We entered into an office facility lease in Emeryville, California, effective July 1, 2012 for a term of two years. This facility is approximately 24,000 square feet and fully furnished. In October 2013, we amended our facility's lease to (i) add approximately 23,000 square feet of furnished office space and (ii) extend the facility's lease period through October 31, 2017, which allows for expansion based on near-term projected staffing growth. We do not own or lease any other facilities.
MI protects mortgage lenders from all or a portion of default-related losses on residential mortgage loans made to home buyers who generally make down payments of less than 20% of the home's purchase price. By protecting lenders and investors from credit losses, we help facilitate the availability of mortgages to prospective, primarily first-time, U.S. home buyers, thus promoting homeownership while protecting lenders and investors against potential losses related to a borrower's default. MI also facilitates the sale of these mortgage loans in the secondary mortgage market, most of which are sold to the GSEs. We are one of seven companies in the U.S. who offer MI. Our business strategy is to become a leading national MI company with our principal focus on writing insurance on high quality, low down payment residential mortgages in the U.S.
As discussed in Part I, Item 1, "Business - Customers," our sales and marketing strategy is focused on attracting as customers mortgage originators in the U.S. that fall into two distinct categories, which we refer to as "National Accounts" and "Regional Accounts." Since April 2013, we have increased our customer base, and we expect to continue to acquire new National and Regional Account customers. In addition to adding new customers, we believe more of our existing customers will begin to allocate more of their business to us for placement of our MI.
Maintain approved status and relationships with National Accounts who purchase loans from Regional Accounts. Retaining these approvals as an authorized MI provider enables Regional Accounts to sell loans with insurance from us to those National Accounts through their correspondent channels. Consequently, these relationships are critical to continuing to grow our business with Regional Accounts.
Primary insurance may be written on a flow basis, in which loans are insured in individual, loan-by-loan transactions, or may be written on a non-flow basis, in which mortgage insurance coverage is placed on more than one loan, typically after the loans have been originated. MI may also be written in a pool policy, where a group of loans (or pool) are insured under a single contract. Pool insurance may have a stated aggregate loss limit for a pool of loans and may also have a deductible under which no losses are paid by the insurer until losses on the pool of loans exceed the deductible.
During the quarter ended December 31, 2014, we had primary NIW of $1.7 billion, compared to primary NIW of $974.9 million during the quarter ended September 30, 2014. We had primary NIW of $3.5 billion for the year ended December 31, 2014 compared to $162.2 million for the year ended December 31, 2013. We did not write any new pool insurance in 2014. Our total NIW for the year ended December 31, 2013 consisted almost entirely of pool insurance written under our Fannie Mae pool agreement, which comprised $5.2 billion of the total NIW of $5.3 billion.
As of December 31, 2014, NMIC had primary IIF of $3.4 billion and pool IIF of $4.7 billion and total RIF of $894.4 million, consisting of $801.4 million of primary RIF, representing insurance on 14,603 loans, and pool RIF of $93.1 million, representing insurance on approximately 21,000 loans. As of December 31, 2013, NMIC had primary IIF of $161.7 million and pool IIF of $5.1 billion and total RIF of $129.6 million, consisting of primary RIF of $36.5 million and pool RIF of $93.1 million. We expect NMIC's primary IIF and RIF to significantly increase over the coming year.
The RIF to NMIC is $93.1 million, which represents the difference between a deductible payable by Fannie Mae on initial losses and a stop loss above which losses are borne by Fannie Mae. NMIC provides this same level of risk coverage over the term of the agreement. We are bound to counter-party requirements contained in the agreement that specify the amount of capital NMIC will need to maintain to support the agreement until the new PMIERs are effective, discussed below in "-Proposed PMIERs." The capital we are required to maintain under the pool agreement is specified as the greater of the following:
A significant portion of our NIW in 2014 was comprised of single premium policies. While our single premium policies currently represent the majority of our NIW and IIF, we expect the mix of our policy types could change meaningfully in future quarters. Lender-paid single premiums are non-refundable and fully earned upon cancellation.
The table below shows NIW, IIF, RIF, policies in force, the weighted average coverage and loans in default, by quarter, for the last five quarters, for our primary book.
Approximately 59% of our IIF and NIW in 2014 was from single premium business.
The table below reflects our pool NIW, IIF and RIF by FICO for the 2013 book as of December 31, 2014.
The tables below reflect our average primary loan size by FICO and the percentage of our RIF by loan type.
new insurance written, which is the new insurance-in-force (aggregate principal amount of the mortgages) that are insured during a period. Many factors affect new insurance written, including, among others, the volume of low down payment
home mortgage originations (which tend to be generated to a greater extent in purchase financings as compared to refinancings) and the competition to provide credit enhancement on those mortgages, which includes primarily competition from the FHA and other private mortgage insurers;
cancellations, which reduce insurance-in-force. Cancellations due to refinancings are affected by the level of current mortgage interest rates compared to the mortgage rates on our insurance-in-force. Refinancings are also affected by current home values compared to values when the loans became insured and the terms on which mortgage credit is available. Upon cancellation of a policy, all premium that is non-refundable is immediately earned. Any refundable premium is returned to the policyholder. To a lesser extent, we expect our future cancellations to be impacted by policies canceled due to claim payment, which require us to return any premium received subsequent to the date the insured mortgage defaults. Finally, cancellations are affected by home price appreciation, which may give homeowners the right to cancel the MI on their loans. Based on current market conditions, we expect our MI policies to have a persistency rate of between 80% and 85%;
Claims incurred are the current expense that is booked within a particular period to reflect actual and estimated claim payments that we believe will ultimately be made as a result of insured loans that are in default. As explained under "Critical Accounting Estimates - Reserve for Claims and Claim Adjustment Expenses" below, we do not recognize an estimate of claim expense for loans that are not in default. Claims incurred are generally affected by:
the state of the economy, including unemployment, which affects the likelihood that borrowers may default on their loans;
the product mix of insurance-in-force, with loans having higher risk characteristics generally resulting in higher defaults and claims;
the rate at which we rescind policies. Because of tighter underwriting standards generally in the mortgage lending industry and the terms of our master policy, we expect that our level of rescission activity will be lower than recent rescission activity experienced by the MI industry; and
We developed our estimates of the expected frequency and severity of claims based on statutory filings by many of our competitors, which contain historical book year performance, as well as an industry dataset which consists of nearly 150 million mortgages and 80 data fields per mortgage, gathered over the past 17 years. As state-regulated entities, mortgage insurers are required to file actuarial justifications for premium rate changes in many states, many of which are publicly available and include historical information on claim frequency and severity. Historical performance data from similar underwriting, house price, and interest rate periods were compared to today to determine a range of expected performance.
As a participant in the mortgage lending and MI industries, we rely on e-commerce and other technologies to provide and expand our products and services. We have established and implemented security measures, controls and procedures to safeguard our information technology systems and to prevent unauthorized access to such systems and any data processed and/or stored in such systems. We periodically employ third parties to evaluate and test the adequacy of such systems, controls and procedures. In addition, we have established a business continuity plan that is designed to allow our business to continue to operate in the midst of certain disruptive events, including any disruptions to our information technology systems. We also have an incident response plan that is designed to address information security incidents, including breaches of our information technology systems. Despite these safeguards, disruptions to and breaches of our information technology systems are possible and may negatively impact our business.
We maintain technology errors and omissions coverage to limit our exposure in the event an incident occurs. This insurance provides coverage for (i) claims related to, among other things, unauthorized network or computer access, unintentional disclosure or misuse of personally identifiable information in our possession, unintentional failure to disclose a breach and (ii) certain costs related to privacy notification, crisis management and business interruption.
The NAIC has formed a working group to explore, among other things, whether certain states' statutory capital requirements applicable to mortgage insurers should be overhauled. We, along with other MI companies are working with the Mortgage Guaranty Insurance Working Group of the Financial Condition (E) Committee of the NAIC (the "Working Group"). The Working Group will determine and make a recommendation to the Financial Condition (E) Committee of the NAIC as to what changes, if any, the Working Group believes are necessary to the solvency regulation for MI companies, including changes to the Mortgage Guaranty Insurers Model Act (Model #630). We have provided feedback to the Working Group since early 2013, and we support more robust capital standards and continue to advocate for a strong capital model. The discussions are ongoing and the ultimate outcome of these discussions and any potential actions taken by the NAIC cannot be predicted at this time. However, given our current strong capital position and having no exposure to risk written in the 2005 through 2008 book years, we believe that NMIC will be well positioned to comply with new capital requirements proposed by the NAIC when they become effective.
As discussed above in Part I, Item 1, "Business - U.S. Mortgage Insurance Regulation - GSE Oversight - GSE Eligibility Requirements," on July 10, 2014, the FHFA released for public input the proposed PMIERs. As announced by FHFA, the PMIERs are expected to take effect 180 days following the publication date of the final PMIERs (the "Effective Date"). Prior to the Effective Date, each private mortgage insurer will be required to either (i) certify to the GSEs that it fully complies with the PMIER financial requirements as of the Effective Date, or (ii) obtain GSE approvals on a transition plan detailing how it will comply with the financial requirements not later than 2 years following the publication date (the "Compliance Date"). We understand that each GSE will publish its own set of PMIERs and that final publication will likely occur during the first half of 2015, making the Effective Date sometime in the second half of 2015. As of the Effective Date, each MI, including NMIC, will have to comply with the financial requirements or have a GSE-approved transition plan in place.
The MI industry is highly competitive and currently consists of seven private mortgage insurers, including NMIC, as well as governmental agencies like the FHA and the VA. See Item I, Part 1, "Business - Sales and Marketing and Competition - Competition."
Although there has been broad policy consensus toward the need for private capital to play a larger role and government credit risk to be reduced in the U.S. housing finance system, recent action by the current administration has made it difficult to predict whether the market share of governmental agencies such as the FHA and VA will continue to recede at the same pace it has since 2010. On January 26, 2015, the FHA reduced its single-family annual mortgage insurance premiums by 50 basis points. It is difficult to predict what, if any, material impact this premium reduction will have as there are factors beyond premium rate that influence a lender's decision to choose private MI over FHA insurance, including among others, relative ease of use of private MI products compared to FHA products.
Another factor that impacts FHA's market share is the size of the loans it is permitted to insure. In 2014, the FHA reduced the maximum size of residential mortgage loans that it may insure in nearly 650 counties. The new national maximum loan limit for certain "high-cost" areas was also reduced from $729,750 to $625,500. The current national standard loan limit for areas where housing costs are relatively low remained unchanged at $271,050. Areas are eligible for FHA loan limits above the national standard limit, and up to the national maximum level, based on median area home prices. At the time, FHA's Commissioner Carol Galante acknowledged that as the housing market continues its recovery, the FHA lowering its loan limits is an important and appropriate step as private capital returns to portions of the market. We cannot predict, however, the FHA's share of new insurance written in the future due to, among other factors, different loan eligibility terms between the FHA and the GSEs; potential future increases in guarantee fees charged by the GSEs; additional changes to the FHA's annual premiums; and the total profitability that may be realized by mortgage lenders from securitizing loans through the Government National Mortgage Association ("Ginnie Mae") when compared to securitizing loans through Fannie Mae or Freddie Mac.
Our financial results to date have been primarily driven by expenditures related to our business development activities, and to a lesser extent, by our investment activities. Although we expect our year-over-year expenses to increase as we grow our business, we ultimately expect that the majority of our operating expenses will be relatively fixed in the long term. As our business matures and we deploy the majority of our capital, including capital raised through equity or debt offerings, or through the use of reinsurance, we are targeting our expense ratio (expenses to premiums written) to fall into a range of 20% to 25%. Until our business matures, our expense ratio is expected to be significantly higher than this range given the low levels of premium written compared to our "fixed" costs customary to operating a mortgage insurance company.
Given our growth during 2014, we believe that a quarter over quarter comparison of net premiums written is more meaningful than comparing net premiums written year over year. For the quarter ended December 31, 2014, we had net premiums written of $14.1 million and net premiums earned of $5.5 million, compared to net premiums written of $9.7 million and net premiums earned of $3.9 million for the quarter ended September 30, 2014. For the quarter ended December 31, 2014, we had net monthly premiums written and earned of $1.8 million compared to $883 thousand for the third quarter of 2014. Monthly NIW increased by approximately 75% quarter over quarter from September 30, 2014 to December 31, 2014.
We have incurred significant net operating losses since our inception. Our net losses were $48.9 million, $55.2 million, and $27.5 million for the each of the years in the three-year period ended December 31, 2014, respectively. Our net loss increased for the year ended December 31, 2013 compared to the year ended December 31, 2012, primarily as a result of the increase in our head count, the development of our IT platform, the depreciation of our IT systems as they were put into service in 2013 and share-based compensation expense. The primary drivers of the decrease in net losses for the year ended December 31, 2014 compared to the year ended December 31, 2013 were the increase in premiums earned, the increase in net investment income and a decrease in our warrant liability, as a result of a decline in our stock price, offset by the continued hiring of management and staff personnel and external and professional costs. Premiums increased as we have added new customers and existing customers have allocated more business to us. We began investing our cash during the first quarter of 2013 and continued to invest and re-balance our portfolio in the second and third quarters of 2013. As a result, our net investment income was lower for the years ended December 31, 2013 and 2012 compared to the year ended December 31, 2014.
Our total underwriting and operating expenses for the year ended December 31, 2014 were $73.0 million compared to $60.7 million and $27.8 million for the years ended December 31, 2013 and 2012, respectively, driven primarily by expanding operations and the hiring of personnel. The following are the components of our underwriting and operating expenses for the periods indicated:
As of December 31, 2014, we had approximately $440 million in cash and investments of which $164 million was held at NMIH. As of December 31, 2014, the amount of restricted net assets held by our consolidated insurance subsidiaries totaled approximately $252 million of our consolidated net assets of approximately $427 million.
NMIH serves as the holding company for our insurance subsidiaries and does not have any significant operations of its own. NMIH's principal liquidity demands include funds for: (i) payment of certain corporate expenses and reimbursable expenses of its insurance subsidiaries; (ii) capital support for its insurance subsidiaries; (iii) potential payments to the Internal Revenue Service ("IRS"); and (iv) the payment of dividends, if any, on its common stock. NMIH is not subject to any limitations on its ability to pay dividends except those generally applicable to corporations, such as NMIH, that are incorporated in Delaware. Delaware corporation law provides that dividends are only payable out of a corporation's capital surplus or (subject to certain limitations) recent net profits. As of December 31, 2014, NMIH's shareholders' equity was approximately $427 million.
support for NMIC and Re One if additional capital is required pursuant to state insurance laws and regulations, by the GSEs or the rating agencies. Holding company cash at December 31, 2014 was $29.9 million.
In addition to investment income, dividends from NMIC and permitted payments under our tax- and expense-sharing arrangements with our subsidiaries are NMIH's principal sources of operating cash. The expense-sharing arrangements between NMIH and its insurance subsidiaries, as amended, have been approved by the Wisconsin OCI, but such approval may be changed or revoked at any time. NMIC's ability to pay dividends to NMIH is subject to various conditions imposed by the GSEs and by insurance regulations requiring insurance department approval. In general, dividends in excess of prescribed limits are deemed "extraordinary" and require insurance regulatory approval. Since inception, NMIC has not paid any dividends to NMIH. As NMIC had a statutory net loss for the year ended December 31, 2014, NMIC cannot pay any dividends to NMIH through December 31, 2015, without the prior approval of the Wisconsin OCI. Additionally, under agreements with the GSEs, NMIC is not permitted to pay shareholder dividends until December 31, 2015 and, under agreements with various state insurance regulators, is not permitted to pay shareholder dividends until January 2016.
Our net investment income for the year ended December 31, 2014 was $5.6 million compared to $4.8 million for the year ended December 31, 2013. During the first quarter of 2013, we began investing our cash holdings in fixed income securities which provide a higher yield than cash. As of December 31, 2014, we believe our portfolio conforms with our investment guidelines. The principal factors affecting our investment income include the size and credit rating of our portfolio and its net yield. As measured by amortized cost (which excludes changes in fair market value, such as those resulting from changes in interest rates), the size of our investment portfolio is mainly a function of capital raised, cash generated from (or used in) operations, such as net premiums received, and investment earnings.
The pre-tax book yield on our portfolio at December 31, 2014 was 1.5%, excluding unrealized gains and losses. The book yield is calculated on our year-to-date net investment income over our average portfolio book value at December 31, 2014. We believe that the yield on our investment portfolio likely will change over time based on potential changes to the interest rate environment, the duration or mix of our investment portfolio or other factors.
The ratings of our investment portfolio at December 31, 2014 and December 31, 2013 were:
There is a tax sharing agreement between NMIH and its subsidiaries, dated August 23, 2012. Under this agreement, each of the parties mutually agreed to file a consolidated federal income tax return for 2012 and subsequent tax years, with NMIH as the direct tax filer. The tax liability of each insurer that is party to the agreement is limited to the amount of liability it would incur if it filed a separate tax return. Any settlements under the agreement between NMIH and a subsidiary will be made within 30 days of the filing of the applicable federal corporate income tax return with the Internal Revenue Service ("IRS"), including subsequent amended filings and IRS adjustments, except when a refund is due to a subsidiary, in which case payment shall be made to the insurer within 30 days after NMIH’s receipt of the applicable tax refund.
As of December 31, 2014, the Company had federal net operating loss carryforwards of $114.5 million, which expire from 2029 to 2034 and state net operating loss carryforwards of $36.0 million, which primarily expire from 2031 to 2034. Section 382 of the Internal Revenue Code ("Section 382") imposes annual limitations on a corporation's ability to utilize its net operating losses ("NOLs") if it experiences an "ownership change." As a result of the acquisition of our insurance subsidiaries, $7.3 million of NOLs are subject to annual limitations of $0.8 million through 2016, then $0.3 million through 2029. If the Company were to experience another "ownership change," further limitations would apply.
We had no off-balance sheet arrangements at December 31, 2014. Contractual obligations at December 31, 2014 are summarized in the table that follows.
The establishment of claim and IBNR reserves is subject to inherent uncertainty and requires significant judgment by management. We establish claim reserves using our best estimates of claim rates, i.e., the percent of loan defaults that ultimately result in claim payments, and claim amounts, i.e., the dollar amounts required to settle claims, to estimate the ultimate claims on loans reported to us as being at least sixty days in default as of the end of each reporting period. We estimate IBNR by analyzing
historical lags in default reporting to determine a specific number of IBNR claims in each reporting period. Our actuary utilizes internal and external data to estimate lags in notice of default reporting. Additionally, our estimates of claim rates and claim sizes are strongly influenced by prevailing economic conditions, for example current rates or trends in unemployment, house price appreciation and/or interest rates, and our best judgment as to the future values or trends of these macroeconomic factors.
We classify our entire investment portfolio as available-for-sale and report it at fair value. The related unrealized gains or losses, after considering the related tax expense or benefit, are reported as a component of accumulated other comprehensive income in stockholders' equity. We expect to hold short-term investments with maturities of greater than three and less than 12 months when purchased, and such investments will be carried at fair value. Any realized gains and losses on sales of investments are determined on a specific-identification basis. We expect that our investment income will consist primarily of interest. We plan to recognize interest income on an accrual basis. Net investment income would represent interest income, net of investment expenses.
adverse conditions specifically related to the security, an industry or a geographic area.
We perform a premium deficiency calculation each fiscal quarter using best estimate assumptions as of the testing date. Per ASC 944, a premium deficiency reserve shall be recognized if the sum of expected claim costs and claim adjustment expenses, expected dividends to policyholders, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums. The calculation of premium deficiency reserves requires the use of significant judgment and estimates to determine the present value of future premiums and present value of expected claims and expenses on our business. The present value of future premiums relies on, among other things, assumptions about persistency and repayment patterns on underlying loans. The present value of expected claims and expenses depends on assumptions relating to severity of claims, claim rates on current defaults and expected defaults in future periods. These assumptions may also include an estimate of expected rescission activity. Assumptions used in calculating premium deficiency reserves can be affected by volatility in the current housing and mortgage lending industries. To the extent
We adopted ASC 718, Compensation - Stock Compensation ("ASC 718"). ASC 718 addresses accounting for share-based awards and recognizes compensation expense, measured using grant date fair value, over the requisite service or performance period of the award. Share-based payments include stock options and RSU grants under the 2012 Stock Incentive Plan. The fair value of stock option grants issued are determined based on an option pricing model which takes into account various assumptions that are subjective. Key assumptions used in the stock option valuation include the fair value of the stock on the grant date, the expected term of the equity award taking into account the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award. RSU grants to employees contain a market and service condition. The fair value of RSU grants to employees prior to our IPO was determined using a Monte Carlo Simulation model at the date of grant. Following the IPO, fair value was determined based on closing price on the grant date. Restricted grants to non-employee directors are valued at our stock price on the date of grant less the present value of anticipated dividends. Expense is recognized over the required service period, which is generally a three-year vesting period for the options (vesting in one-third increments per year).
We have audited the accompanying consolidated balance sheets of NMI Holdings, Inc. as of December 31, 2014 and 2013 and the related consolidated statements of comprehensive loss, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2014. In connection with our audits of the financial statements, we have also audited the financial statement schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
Under the terms of the Private Placement, we were required to obtain approvals from the GSEs by January 17, 2013. Freddie Mac and Fannie Mae approved NMIC as an eligible mortgage insurer, on January 15, 2013 and January 16, 2013, respectively, which approvals are conditioned upon NMIC maintaining certain conditions (the "GSE Approval"). For a further discussion of these conditions, see "Note 11, Commitments and Contingencies."
In November 2013, we completed an initial public offering of 2.4 million shares of our common stock, and our common stock began trading on the NASDAQ on November 8, 2013, under the symbol "NMIH." For a further discussion, see "Note 12, Common Stock Offerings."
In the mortgage insurance industry, a "book" is a group of loans that an MI company insures in a particular period, normally a calendar year. We set premiums at the time a policy is issued based on our expectations regarding likely performance over the term of coverage. The policies we write are guaranteed renewable contracts at the policyholder's option. Premiums may be paid to us on a single, annual or monthly basis. Premiums written on a single premium basis and an annual premium basis are initially deferred as unearned premium reserve and earned over the policy term commencing in the month coverage is effective. Premiums written on policies covering more than one year are amortized over the policy life in accordance with the expiration of risk, which is the anticipated claim payment pattern based on industry experience. Premiums written on annual policies are earned on a monthly pro rata basis. Premiums written on monthly policies are earned as coverage is provided. Premiums written on pool transactions are earned over the period that coverage is provided. Upon cancellation of a policy, all premium that is non-refundable is immediately earned and any refundable premium is returned to the policyholder. Premiums returned to policyholders are recorded as a reduction of written and earned premiums in the current period. The actual return of premium for all periods affects premiums written and earned in those periods.
For the year ended December 31, 2014, two customers represented a material portion of our revenues. At December 31, 2014, approximately 18% of our total RIF was concentrated in California. Our RIF and customer concentrations are not representative of those concentrations that we believe will exist when our insurance portfolio is more mature.
Consistent with industry accounting practices, for purposes of establishing claim reserves, we adhere to the general claim reserving principles contained in Financial Accounting Standards Board Accounting Standards Codification ("ASC") Topic 944, Financial Services - Insurance ("ASC 944"), even though that standard expressly excludes mortgage insurance from its guidance. However, and consistent with our industry, we do not establish claim reserves for anticipated future claims on insured loans that are not currently in default. We do not consider a loan to be in default for claim reserve purposes until we receive notice from the servicer that a borrower has failed to make two consecutive regularly scheduled payments and is at least 60 days in default. In addition to reserves on reported defaults, we establish reserves for estimated claims incurred on loans that have been in default for at least 60 days that have not yet been reported to us by the servicers, often referred to as IBNR.
Purchases and sales of investments are recorded on a trade date basis. Net investment income is recognized when earned and includes interest and dividend income together with amortization of market premiums and discounts using the effective yield method and is net of investment management fees and other investment related expenses. For asset-backed securities and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised as necessary. Any adjustments required due to the change in effective yields and maturities are recognized on a prospective basis through yield adjustments.
Each quarter, we evaluate our investments in order to determine whether declines in fair value below amortized cost were considered other-than-temporary in accordance with applicable guidance. Under the current guidance, a debt security impairment is deemed other-than-temporary if (i) we either intend to sell the security or it is more likely than not that we will be required to sell the security before recovery or (ii) we do not expect to collect cash flows sufficient to recover the amortized cost basis of the security. In evaluating whether a decline in fair value is other-than-temporary, we consider several factors including, but not limited to:
Costs directly associated with the successful acquisition of mortgage insurance policies, consisting of certain selling expenses and other policy issuance and underwriting expenses, are initially deferred and reported as deferred policy acquisition costs ("DAC"). For each book year of business, these costs are amortized to expense in relation to the anticipated recognition of premiums.
We account for warrants to purchase our common shares in accordance with ASC 470-20, Debt with Conversion and Other Options and ASC 815-40, Derivatives and Hedging - Contracts in Entity's Own Equity. Our outstanding warrants may be settled by us using either (i) physical settlement method or (ii) cashless exercise, where shares that are issued upon exercise of the warrants are reduced, to cover the cost of the exercise, in lieu of the holder remitting a cash payment of the exercise price. The warrants expire and are not exercisable after the 10th anniversary of the date the warrant was issued. The exercise price and the number of warrants are subject to anti-dilution provisions whereby the existing exercise price is adjusted downward, and the number of warrants increased, for events that may not be dilutive. The adjustment may be in excess of any dilution suffered. As a result, the warrants are classified
as a liability. We revalue the warrants at the end of each reporting period, and any change in fair value is reported in the statements of operations in the period in which the change occurred. We calculate the fair value of the warrants using a Black-Scholes option-pricing model in combination with a binomial model, and we value the pricing protection features of the warrants using a Monte Carlo simulation model.
We account for stock compensation in accordance with ASC 718, Compensation - Stock Compensation. This addresses accounting for share-based awards and recognition of compensation expense, measured using grant date fair value, over the requisite service or performance period of the award. Share-based payments include restricted stock units ("RSUs") and stock option grants under the 2012 Stock Incentive Plan. We determine the fair value of issued stock option grants using an option pricing model, which takes into account various assumptions that are subjective. Key assumptions used in the stock option valuation include the expected term of the equity award, taking into account the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award. RSU grants to employees contain a market condition and/or service condition. The fair value of RSU grants to employees with a market condition is determined based on a Monte Carlo simulation model at the date of grant. RSU grants to employees with a service condition and RSU grants to non-employee directors are valued at our stock price on the date of grant less the present value of anticipated dividends.
We consider items such as certificates of deposit and money market funds with original maturities of 90 days or less to be cash equivalents. The Company did not have any restricted cash as of December 31, 2014 and 2013.
Certain costs associated with the development of internal-use software are capitalized. Software and equipment are stated at cost, less accumulated amortization and depreciation. Once the software is ready for its intended use, amortization and depreciation are calculated using the straight-line method over the estimated useful lives of the respective assets ranging typically from 3 to 7 years, unless factors indicate a shorter useful life. Amortization of software and depreciation of equipment commences at the beginning of the month following our placement of the assets into use. For further detail, see "Note 9, Software and Equipment."
Premiums receivable consist of premiums due on our mortgage insurance policies. If mortgage insurance premiums are unpaid for more than 120 days, the receivable is written off against earned premium and the related insurance policy is canceled.
required to evaluate and disclose whether its plans alleviate that doubt. The guidance is effective for annual periods ending after December 15, 2016 and for interim and annual periods thereafter. We do not expect the adoption of this update to have a material effect on the presentation of our financial statements and notes therein.
Certain items in the financial statements as of December 31, 2014 and for the periods ending December 31, 2013 and December 31, 2012 have been reclassified to conform to the current period's presentation. There was no effect on net income or shareholders' equity previously reported.
The amortized cost and fair values of available for sale securities at December 31, 2014, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Because most asset-backed securities provide for periodic payments throughout their lives, they are listed below in separate categories.
Level 3 - Unobservable inputs that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. We value our warrant liability utilizing Level 3 inputs.
To determine the fair value of securities available-for-sale in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized by the independent pricing sources including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including data published in market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model. Quality controls are performed by the independent pricing sources throughout this process, which include reviewing tolerance reports,
trading information and data changes, and directional moves compared to market moves. This model combines all inputs to arrive at a value assigned to each security. We have not made any adjustments to the prices obtained from the independent pricing sources. There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the year ended December 31, 2014.
The following is a list of those assets and liabilities that are measured at fair value by hierarchy level as of December 31, 2014 and December 31, 2013:
The following is a roll-forward of Level 3 liabilities measured at fair value for the year ended December 31, 2014:
There were no transfers in or out of Level 3 of the fair value hierarchy during the year ended December 31, 2014.
We establish claim reserves to recognize the estimated liability for insurance claims and claim expenses related to defaults on insured mortgage loans. Our method, consistent with industry practice, is to establish claim reserves only for loans in default. Our claim reserves also include amounts for IBNR. We received our first primary NOD in the second quarter of 2014. For the year ended December 31, 2013, we had no claim or IBNR reserves.
Additionally, we entered into a pool insurance transaction with Fannie Mae, effective September 1, 2013. We would only establish claim or IBNR reserves for this pool transaction, if we expect claims to exceed the transaction's deductible, which represents the amount of claims absorbed by Fannie Mae before we are obligated to pay any claims under the policy. At December 31, 2014, thirty loans in the pool were past due by sixty days or more. These thirty loans represent approximately $1.7 million in RIF. Due to the size of the deductible ($10.3 million), the low level of NODs reported through December 31, 2014 and the high quality of the loans (all loans are less than 80% LTV), we have not established any pool reserves for claims or IBNR for the years ended December 31, 2014 and December 31, 2013.
The following table provides a reconciliation of the beginning and ending reserve balances for insurance claims and claims expenses for the year ended December 31, 2014 and 2013:
Upon exercise of these warrants, the amounts will be treated as additional paid-in capital. During the first quarter of 2014, 7,790 warrants were exercised and we issued 1,115 Class A common shares via a cashless exercise. Upon exercise, we reclassified the fair value of the warrants from warrant liability to additional paid in capital and recognized a gain of approximately $37 thousand. No other warrants were exercised during 2014.
On May 8, 2014, NMIH held its annual shareholder meeting, at which our shareholders voted to approve the NMIH 2014 Omnibus Incentive Plan, which authorizes us to make 4 million shares of NMIH's class A common stock available to be granted. These shares may be either authorized but unissued shares or treasury shares.
A summary of option activity in the plan during the years ended December 31, 2014 and December 31, 2013 is as follows:
The estimated grant date fair values of the stock options granted during 2014 and 2013 were calculated using the Black-Scholes valuation model based on the following assumptions:
A summary of RSU activity in the plan during the years ended December 31, 2014 and December 31, 2013 is as follows:
In February 2013, the Board approved a modification to the vesting terms of approximately 400,000 granted and non-vested RSUs held by our employees. The modification to the vesting terms removed the market condition leaving the RSUs subject to a service condition only. The modification resulted in a change in the period over which compensation costs are recognized and prospective recognition of incremental compensation cost. Incremental compensation cost is measured as the excess of the fair value of the modified award over the fair value of the original award immediately before its terms are modified using relevant valuation inputs as of the modification date.
The remaining weighted average contractual life of non-vested RSUs as of December 31, 2014 was 7.9 years. The weighted-average period over which total compensation related to non-vested RSUs will be recognized is 1.18 years.
The RSUs granted in 2014 were valued at our stock price on the date of grant less the present value of anticipated dividends, which is $0. As of December 31, 2014, there was $3.0 million of total unrecognized compensation cost related to non-vested RSUs compared to $4.3 million as of December 31, 2013.
The income tax benefit of $2.4 million for the year ended December 31, 2014 is related to the tax effects of unrealized gains credited to OCI. Generally, the amount of tax expense or benefit allocated to continuing operations is determined without regard to the tax effects of other categories of income or loss, such as OCI. However, an exception to the general rule is provided in ASC 740-20-45-7 when there is a pre-tax loss from continuing operations and there are items charged or credited to other categories, including OCI, in the current year. The intraperiod tax allocation rules related to items charged or credited directly to OCI can result in disproportionate tax effects that remain in OCI until certain events occur. As a result of a reduction in unrealized losses credited directly to OCI, approximately $2.4 million of tax provision expense has been netted with current year unrealized gains in OCI, and $2.4 million of tax provision benefit was allocated to the income tax provision for continuing operations.
At December 31, 2014 and 2013, we had a net deferred tax liability of $0.1 million as a result of the acquisition of indefinite-lived intangibles from the acquisition of our insurance subsidiaries for which no benefit had been reflected in the acquired net operating loss carry forwards. The tax liability incurred at the acquisition was recorded as an increase in goodwill.
Excluded from deferred tax assets were $2.1 million and $1.5 million of excess stock compensation as of December 31, 2014 and December 31, 2013, respectively, for which any benefit realized will be recorded to stockholders' equity.
As of December 31, 2014 and 2013, we have no reserve for unrecognized tax benefits, and have taken no material uncertain positions in its tax returns that would require measurement and recognition.
The conditions in the GSE Approval require, among other things, that NMIC:
operate at a risk-to-capital ratio not to exceed 15:1 for its first three years and then pursuant to the GSE Eligibility Requirements then in effect;
not declare or pay dividends to affiliates or to NMIH for its first three years, then pursuant to the Eligibility Requirements;
not enter into capital support agreements or guarantees for the benefit of, or purchase or otherwise invest in the debt of, affiliates without the prior written approval of the GSEs for its first three years, then pursuant to the Eligibility Requirements; and
We entered into an office facility lease effective July 1, 2012 for a term of two years. In October 2013, we amended our facility's lease to (i) add 23,000 square feet of furnished office space, and (ii) extend the facility's lease period through October 31, 2017.
We incurred rent expense related to this lease of $1.6 million for the year ended December 31, 2014. Rent expense for the year ended December 31, 2013 was $0.8 million.
On April 17, 2012, we completed the Private Placement, through which we offered and sold an aggregate of 55,000,000 of our Class A common shares resulting in net proceeds of approximately $510 million.
As of December 31, 2013, NMIC had 22 policies in force totaling approximately $36.5 million of RIF, resulting in a RTC ratio of 0.5:1. As of December 31, 2014, NMIC had $800 million in total RIF (1) with a RTC ratio of 3.5:1, significantly below the GSE and state imposed financial requirements. The risk-to-capital calculation for each of our insurance subsidiaries, as well as our combined risk-to-capital calculation, as of December 31, 2014, is presented below.
Represents total risk-in-force divided by statutory policyholders' position which is the metric by which the majority of state insurance regulators will assess our capital adequacy. Additionally, pursuant to the 2013 Fannie Mae pool agreement, we are required to maintain the greater of (a) the risk-to-capital requirements outlined in Fannie Mae's January 2013 approval letter or (b) a risk-to-capital ratio of 18:1 on primary business plus statutory capital equal to the amount of net risk-in-force of the pool.
NMIH is not subject to any limitations on its ability to pay dividends except those generally applicable to corporations that are incorporated in Delaware, such as NMIH. Delaware corporation law provides that dividends are only payable out of a corporation's capital surplus or (subject to certain limitations) recent net profits. As of December 31, 2014, NMIH's capital surplus was approximately $427 million. NMIH's assets, excluding investment in NMIC and Re One, were approximately $179 million at December 31, 2014, and were unencumbered by any debt or other subsidiary commitments or obligations. The insurance subsidiaries are both mono-line mortgage insurance companies, and the assets of each are dedicated only to the support of direct risk and obligations of each mortgage insurance entity. NMIC only writes direct mortgage insurance business and assumes no business from any other entity. Re One only assumes business from NMIC to allow NMIC to comply with statutory risk requirements. Neither NMIC nor Re One have subsidiaries, and therefore do not have subsidiary risks and obligations that compete for its resources.