Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the consolidated financial condition, changes in financial position, and results of operations for the three years ended December 31, 2003, of Triad Guaranty Inc. and its consolidated subsidiaries, collectively the Company. The discussion should be read in conjunction with the Consolidated Financial Statements and Notes.
We have identified the following estimates as critical in that they involve a higher degree of judgment and are subject to a significant degree of variability: reserves for losses and loss adjustment expenses, the timely identification of potentially impaired securities and valuation of those securities, and deferred policy acquisition costs. In developing these estimates, we make subjective and complex judgments that are inherently uncertain and subject to material change as facts and circumstances develop. Although variability is inherent in these estimates, we believe the amounts provided are appropriate based on the facts available upon compilation of the financial statements.
We establish reserves using estimated claim rates (frequency) and estimated claim amounts (severity) to project ultimate losses. Our reserving process incorporates numerous factors in a formula that give effect to current economic conditions and profiles delinquencies by such primary factors as policy year, geography, chronic late payment characteristics, and the number of months the policy has been in default. Because the estimate for loss reserves is sensitive to the estimates of claims frequency and severity, we perform sensitivity analyses to test the reasonableness of the best estimate generated by the loss reserve process. The loss reserve estimation process and the sensitivity analyses support the reasonableness of the best estimate of loss reserves recorded as a liability in the financial statements.
Valuing our investment portfolio involves a variety of assumptions and estimates, particularly for investments that are not actively traded. We rely on external pricing sources for highly liquid publicly traded securities and use an internal pricing matrix for privately placed securities. This matrix relies on our judgment concerning a) the discount rate we use in calculating expected future cash flows, b) credit quality, and c) expected maturity.
Following is a summary of our results for the last three years (dollars in thousands except per share information):
A primary driver of our results is persistency. We define persistency as the percentage of insurance in force remaining from twelve months prior. In 2003, we achieved record levels of production due primarily to the increased level of refinance activity and our increased penetration in the bulk marketplace. However, low persistency levels, also reflective of the higher refinance activity, had a negative impact on our results. Lower persistency adversely affected us in two ways: a) renewal earned premium decreased as the mortgages generating the renewal premium refinanced and b) expenses increased through higher amortization of deferred policy acquisition costs. We saw persistency drop through most of 2003, reaching its low point in the third quarter. Mortgage interest rates crept up in the latter part of the year, resulting in moderately improved persistency in the fourth quarter.
Although terms vary, the bulk market can be broadly categorized into three different segments, or tiers, depending on the risk characteristics of the loans comprising a transaction. The loan characteristics of the three segments are a) predominantly high credit quality, low loan to value (LTV), fully underwritten loans that may have niche characteristics such as non-conforming loan balances and risk concentrations related to geography, transaction purpose, or occupancy type; b) loans that generally have high credit quality and low to moderate LTVs that have been underwritten with reduced, streamlined, or no documentation; and c) generally fully underwritten loans with credit impaired borrowers (FICO credit score less than 575). In general, we believe that bulk business originated in segments b) and c) will report a higher default rate than our flow business. However, we also believe that the lower LTVs associated with bulk business ultimately will generate proportionately lower claim rates as a proportion of the reported defaults and lower levels of severity than flow business. We have entered into bulk transactions primarily in the first two segments mentioned above. At December 31, 2003, only approximately 4% of our insurance in force attributable to structured bulk transactions is categorized in segment c) above.
quarterly persistency rate for the fourth quarter of 2003 was 46.3% compared to 19.3% for the third quarter of 2003 and 32.1% for the fourth quarter of 2002. Changes in interest rates generally take a few months to affect persistency. During the third and fourth quarters of 2003, interest rates moderately increased from the record low levels seen in June and July. If these interest rate levels persist or if interest rates increase further, we believe that persistency should improve in 2004. However, if rates decline significantly from current levels, persistency could return to levels comparable to the first nine months of 2003.
FICO credit scores are one of the factors used in determining credit risk. The following table presents the FICO credit score distribution of our insurance in force at December 31, 2003 and 2002.
As the table shows, we insure some loans that have FICO credit scores below 575. We believe that these loans have a higher probability of loss than a loan with a FICO credit score of 575 or greater. We do not expect loans with FICO scores less than 575 to become a significant portion of our insurance in force.
The difference between direct premiums written and net premiums written is ceded premium. Ceded premium is comprised of premiums paid on both excess of loss reinsurance treaties as well as risk-sharing arrangements with our lender partners (referred to as captive reinsurance arrangements). Driven by an increase in the amount of premium subject to captive reinsurance arrangements, ceded premiums written increased 48.9% to $27.3 million in 2003 from $18.3 million in 2002. Our premium cede rate (the ratio of ceded premiums written to direct premiums written) was 17.7% for 2003 compared to 14.8% for 2002. Our premium cede rate for captive reinsurance arrangements (the ratio of ceded premiums written under captive reinsurance arrangements to total direct premiums written) was 15.4% for 2003 compared to 12.7% for 2002. The average premium cede rate for direct premiums written subject to captive reinsurance arrangements was 35.2% in 2003 compared to 35.8% in 2002. During 2003, approximately $7.6 billion of insurance written, or 46% of flow insurance written (37% of total insurance written including structured bulk transactions) was subject to captive reinsurance arrangements compared to $6.2 billion of insurance written, or 51% of flow
insurance written (46% including structured bulk transactions), in the same period of 2002. The decline in the percentage of flow insurance written subject to captive reinsurance arrangements from 2002 to 2003 is primarily a result of increased production in our lender-paid mortgage insurance program that is not subject to captive reinsurance arrangements. Through December 31, 2003, insurance written attributable to structured bulk transactions was not subject to captive reinsurance arrangements.
Approximately 54.2% of direct flow insurance in force (45.9% of total insurance in force) was subject to captive reinsurance arrangements at December 31, 2003, compared to 51.6% (45.7% of total insurance in force) at December 31, 2002. This increase was due primarily to the increased market penetration of our captive reinsurance arrangements and the high level of refinance activity in 2003, as policies that were previously not subject to captive reinsurance arrangements refinanced and new policies issued were subject to captive reinsurance arrangements. We anticipate that ceded premiums will continue to increase as a result of the expected increase in insurance in force subject to captive reinsurance arrangements.
We continue to see the success of our strategic initiatives to provide captive risk-sharing alternatives to selected lender partners. We remain committed to the concept of captive reinsurance arrangements on a lender-by-lender basis. Captive reinsurance arrangements have evolved during the past year and will continue to evolve in 2004. We will continue to be an active participant with our lender partners in structures utilizing alternative attachment points, risk bands, cede rates, and ceding commissions. One of our competitors announced that, effective April 1, 2003, it would not participate in captive arrangements where the net premium cede rate is greater than 25% (“deep ceded”). According to recent articles, two other competitors have recently announced that they will limit the amount of premium they will cede under deep ceded captive arrangements. Where prudent, we plan to continue to participate in captive risk-sharing arrangements, including deep ceded arrangements, on a lender-by-lender basis. It is uncertain at this time what impact, if any, the competitors’ decisions, as described above, will have on our production of insurance subject to captive reinsurance arrangements.
Earned premiums increased 14.0% to $119.7 million for 2003 from $105.1 million for 2002. The difference between net written premiums and earned premiums in 2003 is due to the significant writings of our annual premium product and the related increase in the unearned premium reserve. Our unearned premium liability increased to $15.6 million at December 31, 2003, from $8.5 million at December 31, 2002. Direct written premium from the annual premium product represented 15.5% of direct premium written in 2003 compared to 7.0% of direct premium written in 2002. The growth in written and earned premiums resulted from strong levels of new insurance written offset by the impact of a low level of persistency and by the increase in ceded premiums.
Net investment income for 2003 was $17.1 million, a 6.1% increase over $16.1 million in 2002. Average invested assets grew by $59 million to $360 million for the year ended December 31, 2003, an increase of 19.6% from $301 million for 2002. The increase in average invested assets is attributable to funds derived from normal operating cash flow in 2003. The percentage increase in net investment income was much lower than the percentage increase in invested assets primarily due to a decrease in investment yields.
We reported $3.0 million of net realized investment gains during 2003 and $2.5 million of net realized investment losses during 2002. Net realized gains during 2003 included approximately $785,000 of impairment writedowns. The writedowns primarily involved securities in the automotive, energy, and pharmaceutical sectors as well as a commercial mortgage-backed security.
Amortization of DAC increased by 31.8% to $18.1 million in 2003 from $13.7 million for 2002. The increase reflects growth in DAC related to the expansion of our insurance in force and accelerated amortization due to higher cancellations from refinance activity in 2003. Our model calculates the amortization of DAC separately for each book year. The model accelerates DAC amortization through a dynamic adjustment when persistency for a book year is lower than the estimated persistency originally utilized in the model. The dynamic adjustment effectively adjusts the estimated policy life originally utilized in the model to a revised policy life based upon the current actual persistency. Low persistency levels during the past two years resulted in additional amortization of deferred policy acquisition costs through dynamic adjustments totaling $5.5 million in 2003 and $2.6 million in 2002. If persistency improves in 2004 compared to 2003, we would expect additional amortization of DAC resulting from the dynamic adjustment to be lower, depending on the level of improvement. However, if persistency does not improve, we would expect similar levels of additional amortization through dynamic adjustments to that which occurred in 2003.
Our effective tax rate was 29.4% for 2003 and 30.9% for 2002. The decrease in the effective tax rate is due primarily to an increase in tax-exempt interest resulting from a higher percentage of assets being invested in tax-preferred securities. We expect our effective tax rate to remain near current levels or increase slightly as we expect earned premium to grow faster than tax-preferred income.
Net income for 2002 increased 9.3% to $45.1 million from $41.3 million in 2001. Net income per share on a diluted basis increased 6.6% to $3.15 for 2002 from $2.95 per share for 2001. This improvement in net income was led by a 24.6% increase in earned premiums and a 9.0% increase in net investment income. Net income for 2002 included after-tax net realized investment losses of $1.6 million, while net income for 2001 included after tax net realized investment gains of $193,000. Also included in net income for 2001 was the receipt of a nonrecurring incentive payment of approximately $1.9 million, relating to the voluntary cancellation of one of our excess of loss corporate reinsurance contracts.
Refinance activity was 40.1% of insurance written in 2002 compared to 35.8% in 2001. Excluding structured bulk transactions, refinance activity was 40.1% of insurance written in 2002 compared to 37.5% of insurance written in 2001. Persistency was 60.9% at December 31, 2002, compared to 67.6% at December 31, 2001. The increased level of refinance activity and the resulting decrease in persistency was reflective of the low interest rate environment that was in place during 2002.
We reported $2.5 million of net realized investment losses during 2002, which included approximately $2.0 million of impairment writedowns. The writedowns primarily involved securities in the telecommunications and technology sectors and, to a lesser degree, the airline, energy, electronic manufacturing, and textile manufacturing industries.
Net losses and loss adjustment expenses (net of reinsurance recoveries) increased by 55.9% in 2002 to $14.1 million from $9.0 million in 2001. The rise reflected an increase in paid losses and delinquent loans as our insurance in force grew and the condition of the economy remained weak. Net paid losses and loss adjustment expenses increased to $10.7 million during 2002 from $6.0 million during 2001. Reported delinquent loans totaled 2,379 at December 31, 2002, compared to 1,420 at December 31, 2001, an increase of 67.5%. Our loss ratio was 13.4% for 2002 compared to 10.7% for 2001.
Amortization of DAC increased by 17.3% to $13.7 million in 2002 from $11.7 million for 2001. The increase in amortization reflected growth in DAC related to the growth of our insurance in force and accelerated amortization due to higher cancellations from refinance activity in 2002. Decreased persistency levels during 2002 and 2001 resulted in additional DAC amortization through dynamic adjustments totaling $2.6 million in 2002 and $2.1 million in 2001.
portfolio. A separate Investments section follows the Financial Position section and reviews our investment portfolio, key portfolio management strategies, and methodologies in which we manage credit risk.
We purchase ten-year non-interest bearing United States Mortgage Guaranty Tax and Loss Bonds (“Tax and Loss Bonds”) in lieu of paying current federal income taxes to take advantage of a special contingency reserve deduction for mortgage guaranty companies. The cumulative sum of the Tax and Loss Bonds purchased, net of those matured, is classified on our balance sheet as prepaid federal income taxes. These purchases of Tax and Loss Bonds are essentially a prepayment of federal income taxes that will become due in ten years when the Tax and Loss Bonds mature. At December 31, 2003, prepaid income taxes amounted to $98.1 million, compared to $77.8 million at December 31, 2002. The change from year to year approximates the change in deferred income tax liability for the year.
the reasonableness of the best estimate generated by the loss reserve process. We periodically review the loss reserve process in order to improve its estimate of ultimate losses on loans currently in default. Adjustments to reserve estimates are reflected in the financial statements in the periods in which the adjustments are made.
The number of loans in default excludes those loans 60 days past due or less. The increase in the default rate for bulk business is attributable primarily to the maturing of the bulk portfolio and the higher expected default rate. Contributing to changes in default rates is changes in the number of policies in force, which is the denominator in the default rate calculation. All else being equal, an increase/decrease in the policies in force results in a lower/higher default rate. As a result, production levels as well as persistency have an effect on the reported default rates. The default occurrences for both flow business and structured bulk business are consistent with management’s expectation.
Credit risk is inherent in an investment portfolio. We manage this risk through a structured approach in which we assess the effects of the changing economic landscape. In identifying “potentially distressed securities”, we first screen for all securities that have a fair value to cost or amortized cost ratio of less than 80%. Additionally, as part of this identification process, we utilize the following information for inclusion on the “potentially distressed securities” list:
In analyzing our “potentially distressed securities” list for other-than-temporary impairments, we pay special attention to securities that have been on the list for a period greater than six months. Our ability and intent to retain the investment for a sufficient time to recover its value is also considered. We assume that, absent reliable contradictory evidence, a security that is potentially distressed for a continuous period greater than nine months has incurred an other-than-temporary impairment. Such reliable contradictory evidence might include, among other factors, a liquidation analysis performed by our investment advisers or outside consultants, improving financial performance of the issuer, or valuation of underlying assets specifically pledged to support the credit.
At December 31, 2003, we had unrealized investment gains of $18.0 million and unrealized investment losses of $769,000. These unrealized gains and losses do not necessarily represent future gains or losses that we will realize. Changing conditions related to specific securities, overall market interest rates, or credit spreads, as well as our decisions concerning the timing of a sale, may impact values we ultimately realize. We monitor unrealized losses through further analysis according to maturity date, credit quality, individual creditor exposure and the length of time the individual security has continuously been in an unrealized loss position. Unrealized losses related to fixed maturities amounted to $687,000 at December 31, 2003, with the preponderance of the unrealized losses related to bonds with a maturity date in excess of ten years. The largest individual unrealized loss on any one security at December 31, 2003, was $134,000 on a $1 million par bond.
We generated positive cash flow from operating activities of $59.3 million in 2003 compared to $47.0 million for 2002 and $43.8 million for 2001. The increase in cash flow from operating activities in 2003 reflects the growth in premiums and investment income and a decrease in other operating expenses paid offset partially by an increase in losses paid. Our business does not routinely require significant capital expenditures other than for enhancements to our computer systems and technological 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.
We cede business to captive reinsurance subsidiaries of certain mortgage lenders (“captives”), primarily under excess of loss reinsurance agreements. Generally, reinsurance recoverables on loss reserves and unearned premiums ceded to these captives are backed by trust funds or letters of credit.
Total stockholders’ equity increased to $369.9 million at December 31, 2003, from $309.4 million at December 31, 2002. This increase resulted primarily from 2003 net income of $51.1 million, an increase in net unrealized gains on invested assets classified as available-for-sale of $2.6 million (net of income tax), and additional paid-in-capital of $6.8 million resulting from the exercise of employee stock options and the related tax benefit.
Total statutory policyholders’ surplus for our insurance subsidiaries increased to $128.6 million at December 31, 2003, from $112.9 million at December 31, 2002. The primary difference between statutory policyholders’ surplus and equity computed under generally accepted accounting principles is the statutory contingency reserve. The balance in the statutory contingency reserve was $302.7 million at December 31, 2003, compared to $245.0 million at December 31, 2002. Statutory capital, for the purpose of computing the total risk in force to statutory capital, includes both policyholders’ surplus and the contingency reserve. Statutory capital amounted to $431.3 million at December 31, 2003, compared to $357.9 million at December 31, 2002.
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:
the amount of insurance written could be adversely 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 amount of insurance written and the growth in insurance in force or risk in force as well as our performance may be adversely impacted by the competitive environment in the private mortgage insurance industry, including the type, structure, and pricing of our products and services and our competitors;
Triad Guaranty Inc.’s management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of December 31, 2003, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, management has concluded that disclosure controls and procedures as of December 31, 2003 were effective in ensuring that material information required to be disclosed in this Annual Report on Form 10-K was recorded, processed, summarized, and reported on a timely basis. Additionally, there were no changes in the Company’s internal controls over financial reporting that occurred during the quarter ended December 31, 2003 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date management carried out its evaluation.
For information regarding our executive officers, reference is made to the section entitled “Executive Officers” in Part I, Item 1 of this Report.
(c) Exhibits - The response to this portion of Item 15 is submitted as a separate section of this report.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 12th day of March 2004.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on the 12th day of March, 2003 by the following persons on behalf of the Registrant in the capacities indicated.
By-Laws of the Registrant as amended March 21, 2003 (Exhibit 3.2(c))(10)
Agreement for Administrative Services among Triad Guaranty Insurance Corporation and Collateral Investment Corp. and Collateral Mortgage, Ltd.(1) (Exhibit 10(c))
Registration Agreement among the Registrant, Collateral Investment Corp. and Collateral Mortgage, Ltd.(2) (Exhibit 10.6)
Employment Agreement between the Registrant and Darryl W. Thompson(2)(3) (Exhibit 10.7)
Employment Agreement between the Registrant and Henry B. Freeman(2)(3) (Exhibit 10.10)
Employment Agreement between the Registrant and Ron D. Kessinger(2)(3) (Exhibit 10.11)
Excess of Loss Reinsurance Agreement between Triad Guaranty Insurance Corporation, Capital Mortgage Reinsurance Company, and Federal Insurance Company.(7) (Exhibit 10.21)
Employment Agreement between the Registrant and Earl F. Wall(3)(9) (Exhibit 10.23)
Chief Financial Officer Sarbanes-Oxley Act Section 302 Certification dated March 12, 2004, 2004 for the Triad Guaranty Inc.’s Annual report on Form 10-K for the year ended December 31, 2003.
Denotes management contract or compensatory plan of arrangement required to be filed as an exhibit to this report pursuant to Item 601 of Regulation S-K.
Incorporated by reference to the exhibit identified in parentheses, filed as an exhibit in the June 30, 1997 Form 10-Q.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Triad Guaranty Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which vary in some respects from statutory accounting practices which are prescribed or permitted by the various insurance departments.
The consolidated financial statements include the amounts of Triad Guaranty Inc. and its wholly-owned subsidiary, Triad Guaranty Insurance Corporation (“Triad”) and Triad’s wholly-owned subsidiaries, Triad Guaranty Assurance Corporation (“TGAC”) and Triad Re Insurance Corporation (“Triad Re”). All significant intercompany accounts and transactions have been eliminated.
Property and equipment is recorded at cost and is depreciated principally on a straight-line basis over the estimated useful lives, generally three to five years, of the depreciable assets. Property and equipment primarily consists of computer hardware and software and furniture and equipment.
Triad purchases ten-year non-interest bearing United States Mortgage Guaranty Tax and Loss Bonds (“Tax and Loss Bonds”) in lieu of paying federal income taxes. Purchases of these Tax and Loss Bonds are treated as prepaid federal income taxes because the payment for Tax and Loss Bonds is essentially a prepayment of federal income taxes that will become due in ten years when the Tax and Loss Bonds mature. Current income tax expense is primarily associated with the maturing of a portion of Triad’s Tax and Loss Bonds.
The Company writes policies that are guaranteed renewable contracts at the policyholder’s option on single premium, annual premium, and monthly premium bases. The Company does not have the option to reunderwrite these contracts. Premiums written on annual policies are earned on a monthly pro rata basis. Single premium policies covering more than one year are amortized over the estimated policy life in accordance with the expiration of risk. Premiums written on a monthly basis generally are earned when received.
During 2003, two individual customers each accounted for approximately 13% of total revenue. One customer accounted for approximately 11% of the Company’s revenue in 2002 while no single customer accounted for 10% or more of the Company’s revenue in 2001.
Basic and diluted earnings per share are based on the weighted-average daily number of shares outstanding. For diluted earnings per share, the denominator includes the dilutive effect of employee stock options on the weighted-average shares outstanding. There are no other reconciling items between the denominator used in basic earnings per share and diluted earnings per share. The numerator used in basic earnings per share and diluted earnings per share is the same for all periods presented.
The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2003 (in thousands):
The majority of the unrealized losses related to fixed maturities that have been in a continuous loss position less than 12 months are interest rate related. The majority of the fixed maturities that have unrealized losses continuously for 12 months or more are the result of thinly traded securities that tend to have lower valuations than actively traded securities. None of the fixed maturity securities with unrealized losses have ever missed, or been delinquent on, a scheduled principal or interest payment. The unrealized losses related to equity securities are the result of temporary market fluctuations.
The amortized cost and estimated fair value of investments in fixed maturity securities, at December 31, 2003, are summarized by stated maturity as follows (in thousands):
Major categories of the Company’s net investment income are summarized as follows (in thousands):
At December 31, 2003, Triad had purchased $269,000 of Tax and Loss Bonds in excess of its current obligations.
The Code permits dividends to be paid only out of earned surplus and also requires prior approval of extraordinary dividends. An extraordinary dividend is any dividend or distribution of cash or other property, the fair market value of which, together with that of other dividends or distributions made within a period of twelve consecutive months, exceeds the greater of (a) ten percent of statutory surplus as regards policyholders or (b) statutory net income for the calendar year preceding the date of the dividend. Consolidated net income as determined in accordance with statutory accounting practices was $69,848,000, $61,787,000, and $55,448,000 for the years ended December 31, 2003, 2002, and 2001, respectively. At December 31, 2003, the amount of the Company’s equity that can be paid out in dividends to the stockholders is $44,496,000, which is the earned surplus of Triad on a statutory basis.
The Company pays unconsolidated affiliated companies for management, investment, and other services. The total expense incurred for such items was $704,000, $664,000, and $562,000 in 2003, 2002, and 2001, respectively. Management believes that the income and expenses incurred for such services approximate costs that the Company and affiliates would have incurred if those services had been provided by unaffiliated third parties.
Approximately 70% of eligible employees participate in the Company’s 401(k) Profit Sharing Plan. Under the plan, employees elect to defer a portion of their wages, with the Company matching deferrals at the rate of 50% of the first 8% of the employee’s salary deferred. The Company’s expense associated with the plan totaled $449,000, $374,000, and $353,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
Certain premiums and losses are assumed from and ceded to other insurance companies under various reinsurance agreements. The ceding agreements principally provide Triad with increased capacity to write business and achieve a more favorable geographic dispersion of risk.
Reinsurance activity for the years ended December 31, 2003, 2002, and 2001, respectively, is as follows (in thousands):
The Company cedes business to captive reinsurance subsidiaries or affiliates of certain mortgage lenders (“captives”) primarily under excess of loss reinsurance agreements. Reinsurance recoverables on loss reserves and unearned premiums ceded to these captives are backed by trust funds or letters of credit.
In 2001, the Company recognized a nonrecurring incentive payment of $1,863,000 related to voluntary cancellation of an excess of loss reinsurance contract maintained by the Company with a non-affiliated
Reinsurance contracts do not relieve Triad from its obligations to policyholders. Failure of the reinsurer to honor its obligation could result in losses to Triad; consequently, allowances are established for amounts deemed uncollectible. Triad evaluates the financial condition of its reinsurers and monitors credit risk arising from similar geographic regions, activities, or economic characteristics of its reinsurers to minimize its exposure to significant losses from reinsurer insolvency.
At December 31, 2003, 1,143,217 shares of the Company’s common stock were reserved and 384,507 shares were available for issuance under the Plan.
The options issued under the Plan in 2003, 2002, and 2001 vest over three years. Certain of the options will immediately vest in the event of a change in control of the Company. Options granted under the Plan terminate no later than 10 years following the date of grant.
Pro forma information required by Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation, has been estimated as if the Company had accounted for stock-based awards under the fair value method of that Statement. The fair value of options granted in 2003, 2002, and 2001 was estimated at the date of the grant using a Black-Scholes option pricing model with the following weighted-average input assumptions: risk-free interest rate of 3.34% for 2003, 3.63% for 2002, and 4.86% for 2001; dividend yield of 0.0%; expected volatility of .38 for 2003, .39 for 2002, and .40 for 2001; and a weighted-average expected life of the option of seven years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The following table summarizes the fair value of options granted in 2003, 2002, and 2001:
The fair values of cash and short-term investments approximate their carrying values due to their short-term maturity or availability.
Triad Guaranty Inc. (the “Company”) is a holding company which, through its wholly-owned subsidiary, Triad Guaranty Insurance Corporation (“Triad”), provides private mortgage insurance coverage in the United States to mortgage lenders to protect the lender against loss from defaults on low down payment residential mortgage loans.