As of December 31, 2001, the Company leases office space in its Winston-Salem headquarters and its eleven underwriting offices located throughout the country comprising approximately 56,000 square feet under leases expiring between 2002 and 2008 and which require annual lease payments of approximately $1.2 million in 2002. With respect to all facilities, the Company has, or believes it will be able to obtain, lease renewals on satisfactory terms. The Company believes its existing properties are well utilized and are suitable and adequate for its present circumstances.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF - ------ FINANCIAL CONDITION AND RESULTS OF OPERATION --------------------------------------------
has continued to increase. According to industry data, Triad's national market share of net new primary insurance written increased to 3.6% for all of 2001 (4.0% for the fourth quarter) from 2.7% for all of 2000. Net new primary insurance written excludes insurance placed upon loans more than 12 months after loan origination, insurance placed upon loans already covered by primary mortgage insurance, and insurance placed upon loans where lender exposure is effectively reduced below defined minimums. This treatment is consistent with the new definitions adopted by the Company and the industry in the third quarter of 2001 regarding the computation of new insurance written for market share purposes. The Company's market share reported for 2000 did not include any bulk transactions, as the Company wrote no new insurance in 2000 attributable to these transactions. Total direct insurance in force reached $21.7 billion at December 31, 2001, compared to $15.1 billion at December 31, 2000, an increase of 43.7%.
Growth in direct premiums written was partially offset by an increase in ceded premiums written. Driven primarily by increases in risk-sharing arrangements and also by excess of loss reinsurance, ceded premiums written increased 111% to $10.6 million from $5.0 million in 2000. The Company's premium cede rate (the ratio of ceded premiums written to direct premiums written) was 11.0% for 2001 compared to 6.5% for 2000. Approximately 37.3% of insurance written (57.9% excluding bulk transactions) during 2001 is subject to captive mortgage reinsurance and other risk-sharing arrangements compared to 42.9% of insurance written in 2000. Management anticipates ceded premiums will continue to increase as a result of the expected increase in risk-sharing programs.
Refinance activity was 35.8% (43.3% in the fourth quarter) of insurance written in 2001 compared to 13.2% (15.2% in the fourth quarter) in 2000. Persistency, or the amount of insurance in force remaining from one-year prior, was 67.6% at December 31, 2001, compared to 82.6% at December 31, 2000. The increase in refinance activity and the decrease in persistency are reflective of the current low interest rate environment.
Other operating expenses increased 13.3% to $18.1 million for 2001 from $16.0 million for 2000. This increase in expenses is primarily attributable to personnel, technology amortization, and equipment costs required to support the Company's product development, system enhancements, and expanded production. The expense ratio (ratio of the amortization of deferred policy acquisition costs and other operating expenses to net premiums written) for 2001 was 35.1% compared to 33.7% for 2000.
Insurance written was $4.4 billion for 2000, an increase of less than 1% from 1999 levels. For the fourth quarter, insurance written increased 50.8% to $1.3 billion in 2000 from $892 million in 1999. For 2000, insurance written was driven by expanded relationships with national lenders as well as innovative product offerings. According to industry data, Triad's national market share of net new primary insurance written, which excluded insurance placed upon loans more than 12 months after loan origination, increased to 2.7% for all of 2000 (3.1% in the fourth quarter) from 2.3% for all of 1999. Total direct insurance in force reached $15.1 billion at December 31, 2000, compared to $13.0 billion at December 31, 1999, an increase of 16.0%.
Total direct premiums written were $76.9 million for 2000, an increase of 17.6% compared to $65.4 million for 1999. Net premiums written increased by 12.8% to $71.9 million in 2000 from $63.7 million for 1999. Earned premiums increased 12.3% to $71.8 million for 2000 from $64.0 million for 1999. This
growth in written and earned premium resulted from both new insurance production in 2000 and an improvement in the Company's persistency. The growth in direct premiums written was offset somewhat by the increase in ceded premiums written. Driven primarily by increases in risk-sharing arrangements and excess of loss reinsurance, ceded premiums written for 2000 increased 200% to $5.0 million from $1.7 million in 1999. Approximately 42.9% of insurance written in 2000 was subject to captive mortgage reinsurance and similar arrangements compared to 22.9% in 1999.
reflected a growing balance of deferred policy acquisition costs to amortize as the Company continued to build its total insurance in force.
The Company generated positive cash flow from operating activities for 2001 of $43.8 million compared to $32.7 million for 2000. The increase in Triad's operating cash flow reflects the growth in premiums and investment income, nonrecurring income related to the cancellation of the excess of loss reinsurance contract, the effects of tax benefits resulting from stock option exercises, and a decrease in paid losses partially offset by the increase in underwriting expenses.
The Company's business does not routinely require significant capital expenditures other than for enhancements to its computer systems and technology capabilities. Positive cash flows are invested pending future payments of claims and expenses. Cash flow shortfalls, if any, could be funded through sales of short-term investments and other investment portfolio securities.
The parent Company's cash flow is dependent on interest income and payments from Triad including cash dividends, management fees, and interest payments under surplus notes. The insurance laws of the State of Illinois impose certain restrictions on dividends from Triad. These restrictions, based on statutory
accounting practices, include requirements that dividends may be paid only out of statutory earned surplus and limit the amount of dividends that may be paid without prior approval of the Illinois Insurance Department. The Illinois Insurance Department permits expenses of the parent company to be reimbursed by Triad in the form of management fees.
Fixed maturity securities represented approximately 89% of the Company's invested assets at December 31, 2001, and the fair value of these fixed rate securities generally bears an inverse relationship to changes in prevailing market interest rates. The Company's long-term debt bears interest at a fixed rate of 7.9% per annum, and as a result, the fair value of this debt is sensitive to changes in prevailing interest rates. A 10% relative increase or decrease in market interest rates that affect the Company's financial instruments would not have a material impact on earnings during the next fiscal year, and would not materially affect the fair value of the Company's financial instruments.
The Company's loss reserves increased to $18.0 million at December 31, 2001, compared to $15.0 million at December 31, 2000. Reserves are established for reported insurance losses and loss adjustment expenses based on when notices of default on insured mortgage loans are received. Reserves are also established for estimated losses incurred on notices of default not yet reported by the lender. Consistent with industry practices, the Company does not establish loss reserves for future claims on insured loans which are not currently in default.
Triad's total statutory policyholders' surplus increased to $105.5 million at December 31, 2001, from $101.0 million at December 31, 2000. This increase resulted primarily from statutory net income of $55.4 million, offset by increases in the statutory contingency reserve of $43.0 million and the $2.6 million effect of adopting new statutory accounting principles that went into effect on January 1, 2001. Triad's statutory earned surplus was $21.8 million at December 31, 2001, compared to $17.3 million at December 31, 2000, reflecting, primarily, growth in statutory net income greater than the increase in the statutory contingency reserve and the impact of the new statutory accounting principles. The balance in the statutory contingency reserve was $193.7 million at December 31, 2001, compared to $150.8 million at December 31, 2000.
Triad is rated "AA" by both Standard & Poor's Ratings Services and Fitch Ratings and "Aa3" by Moody's Investors Service.
In July 2001, the Office of Federal Housing Enterprise Oversight (OFHEO) released its initial risk-based capital rules for Fannie Mae and Freddie Mac. The regulation provided a more preferential capital credit for insurance from a "AAA" rated private mortgage insurer than for insurance from a "AA" rated private mortgage insurer. In December 2001, OFHEO announced proposed revisions to the risk-based capital rules for Fannie Mae and Freddie Mac. Among the proposed revisions, the new rule reduced, but did not eliminate, the capital charge differential between insurance from a "AAA" rated private mortgage insurer and insurance from a "AA" rated private mortgage insurer. In addition, the proposed phase-in period was extended from five years to ten years. The rule was finalized in February 2002 and became effective in March 2002. The continued presence of a capital charge differential could adversely affect Triad. Triad is evaluating various business approaches and options available to address the capital differential contained in the rule. What response, if any, Triad makes and the ultimate impact of the regulation on Triad is unknown at this time.
Management's Discussion and Analysis and this Report contain forward-looking statements relating to future plans, expectations, and performance which involve various risks and uncertainties, including but not limited to the following: interest rates may increase from their current levels; housing transactions and mortgage issuance may decrease for many reasons including changes in interest rates or economic conditions; the Company's market share may change as a result of changes in underwriting criteria or competitive products or rates; the amount of insurance written could be affected by changes in federal housing legislation, including changes in the Federal Housing Administration loan limits and coverage requirements of Freddie Mac and Fannie Mae; the Company's financial condition and competitive position could be affected by legislation impacting the mortgage guaranty industry specifically and the financial services industry in general; rating agencies may revise methodologies for determining the Company's financial strength ratings and may revise or withdraw the assigned ratings at any time; decreases in persistency, which are affected by loan refinancings in periods of low interest rates, may have an adverse effect on earnings; the amount of insurance written and the growth of insurance in force or risk in force as well as the performance of the Company may be adversely impacted by the competitive environment in the private mortgage insurance industry, including the type, structure, and pricing of products and services offered by the Company and its competitors; with consolidation occurring among mortgage lenders and the Company's concentration of insurance in force generated through relationships with significant lender customers, the loss of a significant customer may have an adverse effect on earnings; the Company's performance may be impacted by changes in the performance of the financial markets and general economic conditions. Economic
downturns in regions where Triad's risk is more concentrated could have a particularly adverse effect on Triad's financial condition and loss development. The United States is in an economic downturn that could decrease demand for mortgage insurance and cause loss experience to suffer.
ITEM 7 (A). QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS. - ----------- ------------------------------------------------------------