As of December 31, 2002, the Company leases office space in its Winston-Salem headquarters and its twelve underwriting offices located throughout the country comprising approximately 77,000 square feet under leases expiring between 2003 and 2012 and which require annual lease payments of approximately $1.3 million in 2003. With respect to all facilities, the Company either has renewal options or believes it will be able to obtain lease renewals on satisfactory terms. The Company believes its existing properties are well utilized and are suitable and adequate for its present circumstances.
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 includes net realized investment losses of $2.5 million, or $0.11 per diluted share, while net income for 2001 included net realized investment gains of $297,000, or $0.01 per diluted share. Also included in net income for 2001 was the receipt of a nonrecurring incentive payment of approximately $1.9 million, or $0.09 per diluted share, relating to the voluntary cancellation of one of the Company's excess of loss reinsurance contracts. The payment was reported as other income in the first quarter of 2001.
Operating earnings, which exclude realized investment gains and losses net of related taxes, increased 13.8% to $46.7 million in 2002 compared to $41.1 million in 2001. Operating earnings per share were $3.26 for 2002 compared to $2.94 for 2001, an increase of 11.0%. Management believes operating earnings and operating earnings per share are relevant and useful information, and they are primary measurements used by management in assessing the Company's performance. Management does not believe that net realized investment gains and losses are strong indicators of trends in operations. Operating earnings and operating earnings per share results, as described above, may not be comparable to similarly titled measures reported by other companies. Excluding the effects of the nonrecurring incentive payment from operating results, operating earnings increased 17.3%, and operating earnings per diluted share increased approximately 14.4% for 2002 compared to 2001.
Traditional flow insurance written for 2002 increased 42.8% to $12.2 billion from $8.5 billion in 2001. The increase in insurance written from traditional flow production was primarily the result of expanding relationships with national lenders, strong demand for risk-sharing arrangements, and a lower interest rate environment. Insurance written in 2002 attributable to structured bulk transactions totaled $1.2 billion compared to $4.7 billion in 2001. Structured bulk transactions are generally initiated by secondary mortgage market participants who wish to use mortgage insurance as a credit enhancement. The Company competes against other mortgage insurers as well as other forms of credit enhancements provided by capital markets for these transactions.
Insurance written attributed to structured bulk transactions is likely to vary significantly from period to period due to the relatively small number of transactions that encompass this market (as opposed to the traditional flow market), competitiveness with other mortgage insurers, the attractiveness in the marketplace of mortgage insurance versus other forms of credit enhancements, and the changing loan composition of the market. The Company has evaluated all segments of the bulk market - Prime (predominantly fully underwritten loans, high credit scores, high percentage of low LTVs), Alternative-A (generally high credit score, low to moderate LTV loans that have been underwritten with reduced documentation), and Sub-prime (generally fully underwritten loans with credit impaired borrowers). All insurance written through the bulk channel in 2002 and 2001 was in the Prime segment and the Alternative-A segment of the bulk market.
Consolidation within the mortgage origination industry and Triad's continued focus on national lenders has resulted in a greater percentage of production volume being concentrated among a smaller customer base. The Company's ten largest customers were responsible for 58.9%, 42.3%, and 30.0% of traditional flow risk in force at December 31, 2002, 2001, and 2000, respectively. The loss of one or more of these significant customers could have a significant adverse effect on the Company's business. According to industry data, Triad's national market share of net new primary insurance written, which includes insurance written on a traditional flow basis as well as that attributed to structured bulk transactions, was 3.7% for 2002 (3.9% for the fourth quarter) compared to 3.6% for 2001 (4.0% for the fourth quarter). Triad's national market share of net new primary insurance written on a traditional flow basis was 4.3% for 2002 (4.7% for the fourth quarter) compared to 3.4% for 2001 (4.1% in the fourth quarter). Net new primary insurance written excludes insurance placed on loans more than 12 months after loan origination, insurance placed on loans already covered by primary mortgage insurance, and insurance placed on loans where lender exposure is effectively reduced below defined minimums. This treatment is consistent with the definitions adopted by the Company and the industry in the third quarter of 2001 regarding the computation of new insurance written for market share purposes.
Growth in direct premiums written was partially offset by an increase in ceded premiums written. Driven primarily by increases in risk-sharing arrangements and also by excess of loss reinsurance, ceded premiums written increased 73.8% to $18.3 million in 2002 from $10.6 million in 2001. The Company's premium cede rate (the ratio of ceded premiums written to direct premiums written) was 14.8% for 2002 compared to 11.0% for 2001. The Company's premium cede rate for captive reinsurance was 12.7% for 2002 compared to 6.6% for 2001. Approximately 51% of flow insurance written (46% of total insurance
written including structured bulk transactions) during 2002 is subject to captive mortgage reinsurance and other risk-sharing arrangements compared to 58% of flow insurance written (37% of total insurance written including structured bulk transactions) in 2001. The decline in the percentage of flow insurance written subject to risk-sharing arrangements from 2001 to 2002 is primarily a result of increased production in the Company's lender-paid mortgage insurance program which is generally not subject to risk-sharing arrangements. Through December 31, 2002, insurance written attributable to structured bulk transactions has not been subject to captive mortgage reinsurance or other risk-sharing arrangements. Approximately 45.7% of direct insurance in force is subject to risk-sharing arrangements at December 31, 2002, compared to 34.6% at December 31, 2001. This increase in insurance in force subject to risk-sharing arrangements is due primarily to the increased market penetration of the Company's risk-sharing arrangements and the high level of refinance activity during the past twelve months, as policies that were previously not subject to risk-sharing arrangements refinanced and new policies issued were subject to risk-sharing arrangements. Management anticipates that ceded premiums will continue to increase as a result of the expected increase in insurance written and growth in the Company's risk-sharing programs.
by determining the run off over the prior 12 months of each individual policy year (exclusive of current year production). This method of calculating persistency may vary from that of other mortgage insurers. The Company believes that its calculation presents an accurate measure of the percentage of insurance in force remaining from 12 months prior. The Company's current method of calculating persistency is consistent with the methodology used by the Company in prior years.
The Company actively monitors investment securities considered to be at risk for impairment. When the Company determines that a decline in the value of a security below its amortized cost is other-than-temporary, an impairment loss has occurred. In the event of impairment, the Company writes down the cost basis of the security to its fair value and recognizes a realized loss for the amount of the writedown. Net realized losses of $2.5 million during 2002 included impairment writedowns of approximately $2.0 million on securities held in the Company's portfolio. The net realized gain of $154,000 during the fourth quarter of 2002 included approximately $403,000 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.
that were previously three or more payments in arrears and have not made payments to the current due date. Reserves are established for all insured loans reported as delinquent to the Company by the loan servicer. The Company's loss ratio (the ratio of net incurred losses to net earned premiums) was 13.4% for 2002 compared to 10.7% for 2001. The loss ratio was 15.4% for the fourth quarter of 2002 and 13.2% for the fourth quarter of 2001.
As of December 31, 2002, approximately 83% of the Company's insurance in force was originated in the last 36 months. Management believes, based upon its experience and industry data, that claims incidence for it and other private mortgage insurers is generally highest in the third through sixth years after loan origination. Although the claims experience on insurance written in previous years has been quite favorable, management does not expect losses to remain at the low levels currently reported. The Company expects its incurred losses to increase as a greater amount of its insurance in force reaches its anticipated highest claim frequency years. Furthermore, changes in the economic environment could accelerate paid and incurred loss development. Due to the inherent uncertainty of future premium levels, losses, economic conditions, and other factors that affect earnings, it is difficult to predict with any degree of certainty the impact of such higher claim frequencies on future earnings.
Amortization of deferred policy acquisition costs increased by 17.3% to $13.7 million in 2002 from $11.7 million for 2001. The increase in amortization reflects growth in deferred policy acquisition costs related to the growth of the Company's insurance in force and accelerated amortization due to higher cancellations from refinance activity in 2002. The Company's model calculates the amortization of deferred policy acquisition costs separately for each book year. The model accelerates the amortization of deferred policy acquisition costs through a dynamic adjustment when persistency for a book year is lower than a historical baseline level in order to match the amortization expense with the life of the policies on which the acquisition costs were originally deferred. Low persistency levels during the past two years resulted in additional amortization of deferred policy acquisition costs through dynamic adjustments totaling $2.6 million in 2002 and $2.1 million in 2001.
Net income per share on a diluted basis increased 15.8% to $2.95 for 2001 from $2.55 per share for 2000. Operating earnings per share were $2.94 for 2001 compared to $2.54 for 2000, an increase of 15.8%. Operating earnings per share exclude approximately $297,000 of net realized investment gains in 2001 and $286,000 in 2000. Operating earnings in 2001 include approximately $0.09 per share related to the nonrecurring payment.
Net losses and loss adjustment expenses (net of reinsurance recoveries) increased by 18.9% in 2001 to $9.0 million from $7.6 million in 2000. This rise reflected increased levels of insurance in force. The Company's loss ratio was 10.7% for 2001 compared to 10.6% for 2000. As of December 31, 2001, there were no incurred losses related to the Company's bulk business.
Approximately 76% of the Company's insurance in force at December 31, 2001, was originated in the prior 36 months.
Amortization of deferred policy acquisition costs increased by 42.6% to $11.7 million in 2001 from $8.2 million for 2000. The increase in amortization reflected growth in deferred policy acquisition costs related to the expansion of the Company's insurance in force and accelerated amortization due to higher cancellations from refinance activity in 2001.
The insurance laws of the State of Illinois impose certain restrictions on dividends that Triad can pay the parent company. These restrictions, based on statutory accounting practices, include requirements that dividends may be paid only out of statutory earned surplus and that limit the amount of dividends that may be paid without prior approval of the Illinois Insurance Department.
Fixed maturity securities represented approximately 87% of the Company's invested assets at December 31, 2002, and the fair value of these fixed rate securities generally bears an inverse relationship to changes in prevailing market interest rates. The Company's long-term debt bears interest at a fixed rate of 7.9% per annum, and as a result, the fair value of this debt is sensitive to changes in prevailing interest rates. A 10% relative increase or decrease in market interest rates that affect the Company's financial instruments would not have a material impact on earnings during the next fiscal year, and would not materially affect the fair value of the Company's financial instruments.
The Company's loss and loss adjustment expense reserves increased to $21.4 million at December 31, 2002, compared to $18.0 million at December 31, 2001. Loss and loss adjustment expense reserves are established when notices of default on insured mortgage loans are received. Reserves also are established for estimated losses incurred on notices of default not yet reported by the lender. Consistent with industry practices, the Company does not establish loss reserves for future claims on insured loans that are not currently in default. The growth in loss reserves is the result of the increase in reported defaults and the maturing of the Company's risk in force. The Company expects loss reserves to continue to grow, reflecting the growth and aging of its insurance in force. Including bulk loans, the Company's delinquency ratio (the ratio of delinquent insured loans to total insured loans) was 1.25% at December 31, 2002, compared to 0.89% at December 31, 2001. The Company's delinquency ratios for traditional flow and bulk loans were 1.23% and 1.38%, respectively, at December 31, 2002. There were no reported delinquencies for bulk loans at December 31, 2001.
Triad cedes 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.
Triad's ability to write insurance depends on the maintenance of its financial strength ratings and the adequacy of its capital in relation to risk in force. A significant reduction of capital or a significant increase in risk may impair Triad's ability to write additional insurance. A number of states also generally limit Triad's risk-to-capital ratio to 25-to-1. As of December 31, 2002, Triad's risk-to-capital ratio was 15.5-to-1 as compared to 15.0-to-1 at December 31, 2001, and 11.1-to-1 for the industry as a whole at December 31, 2001, the latest industry data available.
The Office of Federal Housing Enterprise Oversight (OFHEO) issued its risk-based capital rules for Fannie Mae and Freddie Mac in the first quarter of 2002. The regulation provides capital guidelines for Fannie Mae and Freddie Mac in connection with their use of various types of credit protection counterparties including a more preferential capital credit for insurance from a "AAA" rated private mortgage insurer than for insurance from a "AA" rated private mortgage insurer. The phase-in period for the new rules is ten years. The Company does not believe the new rules had an adverse impact in 2002 nor
Management's Discussion and Analysis and this Report contain forward-looking statements relating to future plans, expectations, and performance which involve various risks and uncertainties, including but not limited to the following: interest rates may increase or decrease from their current levels; housing transactions and mortgage insurance may decrease for many reasons including changes in interest rates or economic conditions; the Company's market share may change as a result of changes in underwriting criteria or competitive products or rates; the amount of insurance written could be 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 Company's financial condition and competitive position could be affected by legislation impacting the mortgage guaranty industry specifically and the financial services industry in general; rating agencies may revise methodologies for determining the Company's financial strength ratings and may revise or withdraw the assigned ratings at any time; decreases in persistency, which are affected by loan refinancings in periods of low interest rates, may have an adverse effect on earnings; the amount of insurance written and the growth in insurance in force or risk in force as well as the performance of the Company may be adversely impacted by the competitive environment in the private mortgage insurance industry, including the type, structure, and pricing of products and services offered by the Company and its competitors; if the Company fails to properly underwrite mortgage loans under contract underwriting service agreements, the Company may be required to assume the costs of repurchasing those loans; with consolidation occurring among mortgage lenders and the Company's concentration of insurance in force generated through relationships with significant lender customers, the loss of a significant customer may have an adverse effect on earnings; the Company's performance may be impacted by changes in the performance of the financial markets and general economic conditions; economic downturns in regions where Triad's risk is more concentrated could have a particularly adverse effect on Triad's financial condition and loss development; new OFHEO risk-based capital rules could severely limit the Company's ability to compete against various types of credit protection counterparties, including "AAA" rated private mortgage insurers; changes in the eligibility guidelines of Fannie Mae or Freddie Mac could have an adverse effect on the Company.
The response to this item is submitted on page 54 of this report under the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations."