We do not own any real property. We lease office facilities for our U.S. operations headquarters in Radnor, Pennsylvania and additional offices in Winston-Salem, North Carolina, Irvine, California and Bermuda. We believe our current facilities are adequate for our current needs and that suitable additional space will be available as and when needed.
(1)Prior to the initial public offering ("IPO") which was completed on November 5, 2013, the Company had two classes of common shares outstanding: Class A common shares and Class B-2 common shares. The Class A common shares accrued a 10% cumulative dividend and the Class B-2 common shares had no stated dividend rate with any dividends being declared at the discretion of the Company's Board of Directors. Accordingly, earnings (loss) per common share was calculated using the "two-class" method which provides that earnings and losses be allocated to each class of common shares according to dividends declared and their respective participation rights. Substantially all of the net income (loss) for the periods prior to the IPO was allocated to the Class A common shares for purposes of determining earnings per share. Upon the completion of the IPO, all of the Class A common shares and the Class B-2 common shares converted into a single class of common shares (the "Common Shares"), as more fully described in Note 9 to our consolidated financial statements.
(3)New insurance written ("NIW") includes NIW on a flow basis (in which loans are insured in individual, loan-by-loan transactions) and bulk insurance that we write (in which each loan in a portfolio of loans is insured in a single transaction).
(4)Loss ratio is calculated by dividing the provision for loss and loss adjustment expenses by net premiums earned.
(8)Net risk in force represents total risk in force, net of reinsurance ceded and net of exposure on policies for which loss reserves have been established.
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. See "Business-Regulation-Federal 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."
On July 10, 2014, the FHFA released for public input draft Private Mortgage Insurer Eligibility Requirements (PMIERs). If implemented, the PMIERs would represent revised standards by which private mortgage insurers would be eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs would replace the current eligibility requirements separately established by each of Fannie Mae and Freddie Mac prior to the financial crisis. As proposed, the PMIERs include new financial strength requirements incorporating a risk-based framework that would require approved insurers to have a sufficient level of liquid assets from which to pay claims. These new requirements would impact the amount of capital a mortgage insurer must hold. The draft requirements also include enhanced operational performance expectations and define remedial actions that would apply should an approved insurer fail to comply with the new requirements. The public input period with respect to the PMIERs closed on September 8, 2014. The FHFA has advised us that it does not expect to release the final PMIERs until at least late in the first quarter of 2015.
Under the Dodd-Frank Act, the CFPB is authorized to issue regulations governing a loan originator's determination that, at the time a loan is originated, the consumer has a reasonable ability to repay the loan. The Dodd-Frank Act provides a statutory presumption that a borrower will have the ability to repay a loan if the loan has characteristics satisfying the QM definition. On January 10, 2014, the CFPB implemented a final rule regarding QMs, which we refer to as the "QM Rule". Under the QM Rule, a loan is deemed to be a QM if it has certain loan features, satisfies extensive documentation requirements and meets limitations on fees and points and APRs. The QM Rule provides a "safe harbor" for QM loans with annual percentage rates, or APRs, below the threshold of 150 basis points over the Average Prime Offer Rate, or APOR, and a "rebuttable presumption" for QM loans with an APR above that threshold.
In part as a result of this capital shortfall, Congress has over the past several years considered legislation to reform the FHA. If FHA reform were to raise FHA premiums, tighten FHA credit guidelines, make other changes which make lender use of FHA less attractive, or implement credit risk sharing between FHA and private mortgage insurers, these changes may be beneficial to our business. However, there can be no assurance that any FHA reform legislation will be enacted into law, and what provisions may be contained in any final legislation, if any. Therefore, the future impact on our business is uncertain. See "Business-Regulation-Federal Laws and Regulation-FHA Reform" and "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;
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 86.4% at December 31, 2014. Generally, higher prepayment speeds lead to lower persistency.
• changes in housing values, which affect our ability to mitigate our losses through the sale of properties with loans in default as well as borrower willingness to continue to make mortgage payments when the value of the home is below or perceived to be below the mortgage balance;
• the product mix of IIF, with loans having higher risk characteristics generally resulting in higher defaults and claims;
• the loan-to-value ratio, with higher average loan-to-value ratios tending to increase losses incurred;
• the percentage of coverage on insured loans, with deeper average coverage tending to increase losses incurred;
• credit quality of borrowers, including higher debt-to-income ratios and lower FICO scores, which tend to increase incurred losses;
• the distribution of claims over the life of a book. The average age of our insurance portfolio is young with 97% of our IIF as of December 31, 2014 having been originated since January 1, 2012. As a result, based on historical industry performance, we expect the number of defaults and claims we experience, as well as our provision for losses and loss adjustment expenses, to increase as our portfolio seasons. See "-Mortgage Insurance Earnings and Cash Flow Cycle" below.
to corporate level Federal income taxes. Our U.S. insurance subsidiaries are generally not subject to income taxes in the states in which we operate; however, our non-insurance subsidiaries are subject to state income taxes. In lieu of state income taxes, our insurance subsidiaries pay premium taxes that are recorded in other underwriting and operating expenses. The amount of income tax expense or benefit recorded in future periods will be dependent on the jurisdictions in which we operate and the tax laws and regulations in effect.
Essent Group Ltd. and its wholly-owned subsidiary, Essent Re, are domiciled in Bermuda, which does not have a corporate income tax. Prior to 2014, these entities incurred expenses and generated limited amounts of investment income. In 2014, Essent Re entered into insurance and reinsurance transactions with Freddie Mac and entered into a quota share reinsurance agreement with Essent Guaranty, an affiliate, to reinsure 25% of Essent Guaranty's GSE-eligible NIW effective July 1, 2014.
Our cancellation activity has been relatively low to date because the average age of our insurance portfolio is young. Following is a summary of our IIF at December 31, 2014 by vintage:
As of December 31, 2014, our combined net risk in force for our U.S. insurance companies was $11.4 billion and our combined statutory capital was $705.9 million, resulting in a risk to capital ratio of 16.2 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 and, as discussed in "-Liquidity and Capital Resources-Draft Private Mortgage Insurer Eligibility Requirements" below, the GSEs are currently examining their respective capital rules to determine whether, in light of the recent 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.
The increase in net investment income to $12.3 million for the year ended December 31, 2014 as compared to $4.1 million for the year ended December 31, 2013 is primarily due to an increase in the weighted average balance of our investment portfolio as a result of investing proceeds from our secondary offering of Common Shares in 2014, proceeds from our IPO and capital contributions from our initial investors in 2013, and cash flows generated from operations. The average cash and investment portfolio balance was $887.2 million and $442.8 million during the years ended December 31, 2014 and 2013, respectively. The pre-tax investment income yield was 1.5% and 1.1% in the years ended December 31, 2014 and 2013, respectively. The pre-tax investment income yields are calculated based on amortized cost. See "-Liquidity and Capital Resources" for further details of our investment portfolio.
The following table includes additional information about our loans in default as of the dates indicated:
The decrease in the average reserve per default is primarily due to 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. In addition, historical cure ratios showed improvement in 2014.
• Compensation and benefits increased primarily due to the increase in our workforce to 332 at December 31, 2014 from 289 at December 31, 2013. Additional employees were hired to support the growth in our business, particularly in our sales organization, as well as our underwriting and customer service teams. Compensation and benefits also increased as a result of an increase in annual incentive compensation and incremental cash and stock-based compensation. The increase in stock-based compensation is primarily due to the restricted shares and restricted share units issued to all employees in connection with our initial public offering as well as restricted shares and restricted share units issued in connection with annual incentive compensation. Compensation and benefits includes salaries, wages and bonus, stock compensation expense, benefits and payroll taxes.
• Other expenses, including premium taxes, travel, marketing, hardware, software, rent and other facilities expenses, depreciation, amortization, increased as a result of the expansion of our business. In addition, effective with the completion of our initial public offering, we began to incur certain incremental public company expenses, including insurance and board of directors costs.
Our subsidiaries in the United States file a consolidated U.S. Federal income tax return. Our income tax expense was $47.4 million for the year ended December 31, 2014 compared to an income tax benefit of $7.4 million for the year ended December 31, 2013. Our effective tax rate was 34.9% for the year ended December 31, 2014, which approximates the U.S. federal statutory tax rate as substantially all of our earnings in 2014 were generated in the United States.
Our effective tax rate was (12.7)% for the year ended December 31, 2013. Since inception and prior to June 30, 2013, we had evaluated the realizability of our deferred tax assets on a quarterly basis and concluded that it was more likely than not that some portion or all of the deferred tax asset would not be realized and provided a valuation allowance against the deferred tax assets. Accordingly, we did not record a benefit associated with the losses incurred in prior periods or for other income tax benefits. At June 30, 2013, we concluded that it is more likely than not that our deferred tax assets will be realized. As a result, as of December 31, 2013 we released the valuation allowance on our deferred tax assets in accordance with Accounting Standard Codification ("ASC") No. 740-270. The release of the valuation allowance resulted in the recognition of a net $7.4 million benefit for income taxes for the year ended December 31, 2013.
For the year ended December 31, 2013, we reported net income of $65.4 million, compared to net loss of $13.5 million for the year ended December 31, 2012. The increase in our operating results in 2013 over 2012 was primarily due to an increase in net premiums earned associated with the growth of our IIF and an increase in net investment income as well as the income tax benefit recorded due to the reversal of our valuation allowance against deferred tax assets, partially offset by increases in other underwriting and operating expenses and the provision for losses and loss adjustment expenses and a reduction in other income.
The increase in the number of defaults at December 31, 2013 compared to December 31, 2012 is primarily due to an increase in our IIF and policies in force, as well as further seasoning of our insurance portfolio.
During the year ended December 31, 2013, the provision for losses and LAE was $2.3 million, comprised of $3.0 million of current year losses partially offset by $0.7 million of favorable prior years'
During the year ended December 31, 2013, we paid 16 claims for a total amount of $0.7 million. During the year ended December 31, 2012, we paid one claim for approximately $18,000. Claim severity, representing the total amount of claims paid divided by the related RIF of the defaulted mortgage loans, for the years ended December 31, 2013 and 2012 was 90% and 104%, respectively.
Other underwriting and operating expenses increased to $71.1 million during the year ended December 31, 2013 as compared to $61.1 million for the year ended December 31, 2012. The significant factors contributing to the change in other underwriting and operating expenses are:
• Compensation and benefits increased primarily due to the increase in our workforce to 289 at December 31, 2013 from 209 employees at December 31, 2012. Additional employees were hired to support the growth in our business, particularly in our sales organization, as well as our underwriting and customer service teams. Compensation and benefits also increased as a result of an increase in annual incentive compensation and incremental cash and stock-based compensation. The increase in stock-based compensation is primarily due to the restricted shares and restricted share units issued to all employees in connection with our initial public offering. Compensation and benefits includes salaries, wages and bonus, stock compensation expense, benefits and payroll taxes.
• Depreciation and amortization expense decreased in 2013 compared to 2012 as the substantial majority of the assets acquired from Triad were fully depreciated as of November 30, 2012 and the remaining acquired assets were fully amortized as of November 30, 2013. Depreciation and amortization expense associated with these assets during the years ended December 31, 2013 and 2012 was $0.4 and $12.4 million, respectively.
• Other expenses, including premium taxes, travel, marketing, hardware, software, rent and other facilities expenses, increased as a result of the expansion of our business. In addition, effective with the completion of our initial public offering, we began to incur certain incremental public company expenses, including insurance and board of directors costs.
• our increasing level of profitability in the fourth quarter of 2012 and the first two quarters of 2013 and our expectations regarding the sustainability of these profits;
• the strong credit profile of the loans we have insured since we began to issue mortgage insurance policies in 2010;
• the size of our IIF and our contractual rights for future premiums from this book of business;
• our taxable income for 2012 and our expectations regarding the likelihood of future taxable income; and
• net premiums that we will receive from our existing IIF as well as policies that we write in the future; and
At the operating subsidiary level, liquidity could be impacted by any one of the following factors:
• inability to sell investment assets to provide cash to fund operating needs;
• increase in expected claim payments related to our IIF; or
Cash flow provided by operations totaled $153.7 million for the year ended December 31, 2014 as compared to $119.0 million for the year ended December 31, 2013 and $36.6 million for the year ended December 31, 2012. The increase in cash flow from operations of $34.7 million in 2014 and $82.4 million in 2013 was a result of increases in premium collected and net investment income partially offset by an increase in expenses paid and a decrease in other income in both periods.
Cash flow used in investing activities totaled $96.8 million for the year ended December 31, 2013 as compared to $79.7 million for the year ended December 31, 2012. The increase in cash flow used in investing activities was primarily related to investing a portion of capital contributions from our initial investors and cash flows from the business.
Cash flow provided by financing activities totaled $120.8 million for the year ended December 31, 2014 as compared to cash flow provided by financing activities of $433.1 million for the year ended December 31, 2013. The decrease in cash flow provided by financing activities of $312.3 million was primarily due to a decrease in the issuance of common shares in 2014 as compared to 2013. In 2014, the Company completed a secondary offering of Common Shares for $126.7 million in net proceeds, net of offering costs. In 2013, the Company issued shares to its initial investors and completed its initial public offering resulting in a total of $437.6 million of net proceeds.
In 2014, Essent Re entered into insurance and reinsurance transactions with Freddie Mac and also executed a quota share reinsurance agreement with Essent Guaranty to reinsure 25% of Essent Guaranty's GSE-eligible NIW effective July 1, 2014. During the year ended December 31, 2014, Essent Group Ltd. made capital contributions to Essent Re of $152.4 million to support new business written, including Essent Re's quota share reinsurance agreement with Essent Guaranty that was finalized in the third quarter of 2014. As of December 31, 2014, Essent Re had total stockholders' equity of $155.1 million and net risk in force of $836.0 million.
As of December 31, 2014, the total fair value of our investment portfolio was $1.1 billion, compared to $332.6 million as of December 31, 2013. In addition, our total cash was $24.4 million as of December 31, 2014, compared to $477.7 million as of December 31, 2013. The increase in investments and decrease in cash was primarily due to investing the proceeds from our initial public offering and capital contributions in the form of cash that were received in 2013 which had not been fully invested
The following table includes municipal securities for states that represent more than 10% of the total municipal bond position as of December 31, 2014:
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 2015 under the non-cancelable sublease.
earned over the expected life of the policy. If single premium policies related to insured loans are cancelled due to repayment by the borrower, and the premium is non-refundable, then the remaining unearned premium related to each cancelled policy is recognized as earned premium upon notification of the cancellation. Unearned premium represents the portion of premium written that is applicable to the estimated unexpired risk of insured loans. Rates used to determine the earning of single premium policies are estimates based on an analysis of the expiration of risk.
Our entire investment portfolio is classified as available for sale and is reported at fair value. The related unrealized gains or losses are, after considering the related tax expense or benefit, recognized as a component of accumulated other comprehensive income in stockholders' equity. Realized investment gains and losses are reported in income based upon specific identification of securities sold. Each quarter we perform reviews of all of our investments in order to determine whether declines in fair value below amortized cost were considered other-than-temporary in accordance with applicable guidance. In evaluating whether a decline in fair value is other-than-temporary, we consider several factors including, but not limited to:
• 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;
• failure of the issuer to make scheduled interest or principal payments;
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, 2014, 2013 and 2012, the unrealized losses recorded in the investment portfolio resulted from fluctuations in market interest rates. Each issuer is current on its scheduled interest and principal payments. Accordingly, we recognized no other-than-temporary impairment losses in earnings associated with our investment portfolio.
There are no recently issued accounting standards that are expected to have a material effect on our financial condition, results of operations or cash flows. See Note 2 of our consolidated financial statements.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Essent Group Ltd. and its subsidiaries at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, 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 these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our audits (which was an integrated audit in 2014). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
In these notes to consolidated financial statements, "Essent", "Company", "we", "us", and "our" refer to Essent Group Ltd. and its subsidiaries, unless the context otherwise requires.
Essent Group Ltd. ("Essent Group") is a Bermuda-based holding company, which, through its wholly-owned subsidiaries, offers private mortgage insurance and reinsurance for mortgages secured by residential properties located in the United States. Mortgage insurance facilitates the sale of low down payment (generally less than 20%) mortgage loans into the secondary mortgage market, primarily to the government sponsored enterprises ("GSEs"), Fannie Mae and Freddie Mac. Essent Group was incorporated in Bermuda in July 2008. In March 2014, Essent Group formed Essent Irish Intermediate Holdings Limited ("Essent Irish Intermediate") as a wholly-owned subsidiary. In April 2014, Essent Group contributed all of the outstanding stock of Essent US Holdings, Inc. ("Essent Holdings") to Essent Irish Intermediate. The primary mortgage insurance operations are conducted through Essent Holdings' regulated and licensed wholly-owned subsidiaries, Essent Guaranty, Inc. ("Essent Guaranty") and Essent Guaranty of PA, Inc. ("Essent PA"). Essent Group also has a wholly-owned Bermuda-domiciled Class 3A Insurer licensed pursuant to Section 4 of the Bermuda Insurance Act 1978, Essent Reinsurance Ltd. ("Essent Re"), which offers mortgage-related insurance and reinsurance.
In June 2010, we formed Essent Solutions, LLC ("Essent Solutions"), a wholly-owned, non-insurer subsidiary of Essent Guaranty. Essent Solutions was formed to, among other things, function as an administrative services provider. Since April 2012, Essent Solutions has had minimal business activity.
Essent Re provides insurance and reinsurance coverage of mortgage credit risk. In 2014, Essent Re entered into insurance and reinsurance transactions with Freddie Mac and began to reinsure 25% of Essent Guaranty's GSE-eligible new insurance written effective July 1, 2014 under an affiliate quota share reinsurance agreement.
We monitor our fixed maturities for unrealized losses that appear to be other than temporary. A fixed maturity security is considered to be other-than-temporarily impaired when the security's fair value is less than its amortized cost basis and 1) we intend to sell the security, 2) it is more likely than not that we will be required to sell the security before recovery of the security's amortized cost basis, or 3) we believe we will be unable to recover the entire amortized cost basis of the security (i.e., a credit loss has occurred). When we determine that a credit loss has been incurred, but we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of the security's amortized cost basis, the portion of the other-than-temporary impairment that is credit related is recorded as a realized loss in the consolidated statements of comprehensive income (loss), and the portion of the other-than-temporary impairment that is not credit related is included in other comprehensive income (loss). For those fixed maturities for which an other-than-temporary impairment has occurred, we adjust the amortized cost basis of the security and record a realized loss in the consolidated statements of comprehensive income (loss).
In connection with the acquisition of the proprietary mortgage insurance information technology and operating platform of Triad Guaranty, Inc. and Triad Guaranty Insurance Corporation (collectively referred to as "Triad"), we recorded identifiable intangible assets associated with acquired technology and workforce-in-place. Amortization of these assets began on December 1, 2009 and was increased in April 2011 in connection with the additional purchase price recorded effective March 31, 2011. See additional discussion as to the terms of the Triad transaction and the related purchase accounting in Note 6. The amount of purchase price allocated to the acquired technology was amortized to expense on a straight-line basis over 36 months and was fully amortized as of November 30, 2012. The amount of purchase price allocated to workforce-in-place was amortized to expense on a straight-line basis over 48 months and was fully amortized as of November 30, 2013. We recognized amortization associated with the acquired technology of $12.0 million for the year ended December 31, 2012. We recognized amortization associated with the workforce-in-place of $0.4 million in each of the years ended December 31, 2013 and 2012.
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 acquisition of mortgage
A significant portion of our premium revenue relates to master policies with certain lending institutions. For the year ended December 31, 2014 one lender represented 15% of our total revenue. The loss of this customer could have a significant impact on our revenues and results of operations.
claim (referred to as "claim severity"). Based on this information, at each reporting date we determine our best estimate of loss reserves at a given point in time. Included in loss reserves are reserves for incurred but not reported ("IBNR") claims. IBNR reserves represent our estimated unpaid losses on loans that are in default, but have not yet been reported to us as delinquent by our customers. We will also establish reserves for associated loss adjustment expenses, consisting of the estimated cost of the claims administration process, including legal and other fees and expenses associated with administering the claims process. Establishing reserves is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Our estimates of claim rates and claim sizes will be strongly influenced by prevailing economic conditions, such as the overall state of the economy, current rates or trends in unemployment, changes in housing values and/or interest rates, and our best judgments as to the future values or trends of these macroeconomic factors. Losses incurred are also generally affected by the characteristics of our insured loans, such as the loan amount, loan-to-value ratio, the percentage of coverage on the insured loan and the credit quality of the borrower.
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 (loss).
Prior to its initial public offering ("IPO"), Essent Group's initial investors executed several agreements which committed our initial investors, subject to certain conditions, to make equity contributions in the amount of approximately $600 million in return for Class A common shares of Essent Group. As of January 1, 2012, $258.3 million had been contributed by the investors to Essent Group in return for approximately 25.5 million Class A common shares. In 2012, investors made additional capital contributions to Essent Group totaling $55 million in return for approximately 5.4 million Class A shares and in 2013, investors made additional capital contributions to Essent Group totaling $125 million in return for approximately 12.3 million Class A shares. In total, $438.3 million of capital contributions were made by investors from inception through Essent Group's initial public offering.
Upon the closing of our IPO, all shares of our then-outstanding Class A common shares and Class B-2 common shares, issued under the Company's 2009 Restricted Share Plan as more fully discussed in Note 10, automatically converted into an aggregate of approximately 64.7 million Common Shares. Under the terms of the Amended and Restated Class A Common Share Subscription Agreement (the "Amended Subscription Agreement"), the equity funding commitment terminated upon the completion of the initial public offering.
(1)At December 31, 2014, approximately 59.7% of municipal debt securities were special revenue bonds, 37.5% were general obligation bonds, 1.5% were tax allocation bonds, 0.8% were certification of participation bonds and 0.5% were special assessment bonds. At December 31, 2013, all municipal debt securities were general obligation bonds.
Essent Group realized gross gains and losses on the sale of investments available for sale as follows:
The fair value of investments deposited with insurance regulatory authorities to meet statutory requirements was $8.5 million at December 31, 2014 and $8.6 million at December 31, 2013. In connection with its insurance and reinsurance activities, Essent Re is required to maintain assets in trusts for the benefit of its contractual counterparties. The fair value of the required investments on deposit in these trusts was $51.2 million at December 31, 2014.
Premiums receivable consist of premiums due on our mortgage insurance policies. If mortgage insurance premiums are unpaid for more than 90 days, the receivable is written off against earned premium and the related insurance policy is cancelled. For all periods presented, no provision or allowance for doubtful accounts was required.
On December 1, 2009, under the terms of an asset purchase agreement dated October 7, 2009 between Essent Guaranty and Triad (the "Asset Purchase Agreement"), we acquired all of Triad's proprietary mortgage insurance information technology and operating platform, certain software and substantially all of the supporting hardware, as well as furniture and fixtures, in exchange for payments of up to $30 million in cash, subject to certain conditions outlined in the Asset Purchase Agreement, and the assumption of certain contractual obligations. In addition, pursuant to this transaction, 39 employees of Triad's information technology, operations and compliance departments were offered, and accepted, employment with Essent Guaranty. Effective with the completion of the transaction, Essent Guaranty began providing information systems maintenance and development services, customer service and policy administration support to Triad under the terms of a services agreement dated December 1, 2009 (the "Services Agreement"). Triad retains the obligation for all risks insured under its existing insurance contracts and will continue to directly manage loss mitigation and claim activity on its insured business.
As the assets acquired and liabilities assumed did not constitute a business, the transaction was accounted for as an acquisition of assets. Under the Asset Purchase Agreement, fixed payments of $15 million were due and paid as follows: $10 million on the Closing Date of December 1, 2009, and
For the year ended December 31, 2014, $0.8 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There has been a $0.6 million favorable prior-year development during the year ended December 31, 2014. Reserves remaining as of December 31, 2014 for prior years are $1.7 million as a result of re-estimation of unpaid losses and loss adjustment expenses. For the year ended December 31, 2013, $0.5 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There was a $0.7 million favorable prior year development during the year ended December 31, 2013. Reserves remaining as of December 31, 2013 for prior years are $0.3 million as a result of re estimation of unpaid losses and loss
adjustment expenses. The decreases in both years are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims.
Minimum lease payments shown above have not been reduced by minimum sublease rental income of $0.1 million due in 2015 under the non-cancelable sublease.
In September 2013 and February 2014, certain members of senior management were granted nonvested Common Shares under the 2013 Plan that were subject to time-based and performance-based vesting. The time-based share awards granted in September 2013 vest in four equal installments on January 1, 2015, 2016, 2017 and 2018. The time-based share awards granted in February 2014 vest in three equal installments on March 1, 2015, 2016 and 2017. The performance-based share awards vest based upon our compounded annual book value per share growth percentage during a three-year performance period that commenced on January 1, 2014. The September 2013 performance-based share awards vest on the one-year anniversary of the completion of the performance period, and the February 2014 performance-based share awards vest on March 1, 2017. The portion of the nonvested
Certain of the Company's employees who were not granted nonvested Common Shares were granted nonvested share units in November 2013 that will be settled with Common Shares, subject to time-based vesting, and will vest and settle in equal annual installments during the three-year period commencing January 1, 2014. In connection with our incentive program covering bonus awards for performance year 2013, in February 2014 time-based share awards and share units were issued to certain employees that vest in three equal installments on January 1, 2015, 2016 and 2017.
In May 2014, time-based share units were issued to non-employee directors. The portion of the grant that relates to director compensation for the period from our initial public offering through April 2014 vested on November 1, 2014 and the portion of the grant that relates to director compensation from May 2014 through April 2015 vests 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:
(1)Class A and Class B-2 shares exchanged for Common Shares reflect the 2 for 3 share split and the applicable conversion rates to Common Shares that were effective immediately prior to the closing of the initial public offering.
issuance with an estimated fair market value of $10.92 per share and in 2012, 47,500 Class A common shares were issued that vested upon issuance with an estimated fair market value of $10.11.
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 105,317 and 3,846 in 2014 and 2013, respectively. Class A common shares tendered by employees to pay employee withholding taxes totaled 17,644 and 86,014 in 2013 and 2012, respectively. Class B-2 shares tendered by employees to pay employee withholding taxes totaled 1,714 in 2013. There were no Class B-2 common shares tendered in 2012. The tendered shares were recorded at cost and included in treasury stock.
As of December 31, 2014, the statutory income tax rates of the countries where the Company does business are 35% 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 (benefit).
Bermuda 0.0%). The reconciliation of the difference between income tax expense (benefit) and the expected tax provision at the weighted average tax rate is as follows for the years ended 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 non-interest-bearing United States Mortgage Guaranty Tax and Loss Bonds ("T&L Bonds") issued by the Treasury Department in an amount equal to the tax benefit derived from deducting any portion of
The Company is a party to an investment advisory agreement with Goldman Sachs Asset Management, L.P., a subsidiary of The Goldman Sachs Group, Inc. ("Goldman Sachs"), one of Essent Group's investors. Through the date of our IPO, Goldman Sachs beneficially owned 11.35% of our outstanding shares. Subsequent to the IPO, Goldman Sachs directly held less than 10% of our outstanding shares. Investment expense incurred under the investment advisory agreement totaled $0.5, $0.4, and $0.2 million for the years ended December 31, 2014, 2013 and 2012, respectively. The Company was also a party to underwriting agreements with Goldman Sachs in connection with the IPO and secondary offering of Common Shares. Amounts paid to Goldman Sachs in connection with the underwriting agreements totaled $3.5 million in 2014 and $6.9 million in 2013.
(1)Included in net realized investments gains on our consolidated statement of operations
ASC No. 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The level within the fair value hierarchy to measure the financial instrument shall be determined based on the lowest level input that is significant to the fair value measurement. The three levels of the fair-value hierarchy are as follows:
• Level 3-Valuations derived from one or more significant inputs that are unobservable.
When available, we generally use quoted market prices to determine fair value and classify the financial instrument in Level 1. In cases where quoted market prices for similar financial instruments are available, we utilize these inputs for valuation techniques and classify the financial instrument in Level 2. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flows, present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows and we classify the financial instrument in Level 3. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. No financial instruments were classified as Level 3 at December 31, 2013.
• Investments available for sale-Investments available for sale are valued using quoted market prices in active markets, when available, and those investments are classified as Level 1 of the fair value hierarchy. Level 1 investments available for sale include investments such as U.S. Treasury securities, U.S. agency securities, U.S. agency mortgage-backed securities, mortgage-backed securities and money market funds. Investments available for sale are classified as Level 2 of the fair value hierarchy if quoted market prices are not available and fair values are estimated using quoted prices of similar securities or recently executed transactions for the securities. Municipal securities, corporate debt securities and asset-backed securities are classified as Level 2 investments.
• Amounts due under Asset Purchase Agreement-The fair value of amounts due under Asset Purchase Agreement is estimated using discounted cash flow analyses based on current risk-free interest rates of securities with similar maturities. The fair value estimates of amounts due under Asset Purchase Agreement are classified as Level 2 since quoted market prices are not available, but observable inputs are used in the valuation.
• Derivative liabilities-We define fair value as the current amount that would be exchanged to sell an asset or transfer a liability, other than in a forced liquidation. In determining an exit market, we consider the fact that there is not a principal market for these contracts. In the absence of a principal market, we value our ACIS contracts in a hypothetical market where market participants, and potential counterparties, include other mortgage guaranty insurers or reinsurers with similar credit quality to us. We believe that in the absence of a principal market, this hypothetical market provides the most relevant information with respect to fair value estimates.
The following table presents changes during the year ended December 31, 2014 in Level 3 liabilities measured at fair value on a recurring basis, and the realized and unrealized gains (losses) related to the Level 3 liabilities in the Consolidated Balance Sheets at December 31, 2014. We had no Level 3 assets in the year ended December 31, 2014 and no Level 3 assets or liabilities in the year ended December 31, 2013.
The significant unobservable inputs used for derivative liabilities are constant prepayment rates ("CPR") and default rates on the reference pool of mortgages and the credit spreads on the reference STACR notes. An increase in the default rate and reference STACR credit spread will increase the fair value of the liability. An increase in the CPR will decrease the fair value measurement of the liability.
Net income determined in accordance with statutory accounting practices differs from GAAP. In 2014, 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.
On July 10, 2014, the Federal Housing Finance Agency ("FHFA") released for public input Private Mortgage Insurer Eligibility Requirement ("PMIERs"). If implemented, the PMIERs represent revised standards by which private mortgage insurers would be eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs would replace the current eligibility requirements separately established by each of Fannie Mae and Freddie Mac prior to the financial crisis. As proposed, the PMIERs include new financial strength requirements incorporating a
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, 2014, Essent PA's risk to capital ratio was 14.6 to 1 and there were no amounts outstanding related to this agreement.