On December 1, 2009, we completed the sale of our information technology and operating platform, including substantially all of our computer hardware, to Essent. We also entered into a service agreement on December 1, 2009 with Essent to provide systems maintenance and development services, including disaster recovery services and certain other technology services. Because of the information technology agreement, Triad’s and Essent’s offices may need to be in close proximity to each other.
Certain of the statements contained in this annual report on Form 10-K are "forward-looking statements" and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include estimates and assumptions related to economic, competitive, regulatory, operational and legislative developments and typically are identified by use of terms such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” and similar words, although some forward-looking statements are expressed differently. These forward-looking statements are subject to change, uncertainty and circumstances that are, in many instances, beyond our control and they have been made based upon our current expectations and beliefs concerning future developments and their potential effect on us. Actual developments and their results could differ materially from those expected by us, depending on the outcome of a number of factors, including: the possibility that the Illinois Department of Insurance may take various actions regarding Triad if we do not operate our business in accordance with the revised financial and operating plan and the Corrective Orders, including seeking receivership proceedings; our ability to operate our business in run-off and maintain a solvent run-off; our ability to continue as a going concern; the possibility of general economic and business conditions that are different than anticipated; legislative, regulatory, and other similar developments; changes in interest rates, employment rates, the housing market, the mortgage industry and the stock market; legal and other proceedings regarding modifications and refinancing of mortgages and/or foreclosure proceedings; the possibility that there will not be adequate interest in our common stock to ensure efficient pricing; and the relevant factors described in Item 1A, “Risk Factors” and in the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 section below, as well as in other reports and statements that we file with the Securities and Exchange Commission (the “SEC”). Forward-looking statements are based upon our current expectations and beliefs concerning future events and we undertake no obligation to update or revise any forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements are made, except as required by the federal securities laws. Any forward-looking statements that are made are current only as of the date on which we filed this report.
Triad Guaranty Inc. (“TGI”) is a holding company which, through its wholly-owned subsidiary, Triad Guaranty Insurance Corporation (“TGIC”), is a nationwide mortgage guaranty insurer pursuing a run-off of its existing in-force book of business. The term “run-off” means continuing to service existing mortgage guaranty insurance policies but not writing any new policies. Unless the context requires otherwise, references to “Triad” in this annual report on Form 10-K refer to the operations of TGIC and its wholly-owned subsidiary, Triad Guaranty Assurance Corporation (“TGAC”). References to “we,” “us,” “our,” and the “Company” refer collectively to the operations of TGI and Triad.
reviewing policies for the existence of misrepresentation, fraud or non-compliance with stated programs; and
settling all legitimate filed claims per the provisions of the policies and the two Corrective Orders issued by the Department.
The term “settled,” as used in this report in the context of the payment of a claim, refers to the satisfaction of Triad’s obligations following the submission of valid claims by our policyholders. Prior to June 1, 2009, valid claims were settled solely by a cash payment. As required by the second Corrective Order, effective on and after June 1, 2009, valid claims are settled by a combination of 60% in cash and 40% in the form of a deferred payment obligation (“DPO”). The Corrective Orders, among other things, allow management to continue to operate Triad under the close supervision of the Department, include restrictions on the distribution of dividends or interest on surplus notes payable to TGI by Triad, and include restrictions on the payment of claims.
Persistency, which measures the percentage of insurance in force remaining from one-year prior, is an important metric in understanding our future premium revenue. Generally, the longer a policy remains on our books, or “persists”, the greater the amount of total premium revenue we will earn from the policy.
In run-off, our expenses consist primarily of: settled claims (including loss adjustment expenses) net of any losses ceded to captive reinsurers; changes in reserves for estimated future claim payments on loans that are currently in default (including new defaults that are reported during the year) net of any reserves ceded to captive reinsurers; general and administrative costs of servicing existing policies; other general business expenses; and interest expense on the DPO and on our long-term debt prior to its repurchase and retirement in the third quarter of 2010.
As we are operating in run-off and are issuing no new insurance commitments, our future results of operations largely depend on the amount of future premium that we earn less the amount of losses that we incur each period on the new defaults reported to us. In addition, our results may be significantly impacted by the favorable or adverse development of our loss reserves. Our results from operations will benefit if we are able to settle our loss reserves at a lesser amount than that reported on our balance sheet through loss mitigation, litigation and settlements with servicers. Conversely, our results from operations will be negatively impacted if the settled losses are greater than the loss reserves provided. Our results of operations also depend on a number of other factors, many of which are not under our control. These factors include:
the conditions of the housing, mortgage and capital markets that have a direct impact on default rates, loss mitigation efforts, cure rates and, ultimately, the amount of claims settled;
In understanding our financial position and results of operations, it is important to understand the difference between accounting principles generally accepted in the United States of America (“GAAP”) and statutory accounting principles (“SAP”) applicable to insurance companies and how we use these accounting principles.
Require Triad to obtain prior written approval from the Department before entering into certain transactions with unaffiliated parties;
Require that all valid claims under Triad’s mortgage guaranty insurance policies are settled 60% in cash and 40% by recording a DPO;
The DPO is an interest bearing subordinated obligation of Triad with no stated repayment terms. The requirement to settle claims with both the payment of cash and recording of a DPO became effective on June 1, 2009. The second Corrective Order requires that Triad hold assets to support the DPO liability in a separate account pursuant to a custodial arrangement. At December 31, 2011, the recorded DPO, including accrued interest of $30.6 million, amounted to $629.7 million or 81% of total invested assets compared to $415.7 million or 49% of total invested assets at December 31, 2010. We are currently in discussions with the Department regarding the increasing percentage of assets supporting the DPO liability and the amount of interest credited to the DPO holders.
Failure to comply with the provisions of the Corrective Orders or any other violation of the Illinois Insurance Code may result in the imposition of fines or penalties or subject Triad to further legal proceedings, including the institution by the Department of receivership proceedings for the conservation, rehabilitation or liquidation of Triad. Any such actions would likely lead TGI to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws, or otherwise consider dissolution of the Company. See Item 1A, “Risk Factors” for more information.
Triad is also subject to comprehensive regulation by the insurance departments of the various other states in which it is licensed to transact business. Currently, the insurance departments of the other states are working with the Department in the implementation of the Corrective Orders.
In July 2010, we repurchased and retired the entire $35.0 million par value of TGI’s 7.90% Notes originally due January 15, 2028 (the “Notes”) for an aggregate purchase price of approximately $4.9 million. In accordance with the provisions of ASC 225-20, we recognized an extraordinary gain in 2010 on the repurchase and retirement of approximately $29.6 million. As a result of the repurchase and retirement of the Notes, no further interest will be due under the Notes. See further discussion under the heading, “Liquidity and Capital Resources.”
In determining the number of policies participating in HAMP as well as other foreclosure prevention programs, we rely on information provided to us primarily by the GSEs and servicers. However, we do not believe that we receive timely information on all participating loans nor the current status of the participating loans and we do not have the necessary information to determine the number of our policies in force that would be eligible for such modification programs. Furthermore, a number of the policies that have completed the trial modification period have subsequently re-defaulted and we believe the number of policies that re-default will increase in the future. This could be exacerbated by adverse conditions in the housing market or economy in general. The ultimate impact of HAMP and other modification programs is dependent on the number of policies that are successfully modified and do not re-default. Currently, we are unable to estimate with any degree of precision the number of policies that will ultimately cure and not re-default and are, therefore, unable to estimate the ultimate impact of these programs on our results of operations and financial condition. If HAMP and/or similar programs prove to be effective in preventing ultimate foreclosure, future settled claim activity could be reduced.
Loan servicers and certain government entities have also implemented temporary foreclosure moratoriums in recent years for various reasons, some of which were in response to documentation problems and other issues with foreclosure proceedings. Because the completion of a valid foreclosure is a requirement for the filing of a claim for loss, these moratoriums serve to temporarily reduce our settled claims, but they may lead to greater ultimate claim costs due to the accrual of interest and other expenses. While some of these moratoriums have subsequently been terminated, legal matters involving these issues remain and it is unclear if the initial problems have been fully resolved. While these moratoriums have delayed our claims settled and increased the time a policy remains in our default inventory, we do not expect a significant direct impact on our financial condition from these temporary moratoriums. See Item 1A, “Risk Factors” for more information on the risks and uncertainties associated with foreclosure moratoriums.
A decline in investment income in 2011 due to lower average invested assets and lower market yields. Realized investment gains were substantial in both periods due to discretionary sales.
An increase in net losses and loss adjustment expenses (LAE) in 2011, which was primarily due to a smaller benefit from loss reserve development. The loss and LAE reserve declined by 19% in 2011 compared to a decline of 31% in 2010 while risk in default declined by 23% and 31% in 2011 and 2010, respectively. The lower decline in loss and LAE reserves during 2011 was offset somewhat by an 18% decline in direct settled claims compared to 2010. The loss ratio was 172.5% in 2011 compared to 53.9% in 2010.
An increase in interest expense due to the continued growth in accrued interest related to the DPO liability.
A decline in other operating expenses in 2011 due to the continued reduction of employee cost and other variable costs. Expenses for contract underwriting were also significantly lower in 2011 than in 2010.
On July 15, 2008, we ceased issuing commitments for mortgage insurance, only issuing coverage to borrowers for which we had made a commitment as of that date. We had no production in 2011 and have had no material production since 2008.
Insurance in force is the total principal balance of our insured loans. The following table provides detail on our direct insurance in force at December 31, 2011 and 2010:
At December 31, 2011 and 2010, respectively, approximately 18% and 19% of our gross Primary risk in force was comprised of coverage on loans with the potential for negative amortization (“pay-option ARM”) and interest only loans. An inherent risk in both a pay-option ARM loan and an interest-only loan is the impact of the scheduled milestone in which the borrower must begin making amortizing payments, which can be substantially greater than the minimum payments required before the milestone is met. An additional risk to a pay-option ARM loan is that the payment being made may be less than the amount of interest accruing, creating negative amortization on the outstanding principal of the loan. The majority of our pay-option ARM loan portfolio has accumulated negative amortization and we believe these pay-option ARM loans are or will be subject to significant payment shock, which increases our risk of loss. Many of these pay-option ARM loans are from Arizona, California, Florida, and Nevada, which we refer to as “distressed markets.” Due to the structures of the pay-option ARM loan products that we insure, the majority of these loans typically reach the milestone where the borrower must begin making amortization payments no later than five years from the date the loan was issued. Because many of the pay-option ARMs are from the 2006 and 2007 vintages, the default rates on pay-option ARM loans over the next several years may increase as the remaining loans convert to amortizing payments.
At December 31, 2011 and 2010, respectively, approximately 15% and 16% of our gross Primary risk in force was comprised of coverage on Alt-A loans. We define Alt-A loans as loans that have been underwritten with reduced or no documentation verifying the borrower’s income, assets, or employment and where the borrower has a FICO score greater than 619 at origination. We have found a substantial amount of misrepresentation, program violations, and fraud on the Alt-A loans in our portfolio and Alt-A loans have a relatively high rescission rate. Due in part to depressed conditions in the housing markets, the Alt-A loans, pay-option ARM loans, and interest-only loans have, as a group, performed significantly worse than the remaining prime fixed rate loans through December 31, 2011.
A summary of the individual components of our revenue for 2011 and 2010 follows:
The decrease in direct premium written before the impact of refunds was primarily due to a 23% decline in insurance in force over the year. This decline was mitigated by the recognition of $14.5 million of premium in 2011 representing the net present value of estimated future premiums from Modified Pool contracts exceeding their respective contractual stop-loss limit on a settled basis.
A summary of the significant individual components of losses and expenses for 2011 and 2010 follows:
The following table provides details on both the dollar amount and number of settled claims of both Primary and Modified Pool insurance for 2011 and 2010:
The decrease in the amount of Primary direct settled claims in 2011 compared to 2010 is primarily the result of a decrease in the number of claims settled resulting from a reduction in foreclosures beginning in the fourth quarter of 2010. Average severity, which is calculated by dividing total direct settled claims by the number of claims settled, for Primary settled claims decreased slightly to $54,900 in 2011 from $55,000 in 2010. Average severity for Modified Pool settled claims declined to $62,400 in 2011 from $66,600 in 2010 and was impacted by a number of transactions reaching the stop loss limit on a settled basis. These transactions were primarily originated in 2005 through 2007 and generally had a higher average risk per policy.
The distressed markets accounted for 36% of our Primary risk in default at December 31, 2011 while only comprising 19% of the Primary risk in force.
The distressed markets comprised 39% of Primary settled claims in both 2011 and 2010, while only comprising 14% and 15%, respectively, of the policies in force at the beginning of the period.
The Primary default rate for these policy years was 18% at December 31, 2011 and 20% at December 31, 2010, compared to 13% and 12%, respectively, for the other policy years.
The Primary claim rate for these policy years was 5% at both December 31, 2011 and 2010, compared to 3.0% at both periods for the other policy years.
Other operating expenses decreased 40% during 2011 compared to 2010. A large portion of our variable operating expenses are related to personnel cost which declined by 28% during 2011 primarily due to a 37% decline in headcount and a 70% decline in severance benefits. Lower expenses for premium taxes as well as legal and accounting fees also contributed to the decline in other operating expenses.
During the third quarter of 2011, we outsourced our quality assurance function to a third party, which resulted in the elimination of 17 positions. These employees were primarily responsible for investigating loans for fraudulent information, misrepresentations, or other underwriting violations. All of these employees were subsequently hired by the quality assurance provider and no severance liabilities were incurred. We do not expect any significant savings from the transaction in the short term, however, we believe we will benefit in upcoming years by having highly-skilled individuals available to investigate a declining number of defaults under a variable cost pricing structure.
Total assets decreased by $95.4 million during 2011 to $896.2 million at December 31, 2011. During 2011, total cash and invested assets decreased by $73.7 million to $816.9 million at December 31, 2011, primarily due to a deficit in operating cash flow of $76.6 million.
The following table reflects the composition of our investment portfolio at December 31, 2011 and December 31, 2010:
During 2011, we sold securities with a market value of approximately $233.4 million. The majority of this activity occurred in the third and fourth quarters and was undertaken to realize investment gains given the low market yield environment. Some of the proceeds from the sales were used to fund negative cash flow from operations and the remaining proceeds were reinvested in securities that primarily had shorter-term maturities. Largely due to this discretionary sales activity, the effective duration of our fixed maturity portfolio declined to 2.19 years at December 31, 2011 from 3.4 years at December 31, 2010.
Given our previous substantial losses from operations, regulatory oversight of our operations, and the significant doubt regarding our ability to continue as a going concern, we may be unable to hold impaired assets for a sufficient time to recover their value. As a result, we do not carry unrealized losses forward and recognized impairment losses on all securities whose amortized cost was greater than the fair value at December 31, 2011. Impairment losses are recognized as realized investment losses in the Consolidated Statements of Comprehensive Income (Loss). If we believe that the recorded impairment was due to reasons other than credit related, we will amortize the difference between the impaired value and principal amount into interest income based upon the anticipated maturity date. During 2011, we recognized approximately $3.4 million of impairment losses attributable to the other-than-temporary impairments of securities with market values less than the respective book value. Approximately 18% of the other-than-temporary impairments were related to securities that are credit concerns.
Primarily due to sales activity during 2011 and the resulting recognition of realized gains, unrealized gains at December 31, 2011 declined by 28% compared to December 31, 2010. The unrealized gains are partly due to the recovery in value of previously impaired fixed income securities and do not necessarily represent future gains that we will realize. Changing conditions related to specific securities, overall market interest rates, and credit spreads, as well as our decisions concerning the timing of a sale, may impact the values we ultimately realize.
Credit risk is inherent in an investment portfolio. One way we attempt to limit the inherent credit risk in our portfolio is to maintain investments with relatively high ratings. The following table shows our investment portfolio by credit ratings.
At December 31, 2011, our fixed income portfolio included no direct exposure to the governments of European Union members and specifically to the governments of Greece, Ireland, Italy, Portugal, or Spain, whose obligations have deteriorated in value due to sovereign debt concerns including ratings downgrades and potential debt restructuring. Our fixed income portfolio at December 31, 2011 did include a security of the European Investment Bank, which is rated AAA by S&P, Moody’s, and Fitch, with a market value of $1.0 million. The remainder of our securities classified as Foreign Government were securities of Canadian provinces. However, further deterioration of governments in the European Union, including potential default and ratings downgrades, could have adverse affects on the value of our fixed income portfolio, particularly the financial sector where several individual companies may have a direct interest in European Union sovereign debt.
The accompanying consolidated financial statements have been prepared in accordance with GAAP and assume that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. However, there is substantial doubt regarding our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to comply with terms of the Corrective Orders which is in part dependent on our financial condition. If we are unable to comply with the terms of the Corrective Orders, the Department may institute legal proceedings to place Triad in receivership. If Triad were placed into receivership, all of the assets and future cash flows of Triad would be allocated to Triad’s policyholders to pay insurance claims and to pay creditors and the administrative expenses of the receivership, and none of such assets or cash flows would be available to TGI and its stockholders. In addition, Triad is TGI’s primary source of current and potential future cash flow as TGI has no operations of its own. If Triad were placed in receivership proceedings by the Department, TGI may be forced to institute a proceeding seeking relief from creditors under U.S. bankruptcy laws and it is likely that no funds would ever be available for distribution to our stockholders. The report of our independent registered public accounting firm with respect to our December 31, 2011 and 2010 financial statements included a statement that they believe there is substantial doubt about our ability to continue as a going concern.
Under the Department’s Corrective Orders, all valid claims under Triad’s mortgage guaranty insurance policies are settled 60% in cash and 40% by the recording of a DPO. In addition to the DPO, Triad also accrues simple interest on the DPO. The ultimate payment of both the DPO and the interest are subject to Triad’s future financial performance and requires the approval of the Department. At December 31, 2011, the total amount of the DPO was $629.7 million, including accrued interest of $30.6 million, which equates to 81% of our total invested assets. We are currently in discussions with the Department regarding the increasing percentage of assets supporting the DPO liability and the amount of interest credited to the DPO holders. The specific terms of the Corrective Order requiring the DPO have and will continue to positively impact our operating cash flows until such time as we are required to distribute payments on the DPO. However, because we remain obligated to pay the DPO and will accrue interest on the DPO, we do not expect to realize any ultimate financial benefit or expense from recording a DPO.
We sold our information technology and operating platform to Essent Guaranty, Inc. (“Essent”) in the fourth quarter of 2009. Under the terms of the purchase agreement, Essent acquired all of our proprietary mortgage insurance software and substantially all of the supporting hardware, as well as certain other assets, in exchange for fixed payments of $15 million, contingent payments of up to $15 million, and the assumption by Essent of certain contractual obligations. We have collected the original $15 million fixed portion of the agreement. The $15 million contingent payment is payable in six equal payments, beginning June 2012, and is subject to Essent writing a certain minimum amount of insurance in each of the six consecutive six month periods following November 30, 2011. The majority of the payments are remitted to Triad while a small amount is remitted to TGI. Under a services agreement, Essent is providing ongoing information systems maintenance and services, customer service and policy administration support to Triad. Payment for these services is a variable expense based on the number of policies in force with a minimum payment of $150,000 per month for the initial five-year term of the agreement. These costs were $4.7 million for 2011.
Net cash received from renewal premiums declined by 12% in 2011 to $148.5 million from $169.2 million in 2010. This decrease was due primarily to a 23% decline in insurance in force although a drop in premiums refunded and premium ceded offset the decrease somewhat. Premium refunds were $46.0 million in 2011 compared to $60.5 million in 2010. The liability we have established for expected premium refunds was $32.6 million at December 31, 2011 compared to $29.6 million at December 31, 2010. Premium ceded declined 61% in 2011 to $6.1 million compared to $15.4 million in 2010.
Our deficit in assets increased to $703.6 million at December 31, 2011 compared to a deficit in assets of $586.2 million at December 31, 2010. We expect to continue to report a deficit in assets for the foreseeable future.
Triad’s ability to incur any material operating and capital expenditures, as well as its ability to enter into any new contracts with unaffiliated parties, also requires the Department’s approval (except for certain operating expenditures that have been preapproved by the Department).
Total trust assets supporting captive reinsurance agreements amounted to $41.6 million at December 31, 2011, down from $56.4 million at December 31, 2010. The decline is due to terminations as well as ceded claims paid. Future captive commutations, if any, are not expected to have a material impact on our results of operations or financial condition.
After giving effect to the DPO requirement, Triad’s policyholders’ surplus was $234.7 million at December 31, 2011 compared to $225.9 million at December 31, 2010. However, absent the implementation of the DPO requirement, Triad would have reported a deficiency in policyholders’ surplus of $732.8 million at December 31, 2011 compared to a deficiency in policyholders’ surplus of $592.9 million at December 31, 2010.
In July 2010, we repurchased and retired the entire $35.0 million principal amount of TGI’s 7.90% Notes due January 15, 2028 (the “Notes”) for an aggregate purchase price of approximately $4.9 million. The repurchase and retirement of the Notes eliminated the need for us to continue to make the semi-annual interest payments that otherwise would have been due under the Notes. Currently, TGI has no outstanding debt. Given our current financial condition, we do not believe we would be able to successfully access the capital markets to obtain long-term or short-term financing on either a debt or equity basis.
TGI’s expenses primarily consist of legal, Board, accounting, and consulting fees and are expected to range from approximately $100,000 to $400,000 per quarter. Triad has historically reimbursed TGI for a majority of its operating cash expenses under a management agreement. Pursuant to the Corrective Orders, we are required to submit to the Department a request for reimbursement of these expenses on a quarterly basis. During 2011, TGI cash expenses were approximately $1.0 million and all requested reimbursements, which include the majority of these expenses, have been approved. There can be no assurance these quarterly expenditures will not increase in the future. If the Department prohibits or limits the reimbursement by Triad of TGI’s operating expenses, the cash resources of TGI will be adversely affected.
We had no material off-balance sheet arrangements at December 31, 2011.
We lease office facilities and office equipment at our Winston-Salem location under operating leases with minimum lease commitments that range from one to two years. We currently sublease space on three of the five floors of our office facility to Essent. We had no capitalized leases or material purchase commitments at December 31, 2011.
We calculate our best estimate of the reserve for losses to provide for the estimated costs of settling claims on loans reported in default as of the date of our financial statements. Additionally, we provide a reserve for loans in default that are in the process of being reported to us (incurred but not reported) using an estimate based on the percentage of actual reported defaults. Our reserving process incorporates various components in a model that gives effect to more recent actual experience as well as to current economic conditions and segments defaults by a variety of criteria. The criteria include, among others, policy year, lender, geography and the number of months the policy has been in default, as well as whether the defaults were underwritten as flow business or as part of a structured bulk transaction. We also incorporate in the calculation of loss reserves the probability that a policy may be rescinded for underwriting violations.
The volume of the default risk in force is such that small changes in the factors utilized in our reserve methodology can have a significant impact on reported results. During 2011, we made slight upward revisions to both the frequency and severity factors as a result of our actual loss development resulting in an increase in gross reserves of approximately $43.8 million as of December 31, 2011, most of which was offset by benefits received from Modified Pool structures. During 2010, we decreased the overall frequency factor utilized in our reserve methodology by approximately 10%. The 2010 decrease was precipitated by more favorable development in our cure rates and rescission activity than those assumed in our reserve assumptions utilized at December 31, 2009. At December 31, 2011, the average overall frequency factor implied in the reserve assumptions was 52% compared to 51% one year earlier. The average overall severity factor implied in the reserve assumptions was 107% at December 31, 2011 (we can pay greater than 100% of the covered risk due to interest and certain foreclosure costs that we are required to pay under the terms of our policies) compared to 104% one year earlier. To provide a measure of the sensitivity on pre-tax income and the loss reserves carried on the balance sheet, we have provided the following table that quantifies the impact of reasonable percentage increases and decreases in the average overall frequency and severity factors as of December 31, 2011:
Our loss severity is ultimately limited by the coverage percentage on individual loans but can increase slightly from the current elevated levels. We believe that a 5% increase or decrease in severity is possible based on potential changes in future economic conditions and our past experience. Any aspect that would affect our ability to sell the home of a borrower in default prior to foreclosure would affect our severity. The most prominent of these would be the value of the underlying home. Another issue that can impact the severity is the length of time and the amount of effort required by a servicer to foreclose on a delinquent borrower and ultimately file a claim. Government and private industry programs designed to stem the level of foreclosures, such as HAMP and HARP, could also impact both frequency and severity and the impact of these programs would most likely have a positive effect on our severity and frequency factors.
We have noted that our loss reserves as well as our reported premium income have both been decreased based on the estimate of future rescissions in the existing default portfolio. In general, a rescission occurs when we determine that fraud, misrepresentation or other specified violations, which we refer to collectively as underwriting violations, occurred in the origination of a loan. When these violations are identified, insurance coverage from the date of issuance is voided and the entire previously paid premium is refunded.
During 2009 and 2010, we experienced a much higher level of rescission activity than in previous years. In 2011, the level of rescissions dropped considerably compared to 2010 as fewer defaults were investigated for possible underwriting violations. We incorporate a factor in our computation of loss reserves to account for expected rescissions, based upon the status of our investigation of defaults in progress and our actual experience. The effect of the rescission factor is to reduce the loss reserve by reflecting the probability that we may rescind coverage on a certificate. During 2011, we adjusted our expectations about future rescissions based upon the actual experience during that year. The rescission factor is a significant component of the overall frequency factor utilized in the calculation of our loss reserves and resulted in a reduction to our gross reserves of approximately $205.7 million at December 31, 2011 compared to $310.4 million and $539.7 million at December 31, 2010 and 2009, respectively. We expect that the impact of future rescissions will continue to diminish in 2012 as there are fewer defaults that are eligible for rescissions.
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets. Invested assets utilizing Level 1 inputs are our money market instruments. Approximately 0.6% of our invested assets are Level 1.
Prices or valuation techniques where one or more of the significant inputs are unobservable (i.e., supported with little or no market activity). This includes broker quotes which are non-binding. Certain of our asset-backed securities utilize Level 3 inputs and comprise approximately 0.1% of our invested assets.
We utilize third party pricing services in the valuation of our invested assets and we utilize an investment advisor to assist us in determining if the pricing methodology complies with ASC 820-10. Working under our supervision, the investment advisor reviews the pricing techniques of the third party pricing services and has controls in place to ensure quality. These controls include, but are not limited to, the following:
reviewing price tolerance reports for month-over-month price changes that exceed certain thresholds;
Based upon this review, prices may be challenged and replaced. Our investment advisor will obtain a price for any individual security not priced by the independent pricing services or for any individual security whose price is replaced as a result of the quality control review.
We receive a report from the investment advisor’s independent auditor, prepared in accordance with the Statement on Standards for Attestation Engagements, No. 16, Reporting on Controls at a Service Organization (“SSAE 16”), regarding the investment advisor’s controls that provide reasonable assurance the securities are valued using prices obtained by authorized sources in accordance with the investment advisor’s policies.
Given our recurring losses from operations and the significant doubt regarding our ability to continue as a going concern, we may no longer have the ability to hold impaired assets for a sufficient time to recover their value. As a result, we recognize an impairment loss on all securities that are in an unrealized loss position at each quarter end. We continue to mark all of our securities to fair value and any unrealized gains flow through other comprehensive income (loss) while any unrealized losses are reported under ‘Net realized investment gains (losses)’ in the statements of comprehensive income (loss).
it is likely that our existing assets and future premium will not be sufficient to meet our current and future policyholder obligations absent significant positive changes in the economy and the residential real estate market;
adverse economic conditions in the United States, a continued decline or the lack of significant recovery in home prices, and/or high unemployment levels could increase defaults and limit opportunities for borrowers to cure defaults or for us to mitigate losses, which could have an adverse material impact on our business or results of operations;
the possibility that the Department may take various actions regarding Triad if we do not operate our business in accordance with the Corrective Orders, including instituting receivership proceedings, which would likely eliminate all remaining stockholder value;
our ability to operate our business during run-off and maintain a solvent run-off;
our ability to lower operating expenses to the most efficient level while still mitigating losses effectively during run-off, which will directly impact our financial performance in run-off.
Accordingly, actual results may differ from those set forth in these forward-looking statements. Attention also is directed to other risks and uncertainties set forth in documents that we file from time to time with the SEC.