Expense ratio is calculated by dividing other underwriting and operating expenses by net premiums earned.
We are an established and growing private mortgage insurance company. We were formed to serve the U.S. housing finance industry at a time when the demands of the financial crisis and a rapidly changing business environment created the need for a new, privately funded mortgage insurance company. We believe that our success in acquiring customers and growing our insurance in force has been driven by the unique opportunity we offer lenders to partner with a well-capitalized mortgage insurer, unencumbered by business originated prior to the financial crisis, that provides fair and transparent claims payment practices, and consistency and speed of service. Essent Guaranty, Inc., our wholly-owned insurance subsidiary, is licensed to write coverage in all 50 states and the District of Columbia. The financial strength of Essent Guaranty, Inc. 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").
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."
Under the Dodd-Frank Act, the Consumer Financial Protection Bureau ("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. Under the CFPB's final rule regarding QMs, which we refer to as 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.
-Dodd-Frank Act-Qualified Residential Mortgage Regulations-Risk Retention Requirements" and "Risk Factors-Risks Relating to Our Business-The amount of insurance we write could be adversely affected by the implementation of the Dodd-Frank Act's risk retention requirements and the definition of Qualified Residential Mortgage ("QRM")."
Premiums associated with our U.S. mortgage insurance business are based on insurance in force, or IIF, during all or a portion of a period. A change in the average IIF during a period causes premiums to increase or decrease as compared to prior periods. Average premium rates in effect during a given period will also cause premiums to differ when compared to earlier periods. IIF at the end of a reporting period is a function of the IIF at the beginning of such reporting period plus NIW less policy cancellations (including claims paid) during the period. As a result, premiums are generally influenced by:
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 83.9% at December 31, 2017. Generally, higher prepayment speeds lead to lower persistency.
In connection with the acquisition of our mortgage insurance platform, we entered into a services agreement with Triad Guaranty Inc. and its wholly-owned subsidiary, Triad Guaranty Insurance Corporation, which we refer to collectively as "Triad," to provide certain information technology maintenance and development and customer support-related services. In return for these services, we receive a fee which is recorded in other income. This fee is adjusted monthly based on the number of Triad’s mortgage insurance policies in force and, accordingly, will decrease over time as Triad’s existing policies are cancelled. The services agreement was automatically extended until November 30, 2018 and provides for one subsequent one-year renewal at Triad’s option. See Note 5 to our consolidated financial statements.
We believe, based upon our experience and industry data, that claims incidence for mortgage insurance is generally highest in the third through sixth years after loan origination. As of December 31, 2017, 81% of our IIF relates to business written since January 1, 2015 and was less than three years old. Although the claims experience on new insurance written by us to date has been favorable, we expect incurred losses and claims to increase as a greater amount of this book of insurance reaches its anticipated period of highest claim frequency. The actual default rate and the average reserve per default that we experience as our portfolio matures is difficult to predict and is dependent on the specific characteristics of our current in-force book (including the credit score of the borrower, the loan-to-value ratio of the mortgage, geographic concentrations, etc.), as well as the profile of new business we write in the future. In addition, the default rate and the average reserve per default will be affected by future macroeconomic factors such as housing prices, interest rates and employment.
Our other underwriting and operating expenses include components that are substantially fixed, as well as expenses that generally increase or decrease in line with the level of NIW.
Underwriting and other expenses include legal, consulting, other professional fees, premium taxes, travel, entertainment, marketing, licensing, supplies, hardware, software, rent, utilities, depreciation and amortization and other expenses. We anticipate that as we continue to add customers and increase our IIF, our expenses will also continue to increase. In addition, as a result of the increase in our IIF, we expect that our net premiums earned will grow faster than our underwriting and other expenses resulting in a decline in our expense ratio for the full year 2018 as compared to 2017.
Interest expense is incurred as a result of borrowings under our amended and restated four-year, secured credit facility with a committed capacity of $375 million (the “Credit Facility”). Borrowings under the Credit Facility may be used for working capital and general corporate purposes, including, without limitation, capital contributions to Essent’s insurance and reinsurance subsidiaries. Borrowings accrue interest at a floating rate tied to a standard short-term borrowing index, selected at the Company’s option, plus an applicable margin.
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, Inc., an affiliate. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae.
As discussed above, premiums we collect and earn are generated based on our IIF, which is a function of our NIW and cancellations. From 2010, when we first began writing policies, through December 31, 2017, we have increased our NIW annually. We have also grown the number of customers who have approved us to provide mortgage insurance over this period, as well as increased our NIW from certain customers. The following table includes a summary of the change in our IIF for the years ended December 31, 2017, 2016 and 2015 for our U.S. mortgage insurance portfolio. In addition, this table includes our risk in force ("RIF") at the end of each period.
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 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.
Net premiums written increased in the year ended December 31, 2017 by 29% over the prior year. The increase was due primarily to the increase in average IIF of 32% for the year ended December 31, 2017 as compared to the year ended December 31, 2016.
Other income includes fees earned for information technology and customer support services provided to Triad and contract underwriting revenues. In 2016, other income also included changes in the fair value of the insurance and certain reinsurance policies issued by Essent Re under the ACIS program. These policies were amended in the three months ended September 30, 2016 and are accounted for as insurance rather than as derivatives subsequent to their amendment. The decrease in other income for the year ended December 31, 2017 as compared to the same period in 2016, was primarily due to the favorable net valuation adjustments recorded in 2016 associated with ACIS contracts formerly accounted for as insurance 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.
Our subsidiaries in the United States file a consolidated U.S. Federal income tax return. Our income tax expense was $18.8 million for the year ended December 31, 2017 compared to $89.3 million for the year ended December 31, 2016. 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 and $3.2 million of excess tax benefits associated with the vesting of common shares and common share units during the period as required by ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718), adopted on January 1, 2017. Prior to the adoption of ASU 2016-09, excess tax benefits were recognized in additional paid-in-capital. Our effective tax rate was 28.6% for the year ended 2016. During 2017, the proportion of our consolidated earnings generated in Bermuda increased as a result of insurance and reinsurance contracts executed with Freddie Mac and Fannie Mae and the quota share reinsurance agreement between Essent Guaranty, Inc. and Essent Re. Bermuda does not have a corporate income tax. In 2018, as a result of the reduction of the U.S. statutory corporate income tax rate to 21% and the expected portion of our consolidated earnings to be generated in Bermuda, we anticipate that our effective tax rate will be approximately 16%-17%.
Net premiums earned increased in the year ended December 31, 2016 by 29% compared to the year ended December 31, 2015 primarily due to the increase in our average IIF from $57.8 billion in 2015 to $73.0 billion in 2016, as well as an increase in average premium rate from 0.56% for the year ended December 31, 2015 to 0.57% for the year ended December 31, 2016.
The increase in the average premium rate during the year ended December 31, 2016 is due primarily to an increase in premium earned on the cancellation of non-refundable single premium policies.
In the year ended December 31, 2016, unearned premiums increased by $18.6 million as a result of net premiums written on single premium policies of $99.4 million which was partially offset by $80.8 million of unearned premium that was recognized in earnings during the year. In the year ended December 31, 2015, unearned premiums increased by $44.1 million as a result of net premiums written on single premium policies of $101.1 million which was partially offset by $57.0 million of unearned premium that was recognized in earnings during the year. Included in unearned premium recognized was $36.9 million and $21.8 million related to policy cancellations for the year ended December 31, 2016 and 2015, respectively.
At December 31, 2016 and 2015, we concluded that it was more likely than not that our deferred tax assets would be
Cash flow provided by financing activities totaled $337.6 million for the year ended December 31, 2017, as compared to cash flow provided by financing activities of $93.7 million for the year ended December 31, 2016. The increase in cash flow provided by financing activities was primarily related to the completion of a public offering of common shares for $197.7 million in net proceeds, as well as $150 million of net increased borrowings under the Credit Facility. These cash inflows were partially offset by an increase in treasury stock acquired from employees to satisfy tax withholding obligations.
Our combined risk-to-capital calculation for our U.S. insurance subsidiaries as of December 31, 2017 was as follows:
Essent Re has entered into risk share insurance and reinsurance transactions with Freddie Mac and Fannie Mae. Essent Re also executed a quota share reinsurance transaction with Essent Guaranty, Inc. to reinsure 25% of Essent Guaranty, Inc.’s GSE-eligible NIW effective July 1, 2014. Essent Group Ltd. made capital contributions to Essent Re of $165.0 million and $130.0 million during the years ended December 31, 2017 and 2016, respectively, to support new business. As of December 31, 2017, Essent Re had total stockholders’ equity of $662.8 million and net risk in force of $6.3 billion.
The insurer financial strength rating of Essent Guaranty, Inc., 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.
As of December 31, 2017, stockholders’ equity was $1.9 billion compared to $1.3 billion as of December 31, 2016. This increase was primarily due to net income generated in 2017 and the completion of a public offering of common shares in August 2017.
Based on ratings issued by Moody's, if available. S&P or Fitch Ratings ("Fitch") rating utilized if Moody's not available.
None of the above securities include financial guaranty insurance. Certain securities include state enhancements. The above ratings exclude the effect of such state enhancements.
Our discussion and analysis of our financial condition and results of operation are based upon our consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles ("GAAP"). In preparing our consolidated financial statements, management has made estimates, assumptions and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing these financial statements, management has utilized available information, including our past history, industry standards and the current and projected economic and housing environment, among other factors, in forming its estimates, assumptions and judgments, giving due consideration to materiality. Because the use of estimates is inherent in GAAP, actual results could differ from those estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of companies in similar businesses. A summary of the accounting policies that management believes are critical to the preparation of our consolidated financial statements is set forth below.
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 (loss) 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:
Schedule I-Summary of Investments-Other Than Investments in Related Parties as of December 31, 2017
We have audited the accompanying consolidated balance sheets of Essent Group Ltd. and its subsidiaries as of December 31, 2017 and December 31, 2016, and the related consolidated statements of comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes and schedules listed in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and December 31, 2016 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
The primary mortgage insurance operations are conducted through Essent Guaranty, Inc. ("Essent Guaranty"), which is domiciled in the state of Pennsylvania. Essent Guaranty is headquartered in Radnor, Pennsylvania and maintains operations centers in Winston-Salem, North Carolina and Irvine, California. Essent Guaranty is approved as a qualified mortgage insurer by the GSEs and is licensed to write mortgage insurance in all 50 states and the District of Columbia. Effective July 2014, Essent Guaranty began to reinsure 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 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.
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 insurance business are initially deferred and reported as deferred policy acquisition costs. Consistent with industry accounting practice, amortization of these costs for each underwriting year book of business is recognized in proportion to estimated gross profits. Estimated gross profits are composed of earned premium, interest income, losses and loss adjustment expenses. The deferred costs are adjusted as appropriate for policy cancellations to be consistent with our revenue recognition policy. We estimate the rate of amortization to reflect actual experience and any changes to persistency or loss development. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed recoverable amounts, after considering investment income. Policy acquisition costs deferred were $8.0 million, $7.7 million and $6.6 million for the years ended December 31, 2017, 2016 and 2015, respectively. Amortization of deferred policy acquisition costs
totaled $6.0 million, $5.8 million and $4.7 million for the years ended December 31, 2017, 2016 and 2015, respectively, and was included in other underwriting and operating expenses on the consolidated statements of comprehensive income.
insurance contracts rather than as derivatives subsequent to their amendment. As of December 31, 2017 and 2016, the Company had no derivative instruments.
It is our policy to classify interest and penalties as income tax expense.
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 are effective for annual and interim periods beginning after December 15, 2019. While the Company is still evaluating this ASU, we do not expect it to impact our accounting for insurance losses and loss adjustment expenses ("LAE") as these items are not within the scope of this ASU.
The gross unrealized losses on these investment securities are principally associated with the changes in market interest rates and credit spreads subsequent to their purchase. Each issuer is current on its scheduled interest and principal payments. We assess our intent to sell these securities and whether we will be required to sell these securities before the recovery of their amortized cost basis when determining whether an impairment is other-than-temporary. We recorded other-than-temporary impairments of $0.1 million, $0.1 million and $0.3 million in the years ended December 31, 2017, 2016 and 2015, respectively, on securities in an unrealized loss position. The impairments resulted from our intent to sell these securities subsequent to the reporting dates.
The fair value of investments deposited with insurance regulatory authorities to meet statutory requirements was $8.6 million at December 31, 2017 and $8.5 million at December 31, 2016. 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 investments on deposit in these trusts was $615.8 million at December 31, 2017 and $349.6 million at December 31, 2016.
On December 1, 2009, under the terms of an asset purchase agreement (the "Asset Purchase Agreement") dated October 7, 2009 between Essent Guaranty and Triad Guaranty, Inc. and Triad Guaranty Insurance Corporation (collectively referred to as "Triad"), 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 fixed payments of $15 million, contingent payments of $15 million, and the assumption of certain contractual obligations. The final contingent payment was made in the year ended December 31, 2014 and no further amounts are due to Triad under the Asset Purchase Agreement.
During the third quarter of 2017, certain regions of the U.S. experienced hurricanes which have impacted our insured portfolio’s performance. Specifically, on August 26, 2017, Hurricane Harvey made landfall in southeastern Texas and on September 10, 2017, Hurricane Irma made landfall in southern Florida and caused property damage in certain counties. Loans in default increased by 3,026 in the year ended December 31, 2017, including 2,288 defaults we identified as hurricane-related defaults. 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. In addition, under our master policy, our exposure may be limited on hurricane-related claims. For example, we are permitted to exclude a claim entirely where damage to the property underlying a mortgage was the proximate cause of the default and adjust a claim where the property underlying a mortgage in default is subject to unrestored physical damage. 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. 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 cumulative paid losses and allocated loss adjustment expenses, net of reinsurance. The information about paid loss development for the years ended December 31, 2010 through 2016 is presented as supplementary information.
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, 2017 and 2016, we paid $0.2 million and $0.1 million, respectively, related to remedies. As of December 31, 2017, management believes any potential claims for indemnification related to contract underwriting services through December 31, 2017 are not material to our consolidated financial position or results of operations.
Our authorized share capital consists of 233.3 million shares of a single class of common shares (the "Common Shares"). The Common Shares have no pre-emptive rights or other rights to subscribe for additional shares, and no rights of redemption, conversion or exchange. Under certain circumstances and subject to the provisions of Bermuda law and our bye-laws, we may be required to make an offer to repurchase shares held by members. The Common Shares rank pari passu with one another in all respects as to rights of payment and distribution. In general, holders of Common Shares will have one vote for each Common Share held by them and will be entitled to vote, on a non-cumulative basis, at all meetings of shareholders. In the event that a shareholder is considered a 9.5% Shareholder under our bye-laws, such shareholder's votes will be reduced by whatever amount is necessary so that after any such reduction the votes of such shareholder will not result in any other person being treated as a 9.5% Shareholder with respect to the vote on such matter. Under these provisions certain shareholders may have their voting rights limited to less than one vote per share, while other shareholders may have voting rights in excess of one vote per share.
In connection with the IPO in 2013, Essent Group's Board of Directors adopted, and Essent Group's shareholders approved, the Essent Group Ltd. 2013 Long-Term Incentive Plan (the "2013 Plan"), which was effective upon completion of the initial public offering. The types of awards available under the 2013 Plan include nonvested shares, nonvested share units, non-qualified share options, incentive stock options, share appreciation rights, and other share-based or cash-based awards. Amendments to our 2013 Plan were approved by shareholders and effective as of May 3, 2017. These amendments included a reduction in the maximum number of shares and share units available for issuance to 7.5 million under the Amended and Restated 2013 Plan (inclusive of approximately 2.6 million nonvested shares and share units outstanding as of May 3, 2017), down from the approximately 14.7 million shares and share units originally available for issuance under the 2013 Plan. As of December 31, 2017, there were 4.9 million Common Shares available for future grant under the 2013 Plan.
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 vests on July 1, 2019.
In February 2017, 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 February 2017 vest in three equal installments on March 1, 2018, 2019 and 2020. The performance-based share awards granted in February 2017 vest based upon our compounded annual book value per share growth percentage during a three-year performance period that commenced on January 1, 2017 and vest on March 1, 2020.
The portion of the nonvested performance-based share awards that will be earned based upon the achievement of compounded annual book value per share growth is as follows:
In the event that the compounded annual book value per share growth falls between the performance levels shown above, the nonvested Common Shares earned will be determined on a straight-line basis between the respective levels shown. The compounded annual book value per share growth for each of the 2013, 2014 and 2015 performance-based grants exceeded the maximum performance level and have vested or will vest at 100%.
In May of each year, 2015 through 2017, time-based share units were granted to non-employee directors that vest one year from the date of grant.
Compensation expense, net of forfeitures, and related tax effects recognized in connection with nonvested shares were as follows for the years ended December 31:
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, 2017, Essent Guaranty had unassigned surplus of approximately $70.7 million. Essent Guaranty paid no dividends to Essent Group or any intermediate holding companies in the years ended December 31, 2017, 2016 or 2015. Essent PA had unassigned surplus of approximately $6.5 million as of December 31, 2017. In the years ended December 31, 2017 and 2016, Essent PA paid to its parent company, Essent US Holdings, Inc. ("Essent Holdings") a dividend of $5 million and $3.75 million, respectively. Essent PA did not pay a dividend in 2015.
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, 2017, Essent Re had total equity of $662.8 million.
At December 31, 2017, our insurance subsidiaries were in compliance with these rules, regulations and agreements.
Income tax expense is different from that which would be obtained by applying the applicable statutory income tax rates to income before taxes by jurisdiction (i.e. U.S. 35%; Bermuda 0.0%). The reconciliation of the difference between income tax expense and the expected tax provision at the weighted average tax rate was 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 T&L Bonds in an amount equal to the tax benefit derived from deducting any portion of our statutory contingency reserves. During the years ended December 31, 2017 and 2016, we had net purchases of T&L Bonds in the amount of $70.9 million and $61.9 million, respectively, and held $252.2 million and $181.3 million of T&L Bonds as of December 31, 2017 and 2016, respectively.
In evaluating our ability to realize the benefit of our deferred tax assets, we consider the relevant impact of all available positive and negative evidence including our past operating results and our forecasts of future taxable income. At December 31, 2017 and 2016, after weighing all the evidence, management concluded that it was more likely than not that our deferred tax assets would be realized.
At December 31, 2017 and 2016, the Company had no unrecognized tax benefits. As of December 31, 2017, the U.S. federal income tax returns for the tax years 2014 through 2016 remain subject to examination. The Company has not recorded any uncertain tax positions as of December 31, 2017 or December 31, 2016.
The following table reconciles the net income and the weighted average common shares outstanding used in the computations of basic and diluted earnings per common share for the years ended December 31:
The following table presents changes during the years ended December 31, 2017 and 2016 in Level 3 liabilities measured at fair value on a recurring basis, and the net realized and unrealized losses (gains) related to the Level 3 liabilities in the consolidated balance sheets at December 31, 2017 and 2016. During the years ended December 31, 2017 and 2016, we had no Level 3 assets.
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 2017, Essent Guaranty increased its contingency reserve by $197.9 million and Essent PA increased its contingency reserve by $6.7 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 2017, 2016 or 2015.
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, 2017, Essent PA's risk-to-capital ratio was 5.4:1 and there were no amounts outstanding related to this agreement.
The accompanying Parent Company financial statements should be read in conjunction with the consolidated financial statements and notes to consolidated financial statements. These financial statements have been prepared on the same basis and using the same accounting policies as described in the consolidated financial statements included herein, except that the Parent Company uses the equity-method of accounting for its majority-owned subsidiaries.
During the three years ending December 31, 2017, the Parent Company did not receive any dividends from its subsidiaries.