(5)Combined risk-to-capital ratio equals the sum of net risk in force of Essent Guaranty, Inc. and Essent Guaranty of PA, Inc. divided by combined statutory capital.
(6)Net risk in force represents total risk in force, net of reinsurance ceded and net of exposures on policies for which loss reserves have been established.
We are an established and growing private mortgage insurance company. Essent Guaranty, Inc., our wholly-owned insurance subsidiary which we refer to as "Essent Guaranty," is licensed to write coverage in all 50 states and the District of Columbia. The financial strength ratings of Essent Guaranty are A3 with a stable outlook by Moody's Investors Service ("Moody's"), BBB+ with a negative outlook by S&P Global Ratings ("S&P") and A (Excellent) with a stable outlook by A.M. Best.
We also offer mortgage-related insurance and reinsurance through our wholly-owned Bermuda-based subsidiary, Essent Reinsurance Ltd., which we refer to as "Essent Re." As of December 31, 2020, Essent Re provided insurance or reinsurance relating to GSE risk share and other reinsurance transactions covering approximately $1.4 billion of risk. Essent Re also reinsures 25% of Essent Guaranty's NIW under a quota share reinsurance agreement. The financial strength ratings of Essent Re are BBB+ with a negative outlook by S&P and A (Excellent) with a stable outlook by A.M. Best.
In response to the impact of COVID-19, the federal government has implemented unprecedented measures to assist borrowers in avoiding foreclosures and allow families to remain in their homes. Most notably, under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"), consumers with federally backed mortgages were granted two financial protections: (1) a temporary moratorium on foreclosures, and (2) mortgage forbearance, either in the form of a lower monthly payment or temporarily suspending payments. Under the new law, borrowers have the right to request forbearance for up to 360 days due to hardship caused by COVID-19. We believe that these measures will likely increase the overall duration of the default resolution process and reduce the number of defaults that result in claims compared to our historical default-to-claim experience. However, the increase in the default resolution process may result in increases in claim severities for loans that proceed to claim.
Over 90% of loans insured by Essent are federally backed by Fannie Mae or Freddie Mac. As a mortgage loan in forbearance is considered delinquent, we will provide loss reserves as loans in forbearance are reported to us as delinquent once the borrower has missed two consecutive payments. However, we believe providing borrowers time to recover from the adverse
It is likely that Federal legislation will be necessary to resolve the conservatorship of the GSEs, and such legislation could materially affect the role and charter of the GSEs and the operation of the housing finance system. In 2011, the U.S. Department of the Treasury recommended options for winding down the GSEs and using a combination of Federal housing policy changes to contract the government's footprint in housing finance and restore a larger role for private capital. Since 2011, members of Congress have introduced several bills intended to reform the secondary market and the role of the GSEs, although no comprehensive housing finance or GSE reform legislation has been enacted to date.
Any changes to the charters or statutory authorities of the GSEs would require Congressional action to implement. Congress, however, has not enacted any legislation to date. See "Business-Regulation-Federal Mortgage-Related Laws and Regulations-Housing Finance Reform," "Risk Factors-Risks Relating to Regulation and Litigation-Legislative or regulatory actions or decisions to change the role of the GSEs in the U.S. housing market generally, or changes to the charters of the GSEs with regard to the use of credit enhancements generally and private mortgage insurance specifically, could reduce our revenues or adversely affect our profitability and returns," and "-Changes in the business practices of the GSEs, including actions or decisions to decrease or discontinue the use of mortgage insurance or changes in the GSEs' eligibility requirements for mortgage insurers, could reduce our revenues or adversely affect our profitability and returns."
Effective December 31, 2015, Fannie Mae and Freddie Mac, at the direction of the FHFA, implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. A revised PMIERs framework, which we refer to as "PMIERs 2.0," became effective on March 31, 2019. As of December 31, 2020, Essent Guaranty, our GSE-approved mortgage insurance company, was in compliance with PMIERs 2.0.
Under the Dodd-Frank Act, the Consumer Financial Protection Bureau ("CFPB") is authorized to issue regulations governing a loan originator's determination that, at the time a loan is originated, the consumer has a reasonable ability to repay the loan. The Dodd-Frank Act provides a statutory presumption that a borrower will have the ability to repay a loan if the loan has characteristics satisfying the QM definition. Under the CFPB's final rule regarding QMs, which we refer to as the "QM Rule," a loan is deemed to be a QM if it has certain loan features, satisfies extensive documentation requirements and meets limitations on fees and points and APRs.
The Dodd-Frank Act provides for an originator or issuer risk retention requirement on securitized mortgage loans that do not meet the definition of a QRM. The QRM regulations align the definition of a QRM loan with that of a QM loan. If, however, the QRM definition is changed (or the QM definition is amended) in a manner that is unfavorable to us, such as to give no consideration to mortgage insurance in computing LTV or to require a large down payment for a loan to qualify as a QRM, the attractiveness of originating and securitizing loans with lower down payments may be reduced, which may adversely affect the future demand for mortgage insurance. See "Business-Regulation-Federal Mortgage-Related Laws and Regulation-Dodd-Frank Act-Qualified Residential Mortgage Regulations-Risk Retention Requirements" and "Risk Factors-Risks Relating to Our Business-The amount of insurance we write could be adversely affected by the Dodd-Frank Act's risk retention requirements and the definition of Qualified Residential Mortgage ("QRM")."
We compete with the single-family mortgage insurance programs of the FHA, which is part of the Department of Housing and Urban Development. The most recent FHA report to Congress dated November 13, 2020 on the financial status of the FHA's Mutual Mortgage Insurance Fund, or MMIF, showed the capital reserve ratio of the MMIF at 6.10%, above the Congressionally mandated required minimum level of 2%. See "Risk Factors-Risks Relating to the Operation of Our Business
Premiums are paid either on a monthly installment basis ("monthly premiums"), in a single payment at origination ("single premiums"), or in some cases as an annual premium. For monthly premiums, we receive a monthly premium payment which is recorded as net premiums earned in the month the coverage is provided. Monthly premium payments are based on the original mortgage amount rather than the amortized loan balance. Net premiums written may be in excess of net premiums earned due to single premium policies. For single premiums, we receive a single premium payment at origination, which is recorded as "unearned premium" and earned over the estimated life of the policy, which ranges from 36 to 156 months depending on the term of the underlying mortgage and loan-to-value ratio at date of origination. If single premium policies are cancelled due to repayment of the underlying loan and the premium is non-refundable, the remaining unearned premium balance is immediately recognized as earned premium revenue. Substantially all of our single premium policies in force as of December 31, 2020 were non-refundable. Premiums collected on annual policies are recognized as net premiums earned on a straight-line basis over the year of coverage. For the years ended December 31, 2020 and 2019, monthly premium policies comprised 91% and 89% of our NIW, respectively.
The percentage of IIF that remains on our books after any 12-month period is defined as our persistency rate. Because our insurance premiums are earned over the life of a policy, higher persistency rates can have a significant impact on our profitability. The persistency rate on our portfolio was 60.1% at December 31, 2020. Generally, higher prepayment speeds lead to lower persistency.
Our investment portfolio was predominantly comprised of investment-grade fixed income securities and money market funds as of December 31, 2020. The principal factors that influence investment income are the size of the investment portfolio and the yield on individual securities. As measured by amortized cost (which excludes changes in fair market value, such as from changes in interest rates), the size of our investment portfolio is mainly a function of increases in capital and cash generated from or used in operations which is impacted by net premiums received, investment earnings, net claim payments and expenses. Realized gains and losses are a function of the difference between the amount received on the sale of a security and the security's amortized cost, as well as any provision for credit losses or impairments recognized in earnings. The amount received on the sale of fixed income securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale.
Other income includes revenues associated with contract underwriting services and underwriting consulting services to third-party reinsurers. The level of contract underwriting revenue is dependent upon the number of customers who have engaged us for this service and the number of loans underwritten for these customers. Revenue from underwriting consulting services to third-party reinsurers is dependent upon the number of customers who have engaged us for this service and the level of premiums associated with the transactions underwritten for these customers.
In connection with the acquisition of our mortgage insurance platform, we entered into a services agreement with Triad Guaranty Inc. and its wholly-owned subsidiary, Triad Guaranty Insurance Corporation, which we refer to collectively as "Triad," to provide certain information technology maintenance and development and customer support-related services. In return for these services, we receive a fee which is recorded in other income. Prior to December 1, 2019, this fee was adjusted monthly based on the number of Triad’s mortgage insurance policies in force and, accordingly, decreased over time as Triad’s existing policies were cancelled. Effective December 1, 2019, the services agreement was amended providing for a flat monthly fee through November 30, 2021. The services agreement provides for two subsequent one-year renewals at Triad's option.
•the overall state of the economy, which broadly affects the likelihood that borrowers may default on their loans and have the ability to cure such defaults;
•the product mix of IIF, with loans having higher risk characteristics generally resulting in higher defaults and claims;
•credit quality of borrowers, including higher debt-to-income ratios and lower FICO scores, which tend to increase incurred losses;
•the rate at which we rescind policies. Because of tighter underwriting standards generally in the mortgage lending industry and terms set forth in our master policy, we expect that our level of rescission activity will be lower than rescission activity seen in the mortgage insurance industry for vintages originated prior to the financial crisis; and
have trended towards those of the pre-pandemic periods and we have observed the normalization of other default patterns during this period. In addition, the economic conditions during the fourth quarter of 2020 have been different than those experienced in the second and third quarters of 2020. We believe that while defaults in October 2020 through December 2020 were impacted by the pandemic’s effect on the economy, the underlying credit performance of these defaults may not be the same as the expected performance for default notices received in April 2020 through September 2020 that occurred following the onset of the pandemic and these defaults are more likely to transition like pre-pandemic defaults. Accordingly, although these defaults are classified as COVID-19 defaults, we established reserves for defaults reported in October 2020 through December 2020 using our normal reserve methodology. It is reasonably possible that our estimate of the losses for the COVID-19 defaults could change in the near term as a result of the continued impact of the pandemic on the economic environment, the results of existing and future governmental programs designed to assist individuals and businesses impacted by the virus and the performance of the COVID-19 defaults in the forbearance programs. As more fully described in Note 5 to our consolidated financial statements, at December 31, 2020, we had approximately $2.0 billion of excess of loss reinsurance covering NIW from January 1, 2015 to July 31, 2020 and a quota share reinsurance transaction on a portion of our NIW effective September 1, 2019 through December 31, 2020. The impact on our reserves in future periods will be dependent upon the amount of delinquent notices received from loan servicers, the performance of COVID-19 defaults and our expectations for the amount of ultimate losses on these delinquencies.
Our average net premium rate is calculated by dividing net premiums earned for the U.S. mortgage insurance portfolio by average insurance in force for the period and is dependent on a number of factors, including: (1) the risk characteristics and average coverage on the mortgages we insure; (2) the mix of monthly premiums compared to single premiums in our portfolio; (3) cancellations of non-refundable single premiums during the period; (4) changes to our pricing for NIW; and (5) premiums ceded under third-party reinsurance agreements. For the years ended December 31, 2020, 2019 and 2018, our average net premium rate was 0.46%, 0.49% and 0.50%, respectively. We anticipate that the continued use of third-party reinsurance along with changes to the level of future cancellations of non-refundable single premium policies and mix of IIF will reduce our average net premium rate in future periods.
The risk-to-capital ratio has historically been used as a measure of capital adequacy in the U.S. mortgage insurance industry and is calculated as a ratio of net risk in force to statutory capital. Net risk in force represents total risk in force net of reinsurance ceded and net of exposures on policies for which loss reserves have been established. Statutory capital for our U.S. insurance companies is computed based on accounting practices prescribed or permitted by the Pennsylvania Insurance Department. See additional discussion in "-Liquidity and Capital Resources-Insurance Company Capital."
As of December 31, 2020, our combined net risk in force for our U.S. insurance companies was $29.5 billion and our combined statutory capital was $2.7 billion, resulting in a risk-to-capital ratio of 11.1 to 1. The amount of capital required varies in each jurisdiction in which we operate; however, generally, the maximum permitted risk-to-capital ratio is 25.0 to 1. State insurance regulators are currently examining their respective capital rules to determine whether, in light of the financial crisis, changes are needed to more accurately assess mortgage insurers' ability to withstand stressful economic conditions. As a result, the capital metrics under which they assess and measure capital adequacy may change in the future. Independent of the state regulator and GSE capital requirements, management continually assesses the risk of our insurance portfolio and current market and economic conditions to determine the appropriate levels of capital to support our business.
Net premiums earned increased in the year ended December 31, 2020 by 11% compared to the year ended December 31, 2019 due to the increase in our average IIF from $152.0 billion in 2019 to $178.3 billion in 2020, partially offset by the decrease in the average net premium rate from 0.49% for the year ended December 31, 2019 to 0.46% for the year ended
Net premiums written increased in the year ended December 31, 2020 by 10% over the prior year. The increase was due primarily to the increase in average IIF for the year ended December 31, 2020 as compared to the year ended December 31, 2019, partially offset by an increase in premiums ceded under third-party reinsurance agreements, a decrease in new single premium policies written, changes in the mix of mortgages we insure and changes in our pricing.
In the year ended December 31, 2020, unearned premiums decreased by $28.5 million as a result of net premiums written on single premium policies of $121.9 million which was offset by $150.4 million of unearned premium that was recognized in earnings during the year. In the year ended December 31, 2019, unearned premiums decreased by $16.6 million as a result of net premiums written on single premium policies of $93.5 million which was partially offset by $110.1 million of unearned premium that was recognized in earnings during the year.
The increase in the average case reserve per default was primarily due to provision and cure activity for COVID-19 defaults and changes in the composition (such as mark-to-market loan-to-value ratios, risk in force, and number of months past due) of the underlying loans in default. Based on the forbearance programs in place and the credit characteristics of the COVID-19 defaulted loans, we expect the ultimate number of COVID-19-related defaults that result in claims will be less than our historical default-to-claim experience. Accordingly, we recorded a reserve equal to approximately 7% of the risk in force for the COVID-19 default notices received in April 2020 through September 2020. As a result of cure activity on April 2020 through September 2020 COVID-19 defaults during the year ended December 31, 2020, the average reserve per COVID-19 default has increased from approximately 7% and 11% as of June 30, 2020 and September 30, 2020, respectively, to approximately 16% as of December 31, 2020. The credit characteristics of defaults reported in October 2020 through December 2020 have trended towards those of the pre-pandemic periods and we have observed the normalization of other default patterns during this period. In addition, the economic conditions during the fourth quarter of 2020 have been different than those experienced in the second and third quarters of 2020. We believe that while defaults in October 2020 through December 2020 were impacted by the pandemic’s effect on the economy, the underlying credit performance of these defaults may not be the same as the expected performance for default notices received in April 2020 through September 2020 that occurred following the onset of the pandemic and these defaults are more likely to transition like pre-pandemic defaults. Accordingly, we established reserves for defaults reported in October 2020 through December 2020 using our normal reserve methodology. The reserve for losses and LAE on COVID-19 defaults was $316.3 million at December 31, 2020.
The following table provides a reconciliation of the beginning and ending reserve balances for losses and LAE:
(2)The U.S. mortgage insurance portfolio reserves exclude reserves on GSE and other risk share risk in force at Essent Re of $179 as of December 31, 2019.
During the year ended December 31, 2020, the provision for losses and LAE was $301.3 million, comprised of $317.5 million of current year losses partially offset by $16.2 million of favorable prior years' loss development. During the year ended December 31, 2019, the provision for losses and LAE was $33.0 million, comprised of $50.6 million of current year losses partially offset by $17.6 million of favorable prior years' loss development. In both periods, the favorable prior years' loss development was the result of a re-estimation of amounts ultimately to be paid on prior year defaults in the default inventory, including the impact of previously identified defaults that cured.
Our subsidiaries in the United States file a consolidated U.S. Federal income tax return. Our income tax expense was $77.1 million for the year ended December 31, 2020 compared to $103.3 million for the year ended December 31, 2019. The effective tax rate for the year ended December 31, 2020 was 15.8% before reductions for excess tax benefits associated with the
vesting of common shares and common share units of $0.6 million. The effective tax rate for the year ended December 31, 2019, was 16.0% before reductions for excess tax benefits associated with the vesting of common shares and common share units of $2.2 million. The tax effects associated with the vesting of common shares and common share units are treated as discrete items in the reporting period in which they occur and are not considered in determining the annual effective tax rate.
Pursuant to the FAST Act Modernization and Simplification of Regulation S-K, discussions related to the changes in results of operations for the year ended December 31, 2019 compared to the year ended December 31, 2018 have been omitted. Such omitted discussion can be found under Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the Securities and Exchange Commission on February 18, 2020.
•inability to sell investment assets to provide cash to fund operating needs;
Our U.S. insurance subsidiaries are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate and the GSEs. Under the insurance laws of the Commonwealth of Pennsylvania, the insurance subsidiaries may pay dividends during any twelve-month period in an amount equal to the greater of (i) 10% of the preceding year-end statutory policyholders' surplus or (ii) the preceding year's statutory net income. The Pennsylvania statute also requires that dividends and other distributions be paid out of positive unassigned surplus without prior approval. At December 31, 2020, Essent Guaranty, had unassigned surplus of approximately $343.6 million. Essent Guaranty of PA, Inc. had unassigned surplus of approximately $15.4 million as of December 31, 2020. As a result of PMIERs guidance issued by the GSEs, through June 30, 2021, Essent Guaranty is required to obtain GSE written approval before paying a dividend. Essent Re is subject to certain dividend restrictions as prescribed by the Bermuda Monetary Authority and under certain agreements with counterparties. In connection with a quota share reinsurance agreement with Essent Guaranty, Essent Re has agreed to maintain a minimum total equity of $100 million. As of December 31, 2020, Essent Re had total equity of $1.1 billion. In connection with its insurance and reinsurance activities, Essent Re is required to maintain assets in trusts for the benefit of its contractual counterparties. See Note 3 to our consolidated financial statements. At December 31, 2020, our insurance subsidiaries were in compliance with these rules, regulations and agreements.
Cash flow provided by operating activities totaled $727.9 million for the year ended December 31, 2020, as compared to $589.8 million for the year ended December 31, 2019 and $625.3 million for the year ended December 31, 2018. The increase in cash flow from operations of $138.1 million in 2020 was primarily due to an increase in premiums collected and a decrease in United States Mortgage Guaranty Tax and Loss Bonds (“T&L Bonds”) purchased during 2020. The decrease in cash flow from operations of $35.5 million in 2019 was primarily due to an increase in T&L Bonds purchased and an increase in expenses paid, partially offset by increases in premiums collected and net investment income.
Cash flow used in investing activities totaled $1.2 billion for the year ended December 31, 2020 and primarily related to investing cash flows from the business, net proceeds of approximately $440 million from the completion of a public offering of common shares in June and net increased borrowings under the Credit Facility. Cash flow used in investing activities totaled $545.1 million for the year ended December 31, 2019 and $546.9 million for the year ended December 31, 2018 and primarily related to investing cash flows from the business in both periods.
Cash flow provided by financing activities totaled $458.0 million for the year ended December 31, 2020 and primarily related to $440 million of net proceeds from the completion of a public offering of common shares in June and net increased borrowings under the Credit Facility, partially offset by quarterly cash dividends paid in 2020 and treasury stock acquired from employees to satisfy tax withholding obligations. Cash flow used in financing activities totaled $38.4 million for the year ended December 31, 2019 and primarily related to our inaugural quarterly cash dividend paid in September 2019, quarterly cash dividend paid in December 2019 and treasury stock acquired from employees to satisfy tax withholding obligations. Cash flow used in financing activities totaled $57.0 million for the year ended December 31, 2018 and primarily related to treasury stock acquired from employees to satisfy tax withholding obligations and net repayments of borrowings under the Credit Facility.
During the years ended December 31, 2020 and 2019, no capital contributions were made to our U.S. insurance subsidiaries.
Essent Guaranty has entered into reinsurance agreements that provide excess of loss reinsurance coverage for new defaults on portfolios of mortgage insurance policies issued in 2015 through 2020. The aggregate excess of loss reinsurance coverages decrease over a ten-year period as the underlying covered mortgages amortize. Based on the level of delinquencies reported to us, the insurance-linked note transactions (the “ILNs”) that Essent Guaranty entered into prior to March 31, 2020 became subject to a "trigger event" as of June 25, 2020. The aggregate excess of loss reinsurance coverage will not amortize during the continuation of a trigger event. Effective September 1, 2019, Essent Guaranty entered into a quota share reinsurance agreement with a panel of third-party reinsurers (the "QSR Agreement"). Under the QSR Agreement, Essent Guaranty will cede premiums earned related to 40% of risk on eligible single premium policies and 20% of risk on all other eligible policies written September 1, 2019 through December 31, 2020, in exchange for reimbursement of ceded claims and claims expenses on covered policies, a 20% ceding commission, and a profit commission of up to 60% that varies directly and inversely with ceded claims. These reinsurance coverages also reduces net risk in force and PMIERs Minimum Required Assets. See Note 5 to our consolidated financial statements.
Our combined risk-to-capital calculation for our U.S. insurance subsidiaries as of December 31, 2020 was as follows:
As of December 31, 2020, stockholders’ equity was $3.9 billion compared to $3.0 billion as of December 31, 2019. This increase was primarily due to the completion of a public offering of common shares in June 2020, net income generated in 2020 and an increase in accumulated other comprehensive income related to an increase in our unrealized investment gains, partially offset by dividends paid in 2020.
As of December 31, 2020, investments totaled $4.7 billion compared to $3.4 billion as of December 31, 2019. In addition, our total cash was $102.8 million as of December 31, 2020, compared to $71.4 million as of December 31, 2019. The increase in investments was primarily due to investing net cash flows from operations, the net proceeds from the public offering
(1)Based on ratings issued by Moody's, if available. S&P or Fitch Ratings ("Fitch") rating utilized if Moody's not available.
(1)As of December 31, 2020, for the security in an unrealized loss position, management believes decline in fair value is principally associated with the changes in the interest rate environment subsequent to its purchase. Also, see Note 3 to our consolidated financial statements, which summarizes the aggregate amount of gross unrealized losses by asset class in which the fair value of investments available for sale has been less than cost for less than 12 months and for 12 months or more.
Essent Guaranty has entered into fully collateralized reinsurance agreements ("Radnor Re Transactions") with unaffiliated special purpose insurers domiciled in Bermuda. The Radnor Re special purpose insurers are special purpose variable interest entities that are not consolidated in our consolidated financial statements because we do not have the unilateral power to direct those activities that are significant to their economic performance. As of December 31, 2020, our estimated off-balance sheet maximum exposure to loss from the Radnor Re entities was $0.3 million, representing the estimated net present value of
Our fixed maturity and short-term investments are classified as available for sale and are reported at fair value. The related unrealized gains or losses are, after considering the related tax expense or benefit, recognized as a component of accumulated other comprehensive income (loss) in stockholders' equity. Realized investment gains and losses are reported in income based upon specific identification of securities sold. Each quarter we perform reviews of all of our investments in order to determine whether declines in fair value below amortized cost were considered other-than-temporary in accordance with applicable guidance. In evaluating whether a decline in fair value is other-than-temporary, we consider several factors including, but not limited to:
•credit ratings from third-party rating agencies and changes in these credit ratings below investment-grade;
•current credit spreads, downgrade trends, industry and asset sector trends, and issuer disclosures and financial reports to determine if credit ratings from third-party credit agencies are reasonable; and
A debt security is impaired if the fair value of the security is less than its amortized cost basis. Under the current guidance we determine whether the impairment has resulted from a credit loss or other factors. We determine whether a credit loss exists by considering information about the collectability of the instrument, current market conditions, and reasonable and supportable forecasts of economic conditions. We recognize an allowance for credit losses, up to the amount of the impairment when appropriate, and write down the amortized cost basis of the investment if it is more likely than not we will be required or we intend to sell the investment before recovery of its amortized cost basis. Under the previous other-than-temporary impairment model for available-for-sale debt securities .a debt security impairment was deemed other-than-temporary if we either intend to sell the security, or it was more likely than not that we would be required to sell the security before recovery or we did not expect to collect cash flows sufficient to recover the amortized cost basis of the security. During the years ended December 31, 2020, 2019 and 2018, the unrealized losses recorded in the investment portfolio principally resulted from fluctuations in market interest rates and credit spreads. Each issuer was current on its scheduled interest and principal payments. We recorded impairments of $0.4 million in the year ended December 31, 2020 and other-than-temporary impairments of $0.3 million in the year ended December 31, 2019 for securities in an unrealized loss position. The impairments resulted from our intent to sell these securities subsequent to the reporting date. There were no other-than-temporary impairments in the year ended December 31, 2018.
As described in Notes 2 and 6 to the consolidated financial statements, the Company's recorded reserve for losses and loss adjustment expenses of $374.9 million as of December 31, 2020 is based on management's best estimate of ultimate claim costs for defaulted loans. Upon notification that a borrower has defaulted, management considers internal and third-party information and models to determine the likelihood that a default will reach claim status and projects the amount that the Company will pay if a default becomes a claim. Management's estimates of claim rates and claim sizes will be influenced by prevailing economic conditions, such as the overall state of the economy, current rates or trends in unemployment, changes in housing values and/or interest rates, and management's best judgments as to the future values or trends of these macroeconomic factors. Losses incurred are also generally affected by the characteristics of the Company's insured loans, such as the loan amount, loan-to-value ratio, the percentage of coverage on the insured loan and the credit quality of the borrower.
The primary mortgage insurance operations are conducted through Essent Guaranty, Inc. ("Essent Guaranty"), which is domiciled in the state of Pennsylvania. Essent Guaranty is headquartered in Radnor, Pennsylvania and maintains operations centers in Winston-Salem, North Carolina and Irvine, California. Essent Guaranty is approved as a qualified mortgage insurer by the GSEs and is licensed to write mortgage insurance in all 50 states and the District of Columbia.
We defer certain personnel costs and premium tax expense directly related to the successful acquisition of new insurance policies and amortize these costs over the period the related estimated gross profits are recognized in order to match costs and revenues. We do not defer any underwriting costs associated with our contract underwriting services. Costs related to the acquisition of mortgage insurance business are initially deferred and reported as deferred policy acquisition costs. Consistent with industry accounting practice, amortization of these costs for each underwriting year book of business is recognized in
We measure the cost of employee services received in exchange for awards of equity instruments at the grant date of the award using a fair value based method. Prior to our initial public offering, we estimated the fair value of each nonvested share grant on the date of grant based on management's best estimate using methods further described in Note 10 of our consolidated financial statements. Subsequent to our initial public offering, fair value is determined on the date of grant based on quoted market prices. We recognize compensation expense on nonvested shares over the vesting period of the award. Excess tax benefits and tax deficiencies associated with share-based payments are recognized as income tax expense or benefit in the income statement and treated as discrete items in the reporting period.
It is our policy to classify interest and penalties as income tax expense and to use the aggregate portfolio approach to release income tax effects from accumulated other comprehensive income.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this update modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The provisions of this update were effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted for the removed disclosures. We adopted this standard on January 1, 2020. The adoption of this ASU did not have a material impact on our condensed consolidated financial statements.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this update provide temporary optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. It provides optional expedients and exceptions for applying generally accepted accounting principles to contract, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. This standard may be elected and applied prospectively over time from March 12, 2020 through December 31, 2022 as reference rate reform activities occur. The adoption of, and future elections under, this ASU are not expected to have a material impact on our consolidated financial statements as the ASU will ease, if warranted, the requirements for accounting for the future effects of the rate reform. We continue to monitor the impact the discontinuance of LIBOR or another reference rate will have on our contracts and other transactions.
5). The fair value of the assets on deposit was $8.5 million at December 31, 2020 and $6.4 million at December 31, 2019. Essent Guaranty is also required to maintain assets on deposit for the benefit of the sponsor of a fixed income investment commitment. The fair value of the assets on deposit was $12.0 million at December 31, 2020 and $6.4 million at December 31, 2019.
(1)If the reinsurance agreement is not terminated at the optional termination date, the risk margin component of the reinsurance premium increases by 50%.
(2)If the reinsurance agreement is not terminated at the optional termination date, the reinsurance premium increases by 50%.
The following table summarizes Essent Guaranty's excess of loss reinsurance coverages and retentions as of December 31, 2020:
(4)Reinsurance coverage on new insurance written from September 1, 2019 through July 31, 2020.
(6)Coverage provided pari-passu to the coverage provided by Radnor Re 2019-1 Ltd.
(7)Coverage provided pari-passu to the coverage provided by Radnor Re 2020-1 Ltd.
Based on the level of delinquencies reported to us, the ILN transactions entered into prior to March 31, 2020 became subject to a "trigger event" as of June 25, 2020. The amortization of principal of the notes issued by the unaffiliated special purpose insurers in connection with those ILN transactions is suspended and the aggregate excess of loss reinsurance coverage will not amortize during the continuation of a trigger event.
The amount of monthly reinsurance premiums ceded to the Radnor Re entities will fluctuate due to changes in one-month LIBOR and changes in money market rates that affect investment income collected on the assets in the reinsurance trusts. As the reinsurance premium will vary based on changes in these rates, we concluded that the Radnor Re Transactions contain embedded derivatives that will be accounted for separately like freestanding derivatives.
In connection with the Radnor Re Transactions, we concluded that the risk transfer requirements for reinsurance accounting were met as each Radnor Re entity is assuming significant insurance risk and a reasonable possibility of a significant loss. In addition, we assessed whether each Radnor Re entity was a variable interest entity ("VIE") and the appropriate accounting for the Radnor Re entities if they were VIEs. A VIE is a legal entity that does not have sufficient equity at risk to finance its activities without additional subordinated financial support or is structured such that equity investors lack the ability to make significant decisions relating to the entity’s operations through voting rights or do not substantively
participate in the gains and losses of the entity. A VIE is consolidated by its primary beneficiary. The primary beneficiary is the entity that has both (1) the power to direct the activities of the VIE that most significantly affect the entity’s economic performance and (2) the obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. While also considering these factors, the consolidation conclusion depends on the breadth of the decision-making ability and ability to influence activities that significantly affect the economic performance of the VIE. We concluded that the Radnor Re entities are VIEs. However, given that Essent Guaranty (1) does not have the unilateral power to direct the activities that most significantly affect their economic performance and (2) does not have the obligation to absorb losses or the right to receive benefits that could be potentially significant to these entities, the Radnor Re entities are not consolidated in these financial statements.
For the year ended December 31, 2020, $13.7 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There has been a $16.2 million favorable prior year development during the year ended December 31, 2020. Reserves remaining as of December 31, 2020 for prior years are $39.4 million as a result of re-estimation of unpaid losses and loss adjustment expenses. For the year ended December 31, 2019, $11.9 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There was a $17.6 million favorable prior year development during the year ended December 31, 2019. Reserves remaining as of December 31, 2019 for prior years were $20.0 million as a result of re-estimation of unpaid losses and loss adjustment expenses. In both periods, the favorable prior years' loss development was the result of a re-estimation of amounts ultimately to be paid on prior year defaults in the default inventory, including the impact of previously identified defaults that cured. Original estimates are increased or decreased as additional information becomes known regarding individual claims.
The following table summarizes incurred loss and allocated loss adjustment expense development, IBNR plus expected development on reported defaults and the cumulative number of reported defaults. The information about incurred loss development for the years ended December 31, 2011 to 2019 is presented as supplementary information.
The following table provides a reconciliation of the net incurred losses and paid claims development tables above to the reserve for losses and LAE at December 31, 2020:
On October 14, 2020, Essent Group and its subsidiaries, Essent Irish Intermediate Holdings Limited and Essent US Holdings, Inc. (collectively, the "Borrowers"), entered into a second amended and restated, three-year secured credit facility with a committed capacity of $625 million (the “Credit Facility”). The Credit Facility amends and restates the three-year, secured revolving credit facility entered into on May 2, 2018, and provides for an increase in the revolving credit facility from $275 million to $300 million. At closing, $325 million of new term loans were issued, with $225 million of the proceeds used to repay the existing term loans outstanding and remaining $100 million along with Essent Group cash were used to pay down all amounts outstanding under the revolving component of the Credit Facility. The Credit Facility also provides an option to increase the capacity to $775 million. Borrowings under the Credit Facility may be used for working capital and general corporate purposes, including, without limitation, capital contributions to Essent’s insurance and reinsurance subsidiaries. Borrowings accrue interest at a floating rate tied to a standard short-term borrowing index, selected at the Company’s option, plus an applicable margin. A commitment fee is due quarterly on the average daily amount of the undrawn revolving commitment. The applicable margin and the commitment fee are based on the senior unsecured debt rating or long-term issuer rating of Essent Group to the extent available, or the insurer financial strength rating of Essent Guaranty. The annual commitment fee rate at December 31, 2020 was 0.35%. The obligations under the Credit Facility are secured by certain assets of the Borrowers, excluding the stock and assets of its insurance and reinsurance subsidiaries. The Credit Facility contains several covenants, including financial covenants relating to minimum net worth, capital and liquidity levels, maximum debt to capitalization level and Essent Guaranty's compliance with the PMIERs (see Note 16). The borrowings under the Credit Facility contractually mature on October 16, 2023. As of December 31, 2020, the Company was in compliance with the covenants and $325 million had been borrowed under the Credit Facility with a weighted average interest rate of 2.19%. As of December 31, 2019, $225 million had been borrowed with a weighted average interest rate of 3.51%.
Under the terms of CUW Solutions' contract underwriting agreements with lenders and subject to contractual limitations on liability, we agree to indemnify certain lenders against losses incurred in the event that we make an error in determining whether loans processed meet specified underwriting criteria, to the extent that such error materially restricts or impairs the salability of such loan, results in a material reduction in the value of such loan or results in the lender repurchasing the loan. The indemnification may be in the form of monetary or other remedies. For each of the years ended December 31, 2020 and 2019, we paid less than $0.1 million related to remedies. As of December 31, 2020, management believes any potential claims for indemnification related to contract underwriting services through December 31, 2020 are not material to our consolidated financial position or results of operations.
We lease office space for use in our operations under leases accounted for as operating leases. These leases generally include options to extend them for periods of up to ten years. Our option to extend the term of our primary office locations at the greater of existing or prevailing market rates was not recognized in our right-of-use asset and lease liability. When establishing the value of our right-of-use asset and lease liability, we determine the discount rate for the underlying leases using the prevailing market interest rate for a borrowing of the same duration of the lease plus the risk premium inherent in the borrowings under our Credit Facility. Operating lease right-of-use assets of $8.7 million and $10.0 million as of December 31, 2020 and 2019, respectively, are reported on our consolidated balance sheet as property and equipment. Operating lease liabilities of $10.9 million and $12.6 million as of December 31, 2020 and 2019, respectively, are reported on our consolidated balance sheet as other accrued liabilities. Total rent expense was $2.4 million, $2.5 million and $2.1 million for the years ended December 31, 2020, 2019 and 2018, respectively.
The following table presents lease cost and other lease information as of and for the years ended December 31:
The following table presents a maturity analysis of our lease liabilities as follows at December 31, 2020:
The maturity analysis of our lease liabilities shown above have not been reduced by minimum sublease rental income of $0.1 million due in 2021 under the non-cancelable sublease.
In February 2021, the Board of Directors declared a quarterly cash dividend of $0.16 per common share payable on March 19, 2021, to shareholders of record on March 10, 2021.
In 2013, Essent Group's Board of Directors adopted, and Essent Group's shareholders approved, the Essent Group Ltd. 2013 Long-Term Incentive Plan (the "2013 Plan"), which was effective upon completion of the initial public offering. The types of awards available under the 2013 Plan include nonvested shares, nonvested share units, non-qualified share options, incentive stock options, share appreciation rights, and other share-based or cash-based awards. Nonvested shares and nonvested share units granted under the 2013 Plan have rights to dividends, which entitle the holders to the same dividend value per share as holders of common shares in the form of dividend equivalent units ("DEUs"). DEUs are subject to the same vesting and other terms and conditions as the corresponding nonvested shares and nonvested share units. DEUs vest when the underlying shares or share units vest and are forfeited if the underlying share or share units forfeit prior to vesting. The maximum number of shares and share units available for issuance is 7.5 million under the 2013 Plan. As of December 31, 2020, there were 3.7 million common shares available for future grant under the 2013 Plan.
In May of each year, 2017 through 2020, time-based share units were granted to non-employee directors that vest one year from the date of grant.
Quoted market prices are used for the valuation of common shares granted subsequent to our initial public offering. For nonvested common shares granted in September 2013, prior to our IPO, the valuation estimate was based on analysis provided by the underwriters regarding the estimated fair value of Essent and the estimated IPO price range. Factors considered in determining the IPO price range and common share valuation included prevailing market conditions, estimates of the Company's business potential and earnings prospects, the Company's historical operating results, market valuations of companies deemed comparable to the Company and an assessment of risks and opportunities.
In connection with our incentive program covering bonus awards for performance year 2020, in February 2021, 86,058 nonvested common share units were issued to certain employees and are subject to time-based vesting. In February 2021, 373,552 nonvested common shares were granted to certain members of senior management and are subject to time-based and performance-based vesting. In February 2021, the performance-based share awards granted in 2019 and 2020 to certain members of senior management were amended to provide that such awards will no longer be subject to the achievement of the compounded annual book value per share growth metrics and will be subject to only service-based vesting. As a result, the unvested shares subject to the amended 2019 and 2020 awards will vest on March 1, 2022 and March 1, 2023, respectively, subject to the continued service requirements and other terms and conditions set forth in the applicable award agreements, without taking into consideration any performance metrics. Compensation expense related to amending these awards will be recognized over the remaining vesting period.
Employees have the option to tender shares to Essent Group to pay the minimum employee statutory withholding taxes associated with shares upon vesting. Common shares tendered by employees to pay employee withholding taxes totaled 141,801, 208,947 and 718,726 in 2020, 2019 and 2018, respectively. The tendered shares were recorded at cost and included in treasury stock. All treasury stock has been cancelled as of December 31, 2020 and 2019.
Essent Re is subject to certain dividend restrictions as prescribed by the Bermuda Monetary Authority and under certain agreements with counterparties. In connection with the quota share reinsurance agreement with Essent Guaranty, Essent Re has agreed to maintain a minimum total equity of $100 million. As of December 31, 2020, Essent Re had total equity of $1.1 billion.
For the year ended December 31, 2020, the statutory income tax rates of the countries where the Company does business are 21% in the United States and 0.0% in Bermuda. The statutory income tax rate of each country is applied against the taxable income from each country to calculate the income tax expense.
For the year ended December 31, 2020, pre-tax income attributable to Bermuda and U.S. operations was $129.3 million and $360.8 million, respectively, as compared to $162.8 million and $496.3 million, respectively, for the year ended December 31, 2019 and $128.5 million and $418.2 million, respectively, for the year ended December 31, 2018.
As a mortgage guaranty insurer, we are eligible for a tax deduction, subject to certain limitations, under Section 832(e) of the Internal Revenue Code ("IRC") for amounts required by state law or regulation to be set aside in statutory contingency reserves. The deduction is allowed only to the extent that we purchase T&L Bonds in an amount equal to the tax benefit derived from deducting any portion of our statutory contingency reserves. During the year ended December 31, 2020, we had net purchases of T&L Bonds in the amount of $40.8 million and had net purchases of T&L Bonds in the amount of $59.5 million during the year ended December 31, 2019. As of December 31, 2020 and 2019, we held $302.6 million and $261.9 million of T&L Bonds, respectively.
At December 31, 2020 and 2019, the Company had no unrecognized tax benefits. As of December 31, 2020, the U.S. federal income tax returns for the tax years 2017 through 2019 remain subject to examination. The Company has not recorded any uncertain tax positions as of December 31, 2020 or December 31, 2019.
The nonvested performance-based share awards are considered contingently issuable for purposes of the EPS calculation. Based on the compounded annual book value per share growth as of December 31, 2020, the following percentages of the performance-based share awards would be issuable under the terms of the arrangements if December 31, 2020 was the end of the contingency period:
•Level 3-Valuations derived from one or more significant inputs that are unobservable.
available for sale include investments such as U.S. Treasury securities and money market funds. Investments available for sale are classified as Level 2 of the fair value hierarchy if quoted market prices are not available and fair values are estimated using quoted prices of similar securities or recently executed transactions for the securities. U.S. agency securities, U.S. agency mortgage-backed securities, municipal debt securities, non-U.S. government securities, corporate debt securities, residential and commercial mortgage securities and asset-backed securities are classified as Level 2 investments.
(1)Does not include the fair value of embedded derivatives, which we have accounted for separately as freestanding derivatives and included in other assets or other accrued liabilities in our consolidated balance sheet. See Note 5 for more information.
Net income determined in accordance with statutory accounting practices differs from GAAP. In 2020 and 2019, the more significant differences between net income determined under statutory accounting practices and GAAP for Essent Guaranty and Essent PA relate to policy acquisition costs and income taxes. Under statutory accounting practices, policy acquisition costs are expensed as incurred while such costs are capitalized and amortized to expense over the life of the policy under GAAP. As discussed in Note 12, we are eligible for a tax deduction, subject to certain limitations for amounts required by state law or regulation to be set aside in statutory contingency reserves when we purchase T&L Bonds. Under statutory accounting practices, this deduction reduces the tax provision recorded by Essent Guaranty and Essent PA and, as a result, increases statutory net income and surplus as compared to net income and equity determined in accordance with GAAP.
Effective December 31, 2015, Fannie Mae and Freddie Mac, at the direction of the Federal Housing Finance Agency, implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. In 2018, the GSEs released revised PMIERs framework ("PMIERs 2.0") which became effective on March 31, 2019. As of December 31, 2020, Essent Guaranty, our GSE-approved mortgage insurance company, was in compliance with PMIERs 2.0.
Statement of Statutory Accounting Principles No. 58, Mortgage Guaranty Insurance, requires mortgage insurers to establish a special contingency reserve for statutory accounting purposes included in total liabilities equal to 50% of earned premium for that year. During 2020, Essent Guaranty increased its contingency reserve by $302.5 million and Essent PA increased its contingency reserve by $3.1 million. This reserve is required to be maintained for a period of 120 months to protect against the effects of adverse economic cycles. After 120 months, the reserve is released to unassigned funds. In the event an insurer’s loss ratio in any calendar year exceeds 35%, however, the insurer may, after regulatory approval, release from its contingency reserves an amount equal to the excess portion of such losses. During the year ended December 31, 2020, Essent Guaranty and Essent PA released contingency reserves of $0.1 million and less than $0.1 million, respectively, to unassigned funds upon completion of the 120 month holding period. Essent Guaranty and Essent PA did not release any amounts from their contingency reserves in 2019 or 2018.
Under The Insurance Act 1978, as amended, and related regulations of Bermuda (the "Insurance Act"), Essent Re is required to annually prepare statutory financial statements and a statutory financial return in accordance with the financial reporting provisions of the Insurance Act, which is a basis other than GAAP. The Insurance Act also requires that Essent Re maintain minimum share capital of $1 million and must ensure that the value of its general business assets exceeds the amount of its general business liabilities by an amount greater than the prescribed minimum solvency margins and enhanced capital requirement pertaining to its general business. At December 31, 2020 and 2019, all such requirements were met.
Essent Re's statutory capital and surplus was $1.1 billion and $939.2 million as of December 31, 2020 and 2019, respectively, and statutory net income was $143.5 million and $176.4 million, respectively. Statutory capital and surplus and net income determined in accordance with statutory accounting practices were not significantly different than the amounts determined under GAAP.
Essent Guaranty has a capital maintenance agreement with Essent PA under which Essent Guaranty agreed to contribute funds, under specified conditions, to maintain Essent PA's risk-to-capital ratio at or below 25.0 to 1 in return for a surplus note. As of December 31, 2020, Essent PA's risk-to-capital ratio was 1.7:1 and there were no amounts outstanding related to this agreement.
The accompanying Parent Company financial statements should be read in conjunction with the consolidated financial statements and notes to consolidated financial statements. These financial statements have been prepared on the same basis and using the same accounting policies as described in the consolidated financial statements included herein, except that the Parent Company uses the equity method of accounting for its majority-owned subsidiaries.