growth percentage during a three-year performance period that commenced on January 1, 2015 and vest on July 1, 2019.
In May of each year, 2015 through 2018, time-based share units were granted to non-employee directors that vest one year from the date of grant.
The following tables summarize nonvested common share and nonvested common share unit activity for the year ended December 31:
Quoted market prices are used for the valuation of common shares granted subsequent to our initial public offering. For nonvested common shares granted in September 2013, prior to our IPO, the valuation estimate was based on analysis provided by the underwriters regarding the estimated fair value of Essent and the estimated IPO price range. Factors considered in determining the IPO price range and common share valuation included prevailing market conditions, estimates of the
Employees have the option to tender shares to Essent Group to pay the minimum employee statutory withholding taxes associated with shares upon vesting. Common shares tendered by employees to pay employee withholding taxes totaled 718,726, 223,027 and 184,583 in 2018, 2017 and 2016, respectively. The tendered shares were recorded at cost and included in treasury stock. All treasury stock has been cancelled as of December 31, 2018 and 2017.
Our U.S. insurance subsidiaries are subject to certain capital and dividend rules and regulations as prescribed by jurisdictions in which they are authorized to operate. Under the insurance laws of the Commonwealth of Pennsylvania, Essent Guaranty and Essent PA may pay dividends during any 12-month period in an amount equal to the greater of (i) 10% of the preceding year-end statutory policyholders' surplus or (ii) the preceding year's statutory net income. The Pennsylvania statute also specifies that dividends and other distributions can be paid out of positive unassigned surplus without prior approval. At December 31, 2018, Essent Guaranty had unassigned surplus of approximately $166.8 million. During the year ended December 31, 2018, Essent Guaranty paid to its parent, Essent US Holdings, Inc. ("Essent Holdings"), a $40 million dividend which was used to repay the borrowings remaining under the revolving component of the Credit Facility. Essent Guaranty paid no dividends to Essent Group or any intermediate holding companies in the years ended December 31, 2017 or 2016. Essent PA had unassigned surplus of approximately $10.3 million as of December 31, 2018. Essent PA did not pay a dividend in 2018. In the years ended December 31, 2017 and 2016, Essent PA paid to its parent company, Essent Holdings, a dividend of $5 million and $3.75 million, respectively.
Essent Re is subject to certain dividend restrictions as prescribed by the Bermuda Monetary Authority and under certain agreements with counterparties. In connection with the quota share reinsurance agreement with Essent Guaranty, Essent Re has agreed to maintain a minimum total equity of $100 million. As of December 31, 2018, Essent Re had total equity of $798.6 million.
At December 31, 2018, our insurance subsidiaries were in compliance with these rules, regulations and agreements.
For the year ended December 31, 2018, the statutory income tax rates of the countries where the Company does business are 21% in the United States and 0.0% in Bermuda. The statutory income tax rate of each country is applied against the taxable income from each country to calculate the income tax expense.
On December 22, 2017, the “Tax Cuts and Jobs Act” (“TCJA”) was enacted. The provisions of TCJA include broad tax reforms that are applicable to the Company, including a reduction in the U.S. statutory corporate income tax rate from 35% to
21% effective January 1, 2018. This change in tax rates required us to remeasure our deferred tax assets and liabilities as of the enactment date resulting in a one-time $85.1 million income tax benefit for the year ended December 31, 2017.
For the year ended December 31, 2018 pre-tax income attributable to Bermuda and U.S. operations was $128.5 million and $418.2 million, respectively, as compared to $86.3 million and $312.3 million, respectively, for the year ended December 31, 2017 and $51.6 million and $260.3 million, respectively, for the year ended December 31, 2016.
We provide deferred taxes to reflect the estimated future tax effects of the differences between the financial statement and tax bases of assets and liabilities using currently enacted tax laws. The net deferred tax liability was comprised of the following at December 31:
As a mortgage guaranty insurer, we are eligible for a tax deduction, subject to certain limitations, under Section 832(e) of the IRC for amounts required by state law or regulation to be set aside in statutory contingency reserves. The deduction is allowed only to the extent that we purchase T&L Bonds in an amount equal to the tax benefit derived from deducting any portion of our statutory contingency reserves. During the year ended December 31, 2018, we had a net redemption of T&L Bonds in the amount of $49.8 million and had net purchases of T&L Bonds in the amount of $70.9 million, during the year ended December 31, 2017. As of December 31, 2018 and 2017 we held $202.4 million and $252.2 million of T&L Bonds, respectively.
Essent Holdings and its subsidiaries are subject to income taxes imposed by U.S. law and file a U.S. Consolidated Income Tax Return. Each subsidiary has executed a tax sharing agreement with its parent company, which provides that taxes are settled in cash between parent and subsidiary on a quarterly basis based on separate company pro-forma calculations. Should Essent Holdings pay a dividend to its parent company, Essent Irish Intermediate Holdings Limited, withholding taxes at a rate of 5% under the U.S./Ireland tax treaty would likely apply assuming the Company avails itself of Treaty benefits under the U.S./Ireland tax treaty. Absent treaty benefits, the withholding rate on outbound dividends would be 30%. Currently, however, no withholding taxes are accrued with respect to such unremitted earnings as management has no intention of remitting these earnings. Similarly, no foreign income taxes have been provided on the un-remitted earnings of the Company's U.S. subsidiaries as management has neither the intention of remitting these earnings, nor would any Ireland tax be due, as any Irish tax would be expected to be fully offset by credit for taxes paid to the U.S. An estimate of the cumulative amount of U.S. earnings that would be subject to withholding tax, if distributed outside of the U.S., is approximately $1.2 billion. The associated withholding tax liability under the U.S./Ireland tax treaty would be approximately $61.0 million.
There were 128,575, 44,540 and 96,251 antidilutive shares for the years ended December 31, 2018, 2017 and 2016, respectively.
We use independent pricing sources to determine the fair value of securities available for sale in Level 1 and Level 2 of the fair value hierarchy. We use one primary pricing service to provide individual security pricing based on observable market data and receive one quote per security. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing service and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. U.S. agency securities, U.S. agency mortgage-backed securities, municipal debt securities, non-U.S. government securities, and corporate debt securities are valued by our primary vendor using recently executed transactions and proprietary models based on observable inputs, such as interest rate spreads, yield curves and credit risk. Residential and commercial mortgage securities and asset-backed securities are valued by our primary vendor using proprietary models based on observable inputs, such as interest rate spreads, prepayment speeds and credit risk. As part of our evaluation of investment prices provided by our primary pricing service, we obtained and reviewed their pricing methodologies which include a description of how each security type is evaluated and priced. We review the reasonableness of prices received from our primary pricing service by comparison to prices obtained from additional pricing sources. We have not made any adjustments to the prices obtained from our primary pricing service.
Derivative liabilities-Through June 30, 2016, certain of our Freddie Mac ACIS contracts were accounted for as derivatives. In determining an exit market, we considered the fact that there is not a principal market for these contracts. In the absence of a principal market, we valued these ACIS contracts in a hypothetical market where market participants, and potential counterparties, included other mortgage guaranty insurers or reinsurers with similar credit quality to us. We believed that in the absence of a principal market, this hypothetical market provided the most relevant information with respect to fair value estimates. These ACIS contracts were classified as Level 3 of the fair value hierarchy. During the quarter ended September 30, 2016, these contracts were amended and are now accounted for as insurance contracts rather than as derivatives. As of December 31, 2018 and 2017, the Company had no freestanding derivative instruments.
Net income determined in accordance with statutory accounting practices differs from GAAP. In 2018 and 2017, the more significant differences between net income determined under statutory accounting practices and GAAP for Essent Guaranty and Essent PA relate to policy acquisition costs and income taxes. Under statutory accounting practices, policy acquisition costs are expensed as incurred while such costs are capitalized and amortized to expense over the life of the policy under GAAP. As discussed in Note 12, we are eligible for a tax deduction, subject to certain limitations for amounts required by state law or regulation to be set aside in statutory contingency reserves when we purchase T&L Bonds. Under statutory accounting practices, this deduction reduces the tax provision recorded by Essent Guaranty and Essent PA and, as a result, increases statutory net income and surplus as compared to net income and equity determined in accordance with GAAP.
Effective December 31, 2015, Fannie Mae and Freddie Mac, at the direction of the Federal Housing Finance Agency, implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. As of December 31, 2018, Essent Guaranty, our GSE-approved mortgage insurance company, was in compliance with the PMIERs.
Statement of Statutory Accounting Principles No. 58, Mortgage Guaranty Insurance, requires mortgage insurers to establish a special contingency reserve for statutory accounting purposes included in total liabilities equal to 50% of earned premium for that year. During 2018, Essent Guaranty increased its contingency reserve by $237.9 million and Essent PA increased its contingency reserve by $5.4 million. This reserve is required to be maintained for a period of 120 months to protect against the effects of adverse economic cycles. After 120 months, the reserve is released to unassigned funds. In the event an insurer’s loss ratio in any calendar year exceeds 35%, however, the insurer may, after regulatory approval, release from its contingency reserves an amount equal to the excess portion of such losses. Essent Guaranty and Essent PA did not release any amounts from their contingency reserves in 2018, 2017 or 2016.
Essent Guaranty has a capital maintenance agreement with Essent PA under which Essent Guaranty agreed to contribute funds, under specified conditions, to maintain Essent PA's risk-to-capital ratio at or below 25.0 to 1 in return for a surplus note. As of December 31, 2018, Essent PA's risk-to-capital ratio was 4.2:1 and there were no amounts outstanding related to this agreement.
The following table summarizes the unaudited results of operations for each quarter of 2018 and 2017. We have prepared the consolidated quarterly information on a basis consistent with the audited consolidated financial statements. In the opinion of management, the financial information reflects all adjustments (which include normal recurring adjustments) required for a fair presentation of the financial information for the quarters presented. This information should be read in conjunction with our audited financial statements and the related notes. The results of interim periods are not necessarily indicative of the results for the full year.
Under the insurance laws of the Commonwealth of Pennsylvania, the insurance subsidiaries may pay dividends during any 12-month period in an amount equal to the greater of (i) 10% of the preceding year-end statutory policyholders' surplus or (ii) the preceding year's statutory net income. The Pennsylvania statute also requires that dividends and other distributions be paid out of positive unassigned surplus without prior approval. As of December 31, 2018, Essent Guaranty had unassigned surplus of approximately $166.8 million. During the year ended December 31, 2018, Essent Guaranty paid to its parent, Essent US Holdings, Inc. ("Essent Holdings"), a $40 million dividend which was used to pay down the borrowings remaining under the revolving component of the Credit Facility. Essent PA had unassigned surplus of approximately $10.3 million as of December 31, 2018.
As more fully discussed in Note 7 of our consolidated financial statements, on May 2, 2018, the Credit Facility was amended to increase the committed capacity by $125 million to $500 million and to increase the uncommitted line by $25 million to $100 million. The revolving component of the Credit Facility was increased from $250 million to $275 million, and the Borrowers issued $100 million of additional term loans, resulting in $225 million of term loans outstanding at the consolidated level. The proceeds of $100 million of additional term loans were used to pay down borrowings outstanding under the revolving component of the Credit Facility. At December 31, 2018, the Parent Company's borrowings under the Credit Facility contractually mature in 2021.