At our corporate headquarters, located at 1500 Market Street, West Tower, in Philadelphia, Pennsylvania we currently lease approximately 174,000 square feet of office and storage space.
In connection with our mortgage insurance operations, we lease office space in: Worthington, Ohio; Dayton, Ohio; Plano, Texas; St. Louis, Missouri; and New York. In addition, we lease office space for our Services operations in various cities in California, Connecticut, Colorado, Florida, Maryland, Ohio, Pennsylvania, Texas and Utah.
We currently have two co-location agreements with TierPoint that support data center space and services at their Norristown, Pennsylvania and Philadelphia, Pennsylvania locations. These agreements expire in March 2020. TierPoint serves as a production and disaster recovery location.
We are a diversified mortgage and real estate services business with two business segments-Mortgage Insurance and Services. Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, as well as other credit risk management solutions, to mortgage lending institutions and mortgage credit investors. We provide our mortgage insurance products and services mainly through our wholly-owned subsidiary, Radian Guaranty. Our Services segment is primarily a fee-for-service business that offers a broad array of mortgage, real estate and title services to market participants across the mortgage and real estate value chain, as further detailed in “Results of Operations-Services.” These services, comprising mortgage services, real estate services and title services, are provided primarily through our subsidiaries, including Clayton, Green River Capital, Radian Settlement Services and Red Bell. In 2018, we also acquired the businesses of Entitle Direct and Independent Settlement Services, as well as the assets of Five Bridges, to enhance our Services offerings. Of the combined total of our net premiums earned and services revenue for the years ended December 31, 2018, 2017 and 2016, our Services segment provided 13%, 15% and 16%, respectively.
As a seller of mortgage credit protection and mortgage and other credit risk management solutions, as well as a provider of mortgage, real estate and title services, our results are subject to macroeconomic conditions and other events that impact the housing finance and real estate markets, including events that specifically impact the mortgage origination environment, the credit performance of our underlying insured assets and our future business opportunities.
Mortgage Market Credit Characteristics. Loans originated for the private mortgage insurance market since 2008 consist primarily of high credit quality loans with significantly better credit performance than the loans originated during 2008 and prior periods. Significant contributors to the improved loan quality include the greater risk discipline of loan originators and the private mortgage insurance providers, the Qualified Mortgage (QM) loan requirements under the Dodd Frank Act, including the GSE safe harbor, and the loan-level criteria of the PMIERs financial requirements.
PMIERs. In order to be eligible to insure loans purchased by the GSEs, mortgage insurers such as Radian Guaranty must meet the GSEs’ eligibility requirements, or PMIERs. Radian Guaranty currently is an approved mortgage insurer under the PMIERs and is in compliance with the PMIERs financial requirements. The GSEs have significant discretion under the PMIERs and may amend the PMIERs at any time. On September 27, 2018, the GSEs issued PMIERs 2.0, which will become effective on March 31, 2019. Based on Radian’s financial position at December 31, 2018, Radian expects to comply with PMIERs 2.0 and maintain a significant excess of Available Assets over Minimum Required Assets as of the effective date. See “Item 1. Business-Regulation-GSE Requirements,” “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs” and Note 1 of Notes to Consolidated Financial Statements for additional information.
Significant reduction in our annualized effective tax rate and future cash tax payments due to the reduction in the statutory federal tax rate from 35% to 21% (excluding the impact of Discrete Items), effective January 1, 2018;
See Notes 4 and 7 of Notes to Consolidated Financial Statements and “Item 1. Business-Services-Services Business Overview” for additional information regarding the Services segment.
The mortgage insurance industry is migrating away from a predominantly rate-card-based pricing model, to one where a variety of pricing methodologies are being deployed with differing degrees of risk-based granularity, which may also lead to an increase in the frequency of pricing changes. By the end of 2018 all private mortgage insurers, including Radian, were either piloting or had broadly launched a “Black Box” framework. Currently, these frameworks continue to leverage the same general risk attributes as mortgage insurance pricing historically, and incorporate more granular risk-based pricing factors. Radian’s proprietary “Black Box” framework, RADAR Rates, became broadly available to customers in January 2019. See “Item 1. Business-Mortgage Insurance-Mortgage Insurance Business Overview-Premium Rates” above and “-Radian’s Pricing,” below.
As market conditions change, alternatives to traditional mortgage insurance may be introduced that compete with private mortgage insurance. In 2018, Freddie Mac and Fannie Mae announced the launch of limited pilot programs, Integrated Mortgage Insurance (“IMAGIN”) and Enterprise-Paid Mortgage Insurance (“EPMI”), respectively, as alternative ways for lenders to sell loans with LTVs greater than 80% to the GSEs. These investor-paid mortgage insurance programs, in which insurance is acquired directly by each GSE, have many of the same features and represent an alternative to traditional private mortgage insurance products that are provided to individual lenders. Under the IMAGIN and EPMI programs, which are forward insurance arrangements (forward commitments to insure future loan originations), insurance is provided by a third party which, in turn, cedes the risk to a panel of reinsurers. The reinsurers participating in IMAGIN and EPMI are not subject to compliance with the PMIERs, which may create a competitive disadvantage for private mortgage insurers if these pilot programs are expanded.
Radian’s Pricing. As we continually evaluate our pricing based on many factors, we design our pricing strategies to grow the long-term economic value of our mortgage insurance portfolio and to align with our overall strategic objectives. During 2018, we made a number of pricing changes consistent with these objectives, including:
implementing rate reductions on our borrower-paid Single Premium Policies in order to shift our NIW toward more profitable borrower-paid Single Premium Policies;
Our borrower-paid Single Premium Policies provide us with an increased return on required capital compared to lender-paid Single Premium Policies. Under the Homeowners Protection Act, most borrower-paid Single Premium Policies must be cancelled once the mortgage’s scheduled LTV has declined to 78%. As a result of this automatic cancellation feature and other factors, over the life of the loans, the Minimum Required Assets under the PMIERs are lower than for lender-paid Single Premium Policies. In the nine months since we implemented our pricing strategy for borrower-paid Single Premium Policies, we successfully increased our NIW for borrower-paid Single Premium Policies from 5% of total NIW for the three-month period ended March 31, 2018 to 12% of total NIW for the three-month period ended December 31, 2018, and our NIW for lender-paid Single Premium Policies decreased from 16% to 5% for the same periods.
We target a blended return on required capital on new business on an unlevered basis (i.e., after-tax underwriting returns plus projected investment income) within the mid-teens range. This projected return incorporates the impact of our Single Premium QSR Program, as well as PMIERs 2.0, which will become effective on March 31, 2019, but does not include the impact of other factors, such as our Excess-of-Loss Program and leverage. See “-Operating Environment-PMIERs,” above. Our pricing actions are expected to gradually affect our results over time, as existing IIF cancels and is replaced with NIW at current pricing. As an example, assuming our current NIW levels, mix and persistency levels remain constant, we estimate that it would take approximately three years for approximately one-half of our IIF to reflect our current pricing structure. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF” for additional information.
Reinsurance. Radian’s reinsurance programs represent a component of our long-term risk distribution strategy. From time to time, we have entered into reinsurance transactions as part of our strategy to manage our capital position and risk profile, which includes managing Radian Guaranty’s capital position under the PMIERs financial requirements. We have recently expanded our risk distribution strategy in an effort to optimize the amounts and types of capital and risk distribution deployed against insured risk, including by accessing both the capital and the reinsurance markets to distribute risk. We expect the expansion of our risk distribution strategy to: (i) support our overall capital plans; (ii) lower our cost of capital; and (iii) reduce portfolio risk and financial volatility through economic cycles.
As part of our risk distribution strategy, in November 2018, Radian Guaranty entered into a fully collateralized reinsurance agreement with Eagle Re, an unaffiliated special purpose reinsurer domiciled in Bermuda. This reinsurance agreement provides for up to $434.0 million of aggregate excess-of-loss reinsurance coverage for the applicable percentage of mortgage insurance losses on new defaults on an existing portfolio of eligible Monthly Premium Policies issued between January 1, 2017 and January 1, 2018, with an initial RIF of $9.1 billion. Eagle Re financed its coverage by issuing mortgage insurance-linked notes. In addition, Radian Guaranty entered into a separate excess-of-loss reinsurance agreement for up to $21.4 million of coverage, representing a pro rata share of the credit risk alongside the risk assumed by Eagle Re on those Monthly Premium Policies. These two reinsurance agreements reduced net RIF and PMIERs Minimum Required Assets by a total of $455.4 million, thus reducing the capital required to be held at Radian Guaranty and supporting Radian Guaranty’s $450 million return of capital to Radian Group in December 2018. For additional information about our reinsurance see Note 8 in Notes to Consolidated Financial Statements and “Results of Operations-Mortgage Insurance-Net Premiums Written and Earned.” See “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs” for additional information on the PMIERs.
IRS Matter. Radian finalized a settlement with the IRS which resolved the issues and concluded all disputes related to the IRS Matter. During the second quarter of 2018, we recorded tax benefits of $73.6 million, which includes both the impact of the settlement with the IRS as well as the reversal of certain previously accrued state and local tax liabilities. In 2018, under the terms of the settlement, Radian utilized its “qualified deposits” with the U.S. Treasury to settle its $31 million obligation to the IRS, and in 2019, the Company expects the IRS to refund to Radian the remaining $58 million that was previously on
deposit. During the year ended December 31, 2018, the settlement and related tax benefits resulted in an increase to Radian’s net income per share of $0.34 and an increase in book value per share of $0.34. See Note 10 of Notes to Consolidated Financial Statements for additional information.
In November 2018, Radian acquired Independent Settlement Services. Independent Settlement Services is a technology-driven national appraisal and title management services company that provides real estate information and valuation solutions in all 50 states, as well as proprietary technology that provides lenders, appraisers, servicing firms, due diligence firms and appraisal-management companies with a fully-automated platform to manage the ordering and delivery of products and services.
Our pricing is risk-based and is intended to generally align with the capital requirements under the PMIERs, while considering pricing trends within the private mortgage insurance industry. As a result, our pricing is expected to generate relatively consistent returns across the credit spectrum and to provide relatively stable expected loss ratios regardless of further credit expansion or contraction. In developing our strategies, we monitor various competitive and economic factors while seeking to increase the long-term value of our portfolio by balancing both profitability and volume considerations in developing our pricing and origination strategies. We continued to generate strong NIW in 2018, and believe we remain well positioned to compete for the high-quality business being originated today, while at the same time maintaining projected returns on NIW within our targeted ranges.
Our pricing actions gradually affect our results over time, as existing IIF cancels and is replaced with NIW at current pricing. See “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs-Capital Support for Subsidiaries” and “Results of Operations-Mortgage Insurance-NIW, IIF, RIF” for additional information.
Premiums on our mortgage insurance products are generally paid either on a monthly installment basis (“Monthly Premiums”) or in a single payment (“Single Premiums”) at the time of loan origination. See “Item 1. Business-Mortgage Insurance-Mortgage Insurance Business Overview-Premium Rates-Primary Mortgage Insurance.” Our expected premium yield on our Single Premium Policies is lower than on our Monthly Premium Policies because our premium rates are generally lower for our Single Premium Policies. However, as discussed above, the ultimate profitability of Single Premium Policies may be higher or lower than expected due to prepayments. See “-IIF; Persistency Rate; Mix of Business.”
Other Operating Expenses. Our other operating expenses are affected by the amount of our NIW, as well as the amount of RIF. Our other operating expenses may also be affected by the impact of performance on our incentive
Third-Party Reinsurance. We use third-party reinsurance in our mortgage insurance business to manage capital and risk in an effort to optimize the amounts and types of capital and risk distribution deployed against insured risk. See “Overview-Other 2018 Developments-Reinsurance” and “-IIF; Persistency Rate; Mix of Business.” Currently Radian participates in quota share and excess-of-loss reinsurance programs. When we enter into a quota share reinsurance agreement, the reinsurer receives a premium and, in exchange, agrees to insure an agreed upon portion of incurred losses. These arrangements have the impact of reducing our earned premiums but also reduce our net RIF, which provides capital relief, including under the PMIERs financial requirements. Our incurred losses are reduced by any incurred losses ceded in accordance with the reinsurance agreement, and we often receive ceding commissions from the reinsurer as part of the transaction, which reduces our operating expenses and policy acquisition costs. Our Excess-of-Loss Program accesses both the capital and the reinsurance markets to distribute risk, and includes reinsurance through a variable interest entity funded by mortgage insurance-linked notes, as well as separate excess-of-loss reinsurance with a third-party reinsurer. Our Excess-of-Loss Program reduces our net RIF and our incurred losses are reduced by any incurred losses allocated in accordance with the structure of the transaction. While these arrangements have the impact of reducing our earned premiums, they also provide capital relief, including under the PMIERs financial requirements. See Note 8 of Notes to Consolidated Financial Statements for more information about our reinsurance arrangements.
Our Services segment offers a broad array of services to market participants across the mortgage and real estate value chain. These services comprise mortgage services, real estate services and title services, including technology and turn-key solutions, that provide information and other resources used to originate, evaluate, acquire, securitize, service and monitor residential real estate and loans secured by residential real estate. These services primarily are provided to mortgage lenders, financial institutions, investors and government entities. In addition, we provide title insurance to mortgage lenders as well as directly to borrowers.
Our mortgage services help loan originators and investors evaluate, acquire, surveil and securitize mortgages. These services include loan review, RMBS securitization and distressed asset reviews, review and valuation services related to single family rental properties, servicer and loan surveillance and underwriting. Our real estate services help lenders, investors and real estate agents evaluate, manage, monitor and sell properties. These real estate services include software as a service solutions and platforms, as well as managed services, such as REO asset management, real estate valuation services and real estate brokerage services. Our title services provide a comprehensive suite of title insurance products, title settlement services and both traditional and digital closing services. See “Item 1. Business-Services-Customers,” “Item 1. Business-Services-Services Business Overview,” and Note 1 of Notes to Consolidated Financial Statements for additional information regarding the Services segment.
In contrast to our Mortgage Insurance business, the Services segment is primarily a fee-for-service business without significant balance sheet risk. Key factors impacting results for our Services business include:
Services Revenue. Our Services segment is dependent upon overall activity in the mortgage, real estate and mortgage finance markets, as well as the overall health of the related industries. Due, in part, to the transactional nature of its business, revenues for our Services segment are subject to fluctuations from period to period, including seasonal fluctuations that reflect the activities in these markets. Sales volume is also affected by the number of competing companies and alternative products offered in the market. We believe the diversity of services we offer has the potential to produce fee income from the Services segment throughout various mortgage finance environments, although market conditions can significantly impact the mix and amount of fee income we generate in any particular period. In addition, see Note 2 of Notes to Consolidated Financial Statements for information on revenue recognition policies for our Services segment.
The Services segment is dependent on a limited number of large customers that represent a significant portion of its revenues. An unexpected loss of a major customer could significantly impact the level of Services revenue. Access to Radian Guaranty’s mortgage insurance customer base provides additional opportunities to expand the Services segment’s existing customers. Generally, our contracts do not contain volume commitments and may be terminated by clients at any time.
Revenue for the Services segment also includes inter-segment revenues from services performed for our Mortgage Insurance segment. See Note 4 of Notes to Consolidated Financial Statements for additional information.
Gross Profit on Services. In addition to the key factors affecting Services revenue and cost of services described above, our gross profit on services may fluctuate from period to period due to a shifting mix of services we provide resulting from changes in the relative demand for those services in the marketplace. Shifts in the business mix of our Services business can impact our gross profit because each product and service generally produces a different level of gross margin. These individual gross margins in turn can be impacted in any given period by factors such as the implementation of new regulatory requirements, our operating capacity, competition or other environmental factors.
Net Gains (Losses) on Investments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on such factors as market opportunities, our tax and capital profile and overall market cycles that impact the timing of the sales of securities. Unrealized investment gains and losses arise primarily from changes in the market value of our investments that are classified as trading securities or, effective with our implementation of the update to the standard for the accounting of financial
Tax Cuts and Jobs Act. The enactment of the TCJA resulted in a material reduction of our net deferred tax assets at December 31, 2017, because deferred tax assets and liabilities are measured using the enacted tax rates that are expected to apply to taxable income in the periods in which the deferred tax assets or liabilities are expected to be realized or settled. See Note 10 of Notes to Consolidated Financial Statements for additional information on the TCJA.
Future policy changes or interpretations could have a positive or negative impact on our financial performance depending on how the changes would influence the economy, including business and consumer sentiment and the key factors influencing our performance.
per share for 2018 as compared to 2017 was also impacted by the reduction in the company’s federal statutory tax rate from 35% to 21%, which was effective on January 1, 2018.
Book Value Per Share. The increase in book value per share, from $13.90 at December 31, 2017 to $16.34 at December 31, 2018, is primarily due to net income, partially offset by a decrease of $0.41 per share due to unrealized losses in our available for sale securities, recorded in accumulated other comprehensive income.
The increase in book value per share, from $13.39 at December 31, 2016 to $13.90 at December 31, 2017, is primarily due to our net income and an increase in unrealized gains in other comprehensive income, partially offset by the equity impact of the series of capital and liquidity actions completed in 2017, as discussed above.
Radian Group serves as the holding company for our operating subsidiaries and does not have any operations of its own. Our consolidated operating results for 2018 primarily reflect the financial results and performance of our two business segments-Mortgage Insurance and Services. See Note 4 of Notes to Consolidated Financial Statements for information regarding the basis of our segment reporting, including the related allocations. See “Results of Operations-Mortgage Insurance,” and “Results of Operations-Services” for the operating results of these business segments.
In addition to the results of our operating segments, pretax income (loss) is also affected by other factors. See “Key Factors Affecting Our Results-Other Factors Affecting Consolidated Results.” See “-Use of Non-GAAP Financial Measures” below for more information regarding items that are excluded from the operating results of our operating segments.
The following table highlights selected information related to our consolidated results of operations for the years ended December 31, 2018, 2017 and 2016:
(iv) an increase in other operating expenses; and (v) restructuring and other exit costs associated with our plan to restructure the Services business. These items were partially offset by, among other things: (i) a decrease in provision for losses; (ii) a decrease in loss on induced conversion and debt extinguishment; and (iii) lower interest expense.
Net Gains (Losses) on Investments and Other Financial Instruments. The increase in net losses on investments and other financial instruments for 2018, as compared to 2017, is primarily due to the increase in unrealized losses in our trading portfolio related to changes in fair value resulting from increased interest rates.
Restructuring and other exit costs. For 2018, we recognized $3.6 million of other exit costs associated with impairment of internal-use software. Restructuring and other exit costs for 2018 also include the remaining charges associated with our plan to restructure the Services business. See Note 1 of Notes to Consolidated Financial Statements for more information.
direction of the Services segment, which resulted in these charges, as well as charges for impairment of goodwill and other intangible assets.
Interest Expense. Interest expense for 2018 and 2017 decreased, as compared to 2016. This decrease was primarily due to reductions in interest expense from our: (i) August 2016 redemption of the remaining $195.5 million outstanding principal amount of our Senior Notes due 2017; (ii) January 2017 settlement of the remaining $68.0 million outstanding principal amount of our Convertible Senior Notes due 2019; and (iii) purchases during 2016 of $322.0 million aggregate principal amount of Convertible Senior Notes due 2019.
During 2017, pursuant to cash tender offers, we purchased aggregate principal amounts of $141.4 million, $115.9 million and $152.3 million of our Senior Notes due 2019, 2020 and 2021, respectively, resulting in a loss on induced conversion and debt extinguishment of $45.8 million. During 2017, we also purchased an aggregate principal amount of $21.6 million of our outstanding Convertible Senior Notes due 2017 and settled our obligations on the remaining Convertible Senior Notes due 2019, resulting in losses on debt extinguishment of $1.2 million and $4.5 million, respectively.
Amortization and Impairment of Other Acquired Intangible Assets and Impairment of Goodwill. In 2018, there was no impairment of goodwill or other acquired intangible assets.
Our 2016 effective tax rate was slightly higher than the federal statutory rate of 35%, primarily as a result of the non-deductible portion of the purchase premium relating to our Convertible Senior Notes due 2017 and 2019. The increase was partially offset by the income tax benefit resulting from our return-to-provision adjustment.
believe these measures aid in understanding the underlying performance of our operations. Our senior management, including our Chief Executive Officer (Radian’s chief operating decision maker), uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of the Company’s business segments and to allocate resources to the segments.
Net impairment losses recognized in earnings and losses from the sale of lines of business . The recognition of net impairment losses on investments and the impairment of other long-lived assets does not result in a cash payment and can vary significantly in both amount and frequency, depending on market credit cycles and other factors. Losses from the sale of lines of business are highly discretionary as a result of strategic restructuring decisions, and generally do not occur in the normal course of our business. We do not view these losses to be indicative of our fundamental operating activities. Therefore, whenever these losses occur, we exclude t
For 2018, includes $0.34 of tax benefit related to the settlement of the IRS Matter, which includes both the impact of the settlement with the IRS as well as the reversal of certain related previously accrued state and local tax liabilities. All of the 2017 amount represents additional tax expense related to the remeasurement of our net deferred tax assets as a result of the TCJA enacted in December 2017.
The difference in 2018 includes the tax benefit related to the settlement of the IRS Matter, which includes both the impact of the settlement with the IRS as well as the reversal of certain related previously accrued state and local tax liabilities. All of the 2017 amount represents additional tax expense related to the remeasurement of our net deferred tax assets as a result of the TCJA enacted in December 2017.
During 2018, we continued our strategy of growing our mortgage insurance portfolio by writing insurance on mortgages with high credit quality. At December 31, 2018, we had $221.4 billion in IIF compared to $200.7 billion in IIF at December 31, 2017. We also expanded our risk distribution strategy and continued to focus on effectively managing our capital and liquidity positions. See “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs-Capital Support for Subsidiaries” and Note 1 of Notes to Consolidated Financial Statements for additional information.
Our senior management uses adjusted pretax operating income as our primary measure to evaluate the fundamental financial performance of our business segments. See Note 4 of Notes to Consolidated Financial Statements for more information.
A key component of our current business strategy is to write profitable mortgage insurance on high credit quality mortgages in the U.S. Consistent with this objective, we wrote $56.5 billion of primary new mortgage insurance in 2018, compared to $53.9 billion of NIW in 2017. The NIW written on a Flow Basis in 2018 was Radian’s highest volume in its history. The combination of our NIW and a higher Persistency Rate resulted in an increase in IIF, from $200.7 billion at December 31, 2017 to $221.4 billion at December 31, 2018, as shown in the chart below.
Policy years represent the original policy years, and have not been adjusted to reflect subsequent HARP refinancing activity.
We believe total mortgage origination volume was lower for 2018, as compared to 2017, primarily due to a decrease in refinance mortgage originations resulting from the slightly higher interest rate environment, partially offset by a modest increase in purchase originations. Mortgage insurance penetration in the purchase origination market has gradually increased over the past few years, and because the penetration rate for mortgage insurance is generally three to five times higher on purchase originations than on refinancing transactions, we believe that even though the total mortgage origination volume was lower, the private mortgage insurance market was larger in 2018, compared to 2017.
Consistent with the market trends described above, during 2018 the level of our purchase origination volume increased and our refinance origination volume decreased (each as a percentage of our total NIW), as compared to 2017. As a percentage of our total NIW, the volume of our NIW on mortgage loans with LTVs greater than 95% also increased during 2018, compared to 2017. During 2018, in comparison to 2017, we also continued to experience an increased percentage of our total NIW on mortgage loans to borrowers with higher debt-to-income ratios, including debt-to-income ratios greater than 45%. See “Overview-Operating Environment” for additional information.
Notwithstanding this recent shift toward loans with higher LTVs and borrowers with higher debt-to-income ratios, the mortgage loans underlying our RIF originated after 2008 possess significantly improved credit characteristics compared to our portfolio originated prior to and including 2008. For example, FICO scores for the borrowers of our current portfolio of insured mortgages are higher, and notwithstanding the recent increase in loans with higher LTVs, there are fewer loans with LTVs greater than 95%. In addition, we have limited loans subject to layered risk that combines multiple higher-risk attributes within the same loan, specifically low FICO scores combined with other higher risk characteristics. For example, a de minimis amount of our primary RIF originated after 2008 relates to mortgages with (i) FICO scores less than 680 combined with cash-out refinancings or original LTVs greater than 95% or (ii) FICO scores less than or equal to 720 on an investment property or second home. The table below illustrates the composition of our direct primary mortgage insurance RIF at December 31, 2018 compared to selected prior years, based on FICO score and LTV.
Historical loan data indicates that credit scores and underwriting quality are key drivers of credit performance. As illustrated by the preceding chart, the FICO scores of our primary RIF has significantly improved in business written after 2008. As of December 31, 2018, our portfolio of business written subsequent to 2008, including HARP refinancings, represented approximately 94% of our total primary RIF. The high volume of insurance that we have written on high credit quality loans has led to an improved portfolio mix and, together with favorable credit trends, has had a significant positive impact on our results of operations. For additional information, see the tables that follow, including the table, “Total Primary RIF by Policy Year.”
Incurred losses in 2017 were slightly elevated due to the impact of Hurricanes Harvey and Irma. See “Overview- Operating Environment-Hurricanes” for additional information.
Radian’s stochastic modeling, used for pricing, indicates an approximate 20% through-the-cycle loss ratio on newly originated mortgage insurance business.
The following tables provide selected information as of and for the periods indicated related to mortgage insurance NIW, RIF and IIF. Policy years represent the original policy years, and have not been adjusted to reflect subsequent HARP refinancing activity. Throughout this report, unless otherwise noted, RIF is presented on a gross basis before consideration of the amount ceded under reinsurance. NIW, RIF and IIF for direct Single Premiums include policies written on an individual basis (as each loan is originated) and on an aggregated basis (in which each individual loan in a group of loans is insured in a single transaction, typically after the loans have been originated).
The Persistency Rate for the 12 months ended December 31, 2016 was less than in subsequent years, primarily due to increased refinancing activity and the cancellations of Single Premium Policies in 2016. See “-Net Premiums Written and Earned” below.
Net Premiums Written and Earned. Net premiums written and earned for 2018 increased compared to 2017, primarily due to an increase in our IIF related to an increase in our Monthly Premium Policies. This increase was partially offset by the increased cession percentage on the Single Premium QSR Program. Net premiums written in 2017 increased compared to 2016, primarily due to a decrease in ceded premiums written, combined with the increase in our IIF.
The amounts represent the profit commission on the Single Premium QSR Program, excluding impact of Single Premium Policy cancellations.
Includes premiums earned from our participation in certain Front-end and Back-end credit risk transfer programs.
The following table provides information related to the premium impact of our reinsurance transactions.
As expected, Radian Guaranty experienced an increase in reported delinquencies in FEMA Designated Areas associated with Hurricanes Harvey and Irma during the third and fourth quarters of 2017, followed by cure rates for these delinquencies
Although the number of incremental defaults associated with areas impacted by recent or future natural disasters may become somewhat elevated, consistent with our past experience, we do not expect these incremental defaults to result in a material increase in our incurred losses or paid claims, given the limitations on our coverage related to property damage. However, the future reserve impact of incremental defaults from these or other natural disasters may differ from our previous experience due to overall economic conditions, the pace of economic recovery in the affected areas or other factors. See Note 11 of Notes to Consolidated Financial Statements.
Decrease primarily due to pool commutations that took place during the year.
Includes those charged to a deductible or captive reinsurance transactions, as well as commutations.
Factors that impact the severity of a claim include, but are not limited to: (i) the size of the loan; (ii) the amount of mortgage insurance coverage placed on the loan; (iii) the amount of time between default and claim during which we are expected to cover interest (capped at two years under our Prior Master Policy and capped at three years under our 2014 Master Policy) and certain expenses; and (iv) the impact of certain loss management activities with respect to the loan. The average Claim Severity experienced for loans covered by our primary insurance was 104.9% for 2018, compared to 104.7% in 2017 and 104.1% in 2016.
We considered the sensitivity of our loss reserve estimates at December 31, 2018 by assessing the potential changes resulting from a parallel shift in Claim Severity and Default to Claim Rate for primary loans. For example, assuming all other factors remain constant, for every one percentage point absolute change in primary Claim Severity (which we estimated to be 96% of our risk exposure at December 31, 2018), we estimated that our total loss reserve at December 31, 2018 would change by approximately $4 million. Assuming the portfolio mix and all other factors remain constant, for every one percentage point absolute change in our primary net Default to Claim Rate, we estimated a $10 million change in our primary loss reserve at December 31, 2018.
In addition, as part of our claims review process, we assess whether defaulted loans were serviced appropriately in accordance with our insurance policies and servicing guidelines. To the extent a servicer has failed to satisfy its servicing obligations, our policies provide that we may curtail the claim payment for such default, and in some circumstances, cancel coverage or deny the claim. Before consideration of any subsequent challenges by our lender and servicer customers, Claim Curtailments due to servicer noncompliance with our insurance policies and servicing guidelines, which impact the severity of our claim payments, were $4.7 million for the year ended December 31, 2018, respectively, compared to $7.2 million for the same period in 2017.
Total mortgage insurance claims paid in 2018 of $215.9 million have decreased from claims paid of $390.4 million in 2017. The decrease in claims paid is consistent with the ongoing decline in the outstanding default inventory. In addition, claims paid for the year ended December 31, 2017 included the payment of $54.8 million made in connection with the scheduled final settlement of the Freddie Mac Agreement in the third quarter of 2017. Claims paid in both periods also include the impact of commutations. Although expected claims are included in our reserve for losses, the timing of claims paid is
subject to fluctuation from quarter to quarter, based on the rate that defaults cure and other factors (as described in “Item 1. Business-Mortgage Insurance-Defaults and Claims”) that make the timing of paid claims difficult to predict.
Net of recoveries collected on claims paid in prior years on second-lien mortgage loans.
commissions. These increases were partially offset by lower compensation expense in 2017, including variable incentive-based compensation.
Our expense ratio on a net premiums earned basis represents our Mortgage Insurance segment’s operating expenses (which include policy acquisition costs and other operating expenses, as well as allocated corporate operating expenses), expressed as a percentage of net premiums earned. Our expense ratio was 23.9% for 2018, compared to 24.7% for 2017 and 22.7% for 2016. The increase in net premiums earned during 2018 was the primary driver of the change in the expense ratios between these periods.
The following table summarizes our Services segment’s results of operations for the years ended December 31, 2018, 2017 and 2016:
Our Services segment offers a broad array of mortgage, real estate and title services to market participants across the mortgage and real estate value chain, primarily through our subsidiaries, including Clayton, Green River Capital, Radian Settlement Services and Red Bell. In 2018, we also acquired the businesses of EnTitle Direct (in March 2018) and Independent Settlement Services (in November 2018), as well as the assets of Five Bridges (in December 2018), to enhance our Services offerings. In connection with the restructuring of our Services business, we have refined our Services business strategy going forward to focus on our core mortgage, real estate and title services. These services provide mortgage lenders, financial institutions, mortgage and real estate investors and government entities, among others, with information and other resources that are used to originate, evaluate, acquire, securitize, service and monitor residential real estate and loans secured by residential real estate. Effective with our acquisition of EnTitle Direct in March 2018, we provide title insurance to mortgage lenders as well as directly to borrowers.
The services that we no longer offer as a result of restructuring our Services business have not had a material impact on our consolidated cash flows or results of operations in recent periods. There was no material impact on our consolidated cash flows or results of operations from discontinuing these services. See Notes 1 and 7 of Notes to Consolidated Financial Statements and “Item 1. Business-Services-Services Business Overview” for additional information regarding the Services segment.
Adjusted pretax operating income (loss). Our Services segment’s adjusted pretax operating loss for 2018 was $27.1 million, compared to an adjusted pretax operating loss of $33.8 million in 2017. The decrease in our adjusted pretax operating
Our Services segment’s adjusted pretax operating loss was $33.8 million in 2017 compared to an adjusted pretax operating loss of $20.2 million in 2016. The increase in our adjusted pretax operating loss in 2017, as compared to 2016, was primarily driven by: (i) restructuring and other exit costs and (ii) decreased gross profit, primarily attributable to a shift in mix of services.
Net premiums earned-insurance. Net premiums earned for 2018 increased compared to 2017, as a result of the March 2018 acquisition of EnTitle Direct and the inclusion of its operations.
Services Revenue. Services revenue decreased for 2018, as compared to 2017, primarily due to a decline in mortgage and title services transaction volumes related primarily to lower volume from a large contract, which was substantially completed during the first half of 2018, partially offset by an increase in real estate services. This decrease in services revenue is generally in line with our expectations following our announced restructuring of our Services segment in late 2017, through which we are repositioning the segment to drive future profitability by focusing on the core products and services that we believe have higher growth potential, produce more predictable and recurring fee-based revenues, and better align with our customer needs.
For the year ended December 31, 2018, the top 10 Services customers (which may include our affiliates) generated approximately 42% of the Services segment’s services revenue, as compared to 49% for 2017 and 52% for 2016. Approximately 2%, 4% and 5% of services revenue on a segment basis for the years ended December 31, 2018, 2017 and 2016, respectively, related to sales to our affiliates, and has been eliminated in our consolidated results. The largest single customer generated approximately 15% of the services revenue for the year ended December 31, 2018 as compared to 11% for the years ended December 31, 2017 and December 31, 2016.
Compensation-related costs for 2017 compared to 2016 decreased as a percentage of other operating expenses, primarily because of a reduction in force in 2016, combined with the restructuring actions taken in 2017.
Restructuring and other exit costs. Restructuring and other exit costs were incurred in 2018 and 2017 and include charges associated with our plan to restructure the Services business. The portion of these charges that are included in adjusted pretax operating income are primarily due to severance and related benefit costs. See Notes 1 and 7 of Notes to Consolidated Financial Statements for additional details.
We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. Other items, including payments under operating lease agreements, are not recorded in our consolidated balance sheets as liabilities but represent a contractual commitment to pay.
Includes $234.1 million and $197.7 million of Senior Notes due 2020 and 2021 that may be redeemed, in whole or in part at any time prior to maturity.
Represents contractual payments for operating leases, with the exception of $0.2 million included for capital lease payment obligations through 2020.
Our reserve for losses and LAE reflects the application of accounting policies described below in “Critical Accounting Policies-Reserve for Losses and LAE.” The payments due by period are based on management’s estimates and assume that all of the loss reserves included in the table will result in claim payments, net of expected recoveries.
Radian Group and Radian Mortgage Assurance are parties to a guaranty agreement, which provides that Radian Group will make sufficient funds available to Radian Mortgage Assurance to ensure that Radian Mortgage Assurance has a minimum of $5 million of statutory policyholders’ surplus every calendar quarter. Radian Mortgage Assurance had $8.7 million of statutory policyholders’ surplus and no RIF exposure as of December 31, 2018.
Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance on residential first-lien mortgage loans, as well as other credit risk management solutions, to mortgage lending institutions and mortgage credit investors. We provide our mortgage insurance products and services mainly through our wholly-owned subsidiary, Radian Guaranty. Private mortgage insurance plays an important role in the U.S. housing finance system because it promotes affordable home ownership and helps protect mortgage lenders, investors and other beneficiaries by mitigating default-related losses on residential mortgage loans. Generally, these loans are made to home buyers who make down payments of less than 20% of the purchase price for their home or, in the case of refinancings, have less than 20% equity in their home. Private mortgage insurance also facilitates the sale of these low down payment loans in the secondary mortgage market, most of which are currently sold to the GSEs. Our total direct primary mortgage insurance RIF was $56.7 billion as of December 31, 2018.
PMIERs. In order to be eligible to insure loans purchased by the GSEs, mortgage insurers such as Radian Guaranty must meet the GSEs’ eligibility requirements, or PMIERs. At December 31, 2018, Radian Guaranty is an approved mortgage insurer under the PMIERs and is in compliance with the PMIERs financial requirements. The PMIERs financial requirements require that a mortgage insurer’s Available Assets meet or exceed its Minimum Required Assets. The GSEs may amend the PMIERs at any time, and they have broad discretion to interpret the requirements, which could impact the calculation of Radian Guaranty’s Available Assets and/or Minimum Required Assets.
The PMIERs are comprehensive, covering virtually all aspects of the business and operations of a private mortgage insurer, including internal risk management and quality controls, the relationship between the GSEs and the approved insurer, as well as the approved insurer’s financial condition. In addition, the GSEs have a broad range of consent rights under the PMIERs and require private mortgage insurers to obtain the prior consent of the GSEs before taking certain actions, which may include entering into various intercompany agreements and commuting or reinsuring risk, among others. If Radian Guaranty is unable to satisfy the requirements set forth in the PMIERs, the GSEs could restrict it from conducting certain types of business with them or take actions that may include not purchasing loans insured by Radian Guaranty.
Our Services segment is primarily a fee-for-service business that offers a broad array of services to market participants across the mortgage and real estate value chain. These services comprise mortgage services, real estate services and title services, including technology and turn-key solutions, that provide information and other resources used to originate, evaluate, acquire, securitize, service and monitor residential real estate and loans secured by residential real estate. These services are primarily provided to mortgage lenders, financial institutions, investors and government entities. In addition, we provide title insurance to mortgage lenders as well as directly to borrowers.
Our mortgage services help loan originators and investors evaluate, acquire, surveil and securitize mortgages. These services include loan review, RMBS securitization and distressed asset reviews, review and valuation services related to single family rental properties, servicer and loan surveillance and underwriting. Our real estate services help lenders, investors and
real estate agents evaluate, manage, monitor and sell properties. These real estate services include software as a service solutions and platforms, as well as managed services, such as REO asset management, real estate valuation services and real estate brokerage services. Our title services provide a comprehensive suite of title insurance products, title settlement services and both traditional and digital closing services.
Reinsurance. As part of Radian’s long-term risk distribution strategy, in November 2018, Radian Guaranty entered into a fully collateralized reinsurance agreement with Eagle Re, an unaffiliated special purpose reinsurer domiciled in Bermuda. This reinsurance agreement provides for up to $434.0 million of aggregate excess-of-loss reinsurance coverage for the applicable percentage of mortgage insurance losses on new defaults on an existing portfolio of eligible Monthly Premium Policies issued between January 1, 2017 and January 1, 2018, with an initial RIF of $9.1 billion. In addition, Radian Guaranty entered into a separate excess-of-loss reinsurance agreement for up to $21.4 million of coverage, representing a pro rata share of the credit risk alongside the risk assumed by Eagle Re on those Monthly Premium Policies. See Note 8 for additional information.
We review assets for impairment in accordance with the accounting guidance for long-lived assets. As part of this assessment, during 2018, we incurred $3.6 million of other exit costs associated with impairment of internal-use software that was in addition to the asset impairment charges recognized as part of the restructuring charges associated with our Services business.
Commutations and other negotiated terminations of our insured risks in our Mortgage Insurance segment provide us with an opportunity to exit exposures for an agreed upon payment, or payments, sometimes at an amount less than the previously estimated ultimate liability. Once all exposures relating to such policies are extinguished, all reserves for losses and LAE and other balances relating to the insured policies are generally reversed, with any remaining net gain or loss recorded through provision for losses. We take into consideration the specific contractual and economic terms for each individual agreement when accounting for our commutations or other negotiated terminations, which may result in differences in the accounting for these transactions.
In our Mortgage Insurance business, the default and claim cycle begins with the receipt of a default notice from the loan servicer. Reserves for losses are established upon receipt of notification from servicers that a borrower has missed two monthly payments, which is when we consider a loan to be in default for financial statement and internal tracking purposes. We also establish reserves for associated LAE, consisting of the estimated cost of the claims administration process, including legal and other fees and expenses associated with administering the claims process.
Rate. Our Loss Mitigation Activities have resulted in challenges from certain lender and servicer customers, which have resulted in some reversals of our decisions regarding Rescissions, Claim Denials and Claim Curtailments in the ordinary course. Although we believe that our Loss Mitigation Activities are justified under our policies, certain challenges have resulted in disputes and litigation, which if resolved unfavorably to us, could require us to reassume the risk on, and increase loss reserves for, those policies or pay additional claims. See Note 11 for additional information. Our Master Policies specify the time period during which a suit or action arising from any right of the insured under the policy must be commenced. The assumptions embedded in our estimated Default to Claim Rate on our in-force default inventory include an adjustment to our estimated Rescissions and Claim Denials to account for the fact that we expect a certain number of policies to be reinstated and ultimately to be paid, as a result of valid challenges by such policy holders.
The impact to our reserve due to estimated future Loss Mitigation Activities incorporates our expectations regarding the number of policies that we expect to be reinstated as a result of our claims rebuttal process. Rescissions, Claim Denials and Claim Curtailments may occur for various reasons, including, without limitation, underwriting negligence, fraudulent applications and appraisals, breach of representations and warranties and inadequate documentation, primarily related to our insurance written in years prior to and including 2008. The level of Rescissions, Claim Denials and Claim Curtailments has been declining in recent periods as our defaults related to insurance written in years prior to and including 2008 continue to decline, and we expect this trend to continue.
Insurance enterprises are required to establish a PDR if the net present value of the expected future losses and expenses for a particular product line exceeds the net present value of expected future premiums and existing reserves for that product line. We reassess our expectations for premiums, losses and expenses for our mortgage insurance business at least quarterly and update our premium deficiency analyses accordingly. For our mortgage insurance business, we group our mortgage insurance products into two categories: first-lien and second-lien mortgage loans. As of December 31, 2018 and 2017, the combination of the net present value of our expected future premiums and existing reserves (net of reinsurance recoverables) significantly exceeded the net present value of our future expected losses and expenses associated with our first lien mortgage insurance portfolio. Our second-lien PDR is recorded as a component of other liabilities.
Available for sale securities, trading securities, equity securities and certain other assets are recorded at fair value as described in Note 5. All changes in fair value of trading securities, equity securities (effective January 1, 2018) and certain other assets are included in our consolidated statements of operations. Prior to the implementation of the update to the standard for the accounting of financial instruments effective January 1, 2018, the unrealized gains (losses) associated with equity securities were classified in accumulated other comprehensive income. All changes in the fair value of available for sale securities are recorded in accumulated other comprehensive income (loss).
Includes inter-segment revenues of $3.2 million, $6.7 million, and $8.4 million in 2018, 2017 and 2016, respectively. For 2018, amounts exclude $7.7 million of Services segment net premiums earned-insurance and net investment income, as both are excluded from the scope of the revenue recognition standard. See Note 4 for segment information.
Our Services segment revenues are recognized over time and measured each period based on the progress to date as services are performed and made available to customers. Our contracts with customers, including payment terms, are generally short-term in nature; therefore, any impact related to timing is immaterial. Revenue recognized related to services made available to customers and billed is reflected in accounts and notes receivable. Revenue recognized related to services performed and not yet billed is recorded in unbilled receivables and reflected in other assets. We have no material bad-debt expense. The following represents balances related to Services contracts as of the dates indicated:
Due to the nature of the services provided, our Services arrangements with customers may include any of the following three basic types of contracts:
Cost of services consists primarily of employee compensation and related payroll benefits, the cost of billable labor assigned to revenue-generating activities, as well as corresponding travel and related expenses incurred in providing such services to clients in our Services segment. Cost of services also includes costs paid to outside vendors, including real estate
Title insurance premiums are typically due and earned in full when the real estate transaction is closed. Premiums generally are calculated with reference to the policy amount. The premium charged by a title insurer or an agent is subject to regulation in most areas. Such regulations vary from state to state.
Our provision for income taxes for interim financial periods is based on an estimate of our annual effective tax rate for the full year of 2018 and 2017. When estimating our full year 2018 and 2017 effective tax rates, we adjust our forecasted pre-tax income for gains and losses on our investments, changes in the accounting for uncertainty in income taxes, changes in our beginning of year valuation allowance, and other adjustments. The impact of these items is accounted for as Discrete Items at the applicable federal tax rate.
On December 22, 2017, the TCJA was enacted into law. We were required to recognize the accounting effects of the TCJA in the period of enactment, including remeasuring our deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act,” which provides guidance on accounting for the tax effects of the TCJA for which the accounting was incomplete. To the extent that a company’s accounting for certain income tax effects of the TCJA was incomplete but a reasonable estimate could be made, a company was required to record provisional estimates in the financial statements, during a measurement period not to extend beyond one year of the enactment date. Since the TCJA was passed late in the fourth quarter of 2017, we accounted for the tax effects of the TCJA on a provisional basis and determined reasonable estimates for those effects, which were included in our financial statements as of December 31, 2017. As a result of finalizing our interpretation of related guidance, we completed our accounting in the fourth quarter of 2018 during the one-year measurement period from the enactment date. No material adjustments to our provisional amounts were required.
Included in our restricted cash balances as of December 31, 2018 were: (i) funds for a mortgage insurance reserve policy held in escrow for any future duties, rights and liabilities; (ii) funds held in trust for the benefit of certain policyholders; (iii) escrow funds held for servicer liabilities; and (iv) escrow funds held for title services obligations. Total cash and restricted cash shown in the consolidated statement of cash flows as of December 31, 2018 of $107.0 million comprise cash and restricted cash of $95.4 million and $11.6 million, respectively, as shown on the consolidated balance sheet as of December 31, 2018. Total cash and restricted cash shown in the consolidated statement of cash flows as of December 31, 2017 of $96.2 million comprise cash and restricted cash of $80.5 million and $15.7 million, respectively, as shown on the consolidated balance sheet as of December 31, 2017.
(ii) receiving the related investment or other income; and (iii) having the right to request the return of the loaned securities at any time. We report such securities within other assets in our consolidated balance sheets. We receive cash or other securities as collateral for such loaned securities. Any cash collateral may be invested in liquid assets. Cash collateral, which is reinvested for our benefit by the intermediary in accordance with the investment guidelines contained in the securities lending and collateral agreements, is reflected in short-term investments, with an offsetting liability recognized in other liabilities for the obligation to return the cash collateral to the Borrower. Securities collateral we receive from Borrowers is held on deposit for the Borrower’s benefit and we may not transfer or loan such securities collateral unless the Borrower is in default. Therefore, such securities collateral is not reflected in our consolidated financial statements given that the risks and rewards of ownership are not transferred to us from the Borrowers. See Note 6 for additional information.
Accounts and notes receivable primarily consist of accrued premiums receivable due from our mortgage insurance customers, amounts billed and due from our Services customers for services our Services segment has performed, and profit commission receivable, if any, related to our reinsurance transactions. See Note 8 for details. Accounts and notes receivable are carried at their estimated collectible amounts, net of any allowance for doubtful accounts, and are periodically evaluated for collectability based on past payment history and current economic conditions. Accounts and notes receivable exclude unbilled receivables totaling $19.9 million, which represent receivables for services performed that are not yet billed. Unbilled receivables are presented in other assets.
Goodwill and other acquired intangible assets were established primarily in connection with our acquisition of Clayton. Goodwill is an asset representing the estimated future economic benefits arising from the assets we have acquired that were not individually identified and separately recognized, and includes the value of discounted expected future cash flows of Clayton, Clayton’s workforce, expected synergies with our other affiliates and other unidentifiable intangible assets. Goodwill is deemed to have an indefinite useful life and is subject to review for impairment annually, or more frequently, whenever circumstances indicate potential impairment at the reporting unit level. A reporting unit represents a business for which discrete financial information is available; more than one reporting unit may be aggregated into a single reporting unit if they have similar economic characteristics. Events that could result in an interim assessment of goodwill impairment and/or a potential impairment charge include, but are not limited to: (i) significant under-performance relative to historical or projected future operating results; (ii) significant changes in the strategy for the Services segment; (iii) significant negative industry or economic trends; and (iv) a decline in Radian’s market capitalization below book value if such decline is attributable to the Services segment. Management regularly updates certain assumptions related to our projections, including the likelihood of achieving the assumed potential revenues from new initiatives and business strategies, and if these or other items have a significant negative impact on the reporting unit’s projections we may perform additional analysis to determine whether an impairment charge is needed. Lower earnings over sustained periods also can lead to impairment of goodwill, which could result in a charge to earnings. The value of goodwill is primarily supported by revenue projections, which are mostly driven by projected transaction volume and margins.
In performing the interim quantitative analysis for our goodwill impairment test as of June 30, 2017, we elected to early adopt the update to the accounting standard regarding goodwill and other intangibles, which simplified the subsequent measurement of goodwill by eliminating step two of the goodwill impairment test. Under this guidance, if indicators for
impairment are present, we perform a quantitative analysis to evaluate our long-lived assets for potential impairment, and then determine the amount of the goodwill impairment by comparing a reporting unit’s fair value to its carrying amount. After adjusting the carrying value for any impairment of other intangibles or long-lived assets, an impairment charge is recognized for any excess of the reporting unit’s carrying amount over the reporting unit’s estimated fair value, up to the full amount of the goodwill allocated to the reporting unit.
The stock-based compensation cost related to share-based liability awards is based on the fair value as of the measurement date. The compensation cost for equity instruments is measured based on the grant-date fair value at the date of issuance. For share-based awards with performance conditions related to our own operations, the expense recognized is dependent on the probability of the performance measure being achieved. Compensation cost is generally recognized over the periods that an employee provides service in exchange for the award.
Effective January 1, 2017, upon the implementation of the update to the accounting standard regarding stock-based compensation, windfalls and shortfalls resulting from cancellations, expirations or exercises of stock options are reflected in the consolidated statements of operations as part of our income tax provision, as they occur. Prior to 2017, we applied the short-cut method, under the accounting standard regarding share-based payment, to account for the windfall tax benefits that were expected to result from the exercise of stock options. See Note 16 for further information.
We cede insurance risk through the use of reinsurance contracts and follow reinsurance accounting for those transactions where significant risk is transferred. Loss reserves and unearned premiums are established before consideration is given to amounts related to our reinsurance agreements.
As a provider of mortgage insurance we may enter into contracts with variable interest entities (“VIEs”). VIEs include corporations, trusts or partnerships in which equity investors have: (i) insufficient equity at risk to allow it to finance its activities without additional subordinated financial support and (ii) at-risk equity holders that, as a group, do not have the characteristics of a controlling financial interest.
In August 2018, the FASB issued an update to the accounting standard regarding the disclosure requirements for fair value measurements. The amendments in this update remove certain disclosure requirements regarding transfers between Level I and Level II assets as well as the requirement to disclose the valuation process for Level III assets. This update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. We elected to early adopt the full update as of December 31, 2018 and it did not have a material impact on our financial statements or disclosures.
of the period of adoption.$50 million, which represents a right of use asset, and a corresponding net increase in other liabilities for the same amount. The net increase of approximately $50 million in other liabilities represents a discounted lease liability of approximately $74 million from operating leases, primarily for our various facilities, which represents the present value of these future lease payments discounted at our incremental borrowing rate, partially offset by an adjustment for unamortized allowances and incentives. Additionally, upon adoption we expect to expand our financial statement disclosures as required by the amendments, as well as implement any necessary changes to our control environment and reporting processes to reflect the requirements of the amendments. See Note 14 for additional information about our leases.
In March 2017, the FASB issued an update to the accounting standard regarding receivables. The new standard requires certain premiums on purchased callable debt securities to be amortized to the earliest call date. The amortization period for callable debt securities purchased at a discount will not be impacted. The provisions of this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. We do not expect the adoption of this update to have a material effect on our financial statements and disclosures.
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding, while diluted net income per share is computed by dividing net income attributable to common stockholders by the sum of the weighted-average number of common shares outstanding and the weighted-average number of dilutive potential common shares. Dilutive potential common shares relate to our share-based compensation arrangements and our outstanding convertible senior notes, if any. For all calculations, the determination of whether potential common shares are dilutive or anti-dilutive is based on net income.
As applicable, includes coupon interest, amortization of discount and fees, and other changes in income or loss that would result from the assumed conversion. Included in the year ended December 31, 2017 is a benefit related to our adjustment of estimated accrued expense to actual amounts, resulting from the January 2017 settlement of our obligations on the remaining Convertible Senior Notes due 2019.
We have two strategic business units that we manage separately-Mortgage Insurance and Services. Adjusted pretax operating income (loss) for each segment represents segment results on a standalone basis; therefore, inter-segment eliminations and reclassifications required for consolidated GAAP presentation have not been reflected.
Contract underwriting activities are reported within our Services segment. We include underwriting-related expenses for mortgage insurance, based on a pro-rata volume of mortgage applications excluding third-party contract underwriting services, in our Mortgage Insurance segment’s other operating expenses before corporate allocations. We include underwriting-related expenses for third-party contract underwriting services, based on a pro-rata volume of mortgage applications, in our Services segment’s cost of services and other operating expenses before corporate allocations, as applicable.
Our senior management, including our Chief Executive Officer (Radian’s chief operating decision maker), uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of each of Radian’s business segments and to allocate resources to the segments. Adjusted pretax operating income (loss) is defined as pretax income (loss) from continuing operations excluding the effects of net gains (losses) on investments and other financial instruments, loss on induced conversion and debt extinguishment, acquisition-related expenses, amortization or impairment of goodwill and other acquired intangible assets, and net impairment losses recognized in earnings and losses from the sale of lines of business.
Amortization or impairment of goodwill and other acquired intangible assets. Amortization of acquired intangible assets represents the periodic expense required to amortize the cost of acquired intangible assets over their estimated useful lives. Acquired intangible assets with an indefinite useful life are also periodically reviewed for potential impairment, and impairment adjustments are made whenever appropriate. These charges are not viewed as part of the operating performance of our primary activities and therefore are excluded from our calculation of adjusted pretax operating income (loss).
Net of ceded premiums written under the QSR Program and the Single Premium QSR Program. See Note 8 for additional information.
For the year ended December 31, 2018, this item comprises other operating expenses of $1.5 million and restructuring and other exit costs of $4.0 million, each as included in the consolidated statement of operations. For the year ended December 31, 2017, the full amount is included in restructuring and other exit costs in the consolidated statement of operations. See Note 1.
There was no single mortgage insurance customer that accounted for more than 10% of NIW or more than 10% of our consolidated revenues (excluding net gains (losses) on investments and other financial instruments) in 2018, 2017 or 2016.
Includes $27.9 million of securities loaned to third-party Borrowers under securities lending agreements, classified as other assets in our consolidated balance sheets. See Note 6 for more information.
Does not include the fair value of an immaterial embedded derivative, which we have accounted for separately as a freestanding derivative and classified in other assets in our consolidated balance sheet. See Note 8 for more information.
State and municipal obligations. The fair value of state and municipal obligations is estimated using recent transaction activity, including market observations. Valuation models are used, which incorporate bond structure, yield curve, credit spreads
Money market instruments. The fair value of money market instruments is based on daily prices, which are published and available to all potential investors and market participants. As such, these securities are categorized in Level I of the fair value hierarchy.
Other investments. These securities primarily consist of commercial paper and short-term certificates of deposit, which are categorized in Level II of the fair value hierarchy. The fair value of these investments is estimated using market data for comparable instruments of similar maturity and average yield.
As a result of implementing the update to the standard for the accounting of financial instruments effective January 1, 2018, other invested assets, primarily consisting of investments in limited partnerships, are no longer carried at amortized cost, and instead are valued in our consolidated balance sheets using the net asset value as a practical expedient to estimate fair value.
Senior Notes. The fair value is estimated based on the quoted market prices for the same or similar instruments. See Note 12 for further information.
Our available for sale securities within our investment portfolio consisted of the following as of the dates indicated:
Includes securities with a fair value of $77.7 million serving as collateral for FHLB advances.
Primarily consists of investments in fixed-income and equity exchange-traded funds and publicly-traded business development company equities.
For securities deemed “available for sale” and that are in an unrealized loss position, the following tables show the gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of the dates indicated. Included in the amounts as of December 31, 2018, are loaned
Although we held securities in an unrealized loss position as of December 31, 2018, we did not consider those securities to be other-than-temporarily impaired as of such date. For all investment categories, the unrealized losses of 12 months or greater duration as of December 31, 2018 were generally caused by interest rate or credit spread movements since the purchase date, and as such, we expect to recover the amortized cost basis of these securities. As of December 31, 2018, we did not have the intent to sell any debt securities in an unrealized loss position and we determined that it is more likely than not that we will not be required to sell the securities before recovery of their cost basis, which may be at maturity; therefore, we did not consider these investments to be other-than-temporarily impaired at December 31, 2018.
For the year ended December 31, 2018, we recorded other-than-temporary impairment losses in earnings of $1.7 million due to our intent to sell certain: (i) corporate bonds and notes and (ii) state and municipal obligations, each with an amortized cost basis greater than their fair value. While we recognized other-than-temporary impairment losses related to our intent to sell securities, there were no credit-related other-than-temporary impairment losses recognized in earnings during the year ended December 31, 2018.
Under our securities lending agreements, the Borrower is required to provide to us collateral, consisting of cash or securities, in amounts generally equal to or exceeding (i) 102% of the value of the loaned securities (105% in the case of foreign securities) or (ii) another agreed-upon percentage not less than 100% of the market value of the loaned securities. Any cash collateral we receive may be invested in liquid assets.
Our securities loaned under securities lending agreements are reported at fair value within other assets in our consolidated balance sheets. All of our securities lending agreements are classified as overnight and revolving. None of the amounts are subject to offsetting.
Net realized and unrealized gains (losses), including impairment losses, on investments and other financial instruments consisted of:
For each period indicated, the net change in unrealized gains (losses) on investment securities shown below represents a component of net gains (losses) on investments and other financial instruments. The net change in unrealized gains (losses) on trading securities and equity securities that were still held at each period end were as follows:
The change in unrealized gains (losses) recorded in accumulated other comprehensive income (loss) consisted of the following:
The contractual maturities of fixed-maturity investments available for sale as follows:
Available for sale includes securities loaned under securities lending agreements with a fair value of $7.4 million.
As of December 31, 2018 and 2017, our investment portfolio included no securities of countries that have obligations that have been under particular stress due to economic uncertainty, potential restructuring and ratings downgrades.
For the years ended December 31, 2018, 2017 and 2016, we did not sell or transfer any fixed-maturity investments classified as held to maturity. For the years ended December 31, 2018, 2017 and 2016, we did not transfer any securities from the available for sale or trading categories.
As of December 31, 2018, we did not have any investment in any person (including affiliates thereof) that exceeded 10% of our total stockholders’ equity.
Our investments include securities on deposit with various state insurance commissioners of $17.6 million and $11.8 million at December 31, 2018 and 2017, respectively.
All of our goodwill and other acquired intangible assets relate to our Services segment. The following table shows the changes in the carrying amount of goodwill as of and for the years ended December 31, 2018 and 2017:
The following is a summary of the gross and net carrying amounts and accumulated amortization of our other acquired intangible assets as of the periods indicated:
Includes an impairment charge of $14.9 million in the quarter ended June 30, 2017.
Includes an impairment charge of $0.9 million in the quarter ended June 30, 2017.
For the years ended December 31, 2018, 2017 and 2016, amortization expense was $12.4 million, $11.8 million and $13.2 million, respectively. The estimated aggregate expense for 2019 and thereafter is as follows:
Goodwill is an asset representing the estimated future economic benefits arising from the assets we have acquired that are not individually identified and separately recognized, and includes the value of the discounted expected future cash flows from these businesses, the workforce, expected synergies with our other affiliates and other unidentifiable intangible assets. Goodwill is deemed to have an indefinite useful life and is subject to review for impairment annually, or more frequently, whenever events and circumstances indicate potential impairment.
In the second quarter of 2017, we elected to early adopt the update to the accounting standard regarding goodwill and other intangibles, as discussed in Note 2. In accordance with the updated standard, our goodwill impairment test is a two-step process. Step one compares a reporting unit’s estimated fair value to its carrying value. If the carrying amount exceeds the estimated fair value, the second step must be completed to measure the amount of the reporting unit’s goodwill impairment loss, if any. Any excess of the reporting unit’s carrying amount over its estimated fair value is recognized as an impairment charge, up to the full amount of the goodwill allocated to the reporting unit, after adjusting the carrying value for any impairment of other intangibles or long-lived assets. For purposes of performing our goodwill impairment test, we have concluded that the Services segment constitutes one reporting unit to which all of our recorded goodwill is related.
For financial reporting purposes, other acquired intangible assets with finite lives will be amortized over their applicable estimated useful lives in a manner that approximates the pattern of expected economic benefit from each intangible asset, as follows:
Goodwill. We conducted our annual goodwill impairment analysis in the fourth quarter of 2018. Although the goodwill associated with our fourth quarter 2018 acquisitions is included in our goodwill as of December 31, 2018, these recent acquisitions were excluded from our impairment analysis as of the measurement date.
Other Acquired Intangible Assets. As of December 31, 2018, we also evaluated the recoverability of our other acquired intangible assets. Factors affecting the estimated fair value of our goodwill, as described above, were also considered in estimating the recoverability of our other acquired intangible assets. Based on our analysis, there was no impairment indicated for other acquired intangible assets, as the carrying amounts were estimated to be recoverable from future cash flows. As of December 31, 2018, the balance of client relationships and technology includes recently acquired assets from our fourth quarter 2018 acquisitions. These recently acquired assets were excluded from our recoverability analysis.
Goodwill. We performed an interim goodwill impairment test as of June 30, 2017, due to events and circumstances identified during our June 30, 2017 qualitative analysis that indicated that it was more likely than not that the fair value was less than the carrying amount. We performed our qualitative assessment of goodwill at June 30, 2017, focusing on the impact of certain key factors affecting our Services segment, including: (i) decisions related to changes in the business strategy for our Services segment determined in the second quarter of 2017, following our Chief Executive Officer’s evaluation of both existing products and new product development opportunities and (ii) second quarter 2017 results for our Services segment which were negatively impacted by market trends. Our expectation that these market trends would persist negatively impacted our projected future cash flows compared to the projections used in our prior valuation.
Our quantitative valuation analysis, performed in connection with our annual goodwill impairment analysis in 2016, relied heavily on achieving the growth rates in our projected future cash flows. The impact of the market trends observed during the second quarter of 2017, which we expected to continue, together with our strategic decisions discussed above, resulted in changes to our expected product mix and the expected growth rates associated with various initiatives, which in turn generated material reductions to our forecasted net cash flows. Given the significant negative impact that the market trends and our strategic decisions would have on the timing and amount of our projected future cash flows in comparison to our original projections, we performed a quantitative analysis of the associated goodwill and other acquired intangible assets as of June 30, 2017.
Other Acquired Intangible Assets. As of June 30, 2017, we evaluated the recoverability of our other acquired intangible assets. Factors affecting the estimated fair value of our goodwill, as described above, also affected the estimated recoverability of our other acquired intangible assets. Based on our analysis in the second quarter of 2017, impairment was indicated for the Services segment’s client relationships and technology, related to certain product lines that were affected by the factors above. There was no impairment indicated for the remaining intangible assets, as the remaining carrying amounts were estimated to be recoverable despite the decline in projected earnings.
2016 Single Premium QSR Agreement. In the first quarter of 2016, in order to proactively manage the risk and return profile of Radian Guaranty’s insured portfolio and continue managing its capital position under the PMIERs financial requirements in a cost-effective manner, Radian Guaranty entered into the 2016 Single Premium QSR Agreement with a panel of third-party reinsurers. Under the 2016 Single Premium QSR Agreement, effective January 1, 2016, Radian Guaranty began ceding the following Single Premium IIF and NIW, subject to certain conditions:
20% of its existing performing Single Premium Policies written between January 1, 2012 and March 31, 2013;
2018 Single Premium QSR Agreement. In October 2017, we entered into the 2018 Single Premium QSR Agreement with a panel of third-party reinsurers. Under the 2018 Single Premium QSR Agreement, we expect to cede 65% of our Single Premium NIW beginning with the business written in January 2018, subject to certain conditions that may affect the amount ceded, including a limitation on ceded premiums written equal to $335 million for policies issued between January 1, 2018 and December 31, 2019. Notwithstanding this limitation, the parties may mutually agree to amend the agreement, including with respect to any limitations on the amounts of insurance that may be ceded.
Radian Guaranty receives a 25% ceding commission for premiums ceded pursuant to this transaction. Radian Guaranty also receives an annual profit commission based on the performance of the loans subject to the agreement, provided that the loss ratio on the subject loans is below 56% for that calendar year. Radian Guaranty may discontinue ceding new policies under the agreement at the end of any calendar quarter.
The agreement is scheduled to terminate on December 31, 2029. However, Radian Guaranty may terminate this agreement prior to the scheduled date if one or both of the GSEs no longer grant full credit for the reinsurance. Radian Guaranty also has the option, based on certain conditions and subject to a termination fee, to terminate the agreement as of January 1, 2022, or at the end of any calendar quarter thereafter. Termination of the agreement would result in Radian Guaranty reassuming the related RIF in exchange for a net payment from the reinsurer calculated in accordance with the terms of the agreement. RIF ceded under the 2018 Single Premium QSR Agreement was $1.9 billion as of December 31, 2018.
In 2012, Radian Guaranty entered into the QSR Program with a third-party reinsurance provider. Radian Guaranty has ceded the maximum amount permitted under the QSR Program and is no longer ceding NIW under this program. RIF ceded under the QSR Program was $0.9 billion, $1.2 billion and $1.6 billion as of December 31, 2018, 2017 and 2016, respectively.
Eagle Re financed its coverage by issuing mortgage insurance-linked notes in an aggregate amount of $434.0 million to unaffiliated investors. The notes mature on November 25, 2028, but are subject to earlier termination by Eagle Re, upon Radian Guaranty’s exercise of its rights to terminate the reinsurance agreement. The notes are non-recourse to any assets of Radian Guaranty or its affiliates. The proceeds of the notes have been deposited into a reinsurance trust account for the benefit of Radian Guaranty, and are required to be the source of reinsurance claim payments to Radian Guaranty and principal repayments on the mortgage insurance-linked notes. Funds in the reinsurance trust account are required to be invested in U.S. government money market funds, cash or U.S. Treasury securities at all times.
Although the risk transfer requirements for reinsurance accounting have been met and there is also no recourse to Radian Guaranty by the holders of the mortgage insurance-linked notes, reinsurance does not relieve us of our obligations to our policyholders. In the event the VIE is unable to meet its obligations to us, our insurance subsidiaries would be liable to make claims payments to our policyholders. In the event that all of the assets in the reinsurance trust (consisting of U.S. government money market funds, cash or U.S. Treasury securities) have become worthless and the VIE is unable to make its payments to us, our maximum potential loss would be the amount of mortgage insurance claim payments for losses on the insured policies, net of the aggregate reinsurance payments already received, up to the full $434.0 million aggregate excess-of-loss reinsurance coverage amount. In the same scenario, the related embedded derivative of $1.1 million, currently recorded in other assets, would no longer have value.
Eagle Re represents our only variable interest entity as of December 31, 2018. The following table presents Eagle Re’s total assets as well as Radian Guaranty’s maximum exposure to loss associated with Eagle Re, each as of December 31, 2018.
Represents the maximum amount that would be payable in the future by Radian Guaranty to its policyholders on claims, without the benefit of any corresponding reinsurance recoverables, in the event of the combination of two events: (i) all of the assets in the reinsurance trust (consisting of U.S. government money market funds, cash or U.S. Treasury securities) have become worthless and (ii) $660.4 million of claims have been paid on the reinsured RIF.
Although we use reinsurance as one of our risk management tools, reinsurance does not relieve us of our obligations to our policyholders. In the event the reinsurers are unable to meet their obligations to us, our insurance subsidiaries would be liable for any defaulted amounts. However, in all of our reinsurance transactions, the reinsurers have established a trust to help
Property and equipment at cost, less accumulated depreciation of $62.9 million and $57.6 million at December 31, 2018 and 2017, respectively. Depreciation expense was $8.0 million, $6.9 million and $5.6 million for the years ended December 31, 2018, 2017 and 2016 respectively.
The significant components of our net deferred tax assets and liabilities from continuing operations are summarized as follows:
For periods beginning after December 31, 2017, we began realizing a significant reduction in our annualized effective tax rate, before considering Discrete Items, primarily due to the reduction in the federal corporate tax rate from 35% to 21%.
As of December 31, 2018, we recorded a net current income tax receivable of $43.8 million, which primarily relates to the unused portion of our qualified deposits relating to our IRS settlement, partially offset by liabilities of $33.6 million related to applying the standards of accounting for uncertainty in income taxes. We have $2.2 million of U.S. NOL carryforwards, related to our March 2018 acquisition of EnTitle, which is subject to limitation under IRC Section 382. To the extent not utilized, the U.S. NOL carryforwards will expire by tax year 2038. Certain entities within our consolidated group have also generated deferred tax assets of approximately $67.7 million, relating primarily to state and local NOL carryforwards which, if unutilized, will expire during various future tax periods.
This settlement with the IRS resolved the issues and concluded all disputes related to the IRS Matter. In the three-month period ended June 30, 2018, we recorded tax benefits of $73.6 million, which includes both the impact of the settlement with the IRS as well as the reversal of certain previously accrued state and local tax liabilities. In 2018, under the terms of the settlement, Radian utilized its “qualified deposits” with the U.S. Treasury to settle its $31 million obligation to the IRS, and in 2019, the Company expects the IRS to refund to Radian the remaining $58 million that was previously on deposit. See Note 9 for additional information about these qualified deposits.
As of December 31, 2018, we have $16.6 million of unrecognized tax benefits that would affect the effective tax rate, if recognized. We have no interest or penalty accrued as of December 31, 2018. Our policy for the recognition of interest and penalties associated with uncertain tax positions is to record such items as a component of our income tax provision, of which $2.2 million and $1.8 million were recorded for the years ended December 31, 2017 and 2016, respectively. In 2018, we recorded an income tax benefit of $61.6 million for interest and penalties primarily related to our IRS settlement.
Our reserve for losses and LAE, at the end of each period indicated, consisted of:
The following table shows our mortgage insurance reserve for losses and LAE by category at the end of each period indicated:
For the periods indicated, the following table presents information relating to our mortgage insurance reserve for losses, including our IBNR reserve and LAE, but excluding our second-lien mortgage loan PDR:
Related to ceded losses recoverable, if any, on reinsurance transactions, the QSR Program and the Single Premium QSR Program. See Note 8 for additional information.
Related to underlying defaulted loans with a most recent default notice dated in the year indicated. For example, if a loan had defaulted in a prior year, but then subsequently cured and later re-defaulted in the current year, that default
Loss Reserves. Our mortgage insurance loss reserves at December 31, 2018 declined as compared to December 31, 2017, primarily as a result of the amount of paid claims continuing to outpace losses incurred related to new default notices reported in the current year. Reserves established for new default notices were the primary driver of our incurred losses for 2018, and they were primarily impacted by the number of new primary default notices received in the period and our related gross Default to Claim Rate assumption applied to those new defaults, which declined from 10% at December 31, 2017 to 8% at December 31, 2018. The provision for losses during 2018 was positively impacted by favorable reserve development on prior year defaults, which was primarily driven by a reduction during the period in certain Default to Claim Rate assumptions for these prior year defaults compared to the assumptions used at December 31, 2017. The reductions in Default to Claim Rate assumptions resulted from observed trends, primarily higher Cures than were previously estimated.
Hurricane Impact 2018/2017. During the third quarter of 2017, Hurricanes Harvey and Irma caused extensive property damage to areas of Texas, Florida and Georgia, as well as other general disruptions including power outages and flooding. Although the mortgage insurance we write protects the lenders from a portion of losses resulting from loan defaults, it does not provide protection against property loss or physical damage. Our Master Policies contain an exclusion against physical damage, including damage caused by floods or other natural disasters. Depending on the policy form and circumstances, we may, among other things, deduct the cost to repair or remedy physical damage above a de minimis amount from a claim payment and/or, under certain circumstances, deny a claim where (i) the property underlying a mortgage in default is subject to unrestored physical damage or (ii) the physical damage is deemed to be the principal cause of default. Following Hurricanes Harvey and Irma, we observed an increase in new primary defaults from FEMA Designated Areas associated with these hurricanes. As expected most of these hurricane-related defaults cured by the end of 2018, and at higher cure rates than the rates for our general population of defaults. We assigned a 3% Default to Claim Rate assumption to the new primary defaults from FEMA Designated Areas associated with Hurricanes Harvey and Irma that were reported subsequent to those two natural disasters and through February 2018. These incremental defaults did not have a material impact on our provision for losses in 2017 or 2018.
Claims Paid. Total claims paid decreased for 2018, compared to 2017. The decrease in claims paid is consistent with the ongoing decline in the outstanding default inventory. In addition, claims paid for 2017 were higher because they included payments that were made in connection with the scheduled final settlement of the Freddie Mac Agreement in the third quarter of 2017.
Our loss reserves at December 31, 2016 declined as compared to December 31, 2015, primarily as a result of the amount of paid claims continuing to exceed losses incurred related to new default notices reported in the current year. Reserves established for new default notices were the primary driver of our total incurred loss for 2016, and they were impacted primarily by the number of new primary default notices received in the period and our related gross Default to Claim Rate
Our aggregate weighted-average Default to Claim Rate assumption (net of Claim Denials and Rescissions) used in estimating our primary reserve for losses was 33% (31% excluding pending claims) at December 31, 2018 compared to 31% (29% excluding pending claims) at December 31, 2017. The increase in our Default to Claim Rate in 2018 was primarily driven by a reduction in the number of defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma (which had a lower Default to Claim Rate of 3%). Excluding the impact of defaults associated with these FEMA Designated Areas, our aggregate weighted-average net Default to Claim Rate (net of Claims Denials and Rescissions) was 33% at December 31, 2018, as compared to 38% at December 31, 2017. As of December 31, 2018, our gross Default to Claim Rates on our primary portfolio ranged from 8% for new defaults, to 68% for other defaults not in Foreclosure Stage, and 75% for Foreclosure Stage Defaults. As of December 31, 2017, these gross Default to Claim Rates ranged from 10% for new defaults, to 62% for other defaults not in Foreclosure Stage, and 81% for Foreclosure Stage Defaults. Our Default to Claim Rate estimates on defaulted loans are mainly developed based on the Stage of Default and Time in Default of the underlying defaulted loans grouped according to the period in which the default occurred, as measured by the progress toward foreclosure sale and the number of months in default. Our estimate of expected Rescissions and Claim Denials (net of expected Reinstatements) embedded in our estimated Default to Claim Rate is generally based on our recent experience. Consideration is also given to differences in characteristics between those rescinded policies and denied claims and the loans remaining in our defaulted inventory.
We considered the sensitivity of first-lien loss reserve estimates at December 31, 2018 by assessing the potential changes resulting from a parallel shift in Claim Severity and Default to Claim Rate estimates for primary loans. For example, assuming all other factors remain constant, for every one percentage point change in primary Claim Severity (which we estimate to be 96.0% of risk exposure at December 31, 2018), we estimated that our loss reserves would change by approximately $3.8 million at December 31, 2018. Assuming all other factors remain constant, for every one percentage point change in our overall primary net Default to Claim Rate (which we estimate to be 33% at December 31, 2018, including our assumptions related to Rescissions and Claim Denials), we estimated a $10.4 million change in our loss reserves at December 31, 2018.
The information about net incurred losses and paid claims development for the years ended prior to 2018 is presented as supplementary information.
Represents total number of new default notices received in each calendar year as compiled monthly based on reports received from loan servicers. As reflected in our Default to Claim Rate assumptions, a significant portion of reported defaults generally do not result in a claim. In certain instances, a defaulted loan may cure, and then re-default in a later period. Consistent with our reserving practice, each new event of default is treated as a unique occurrence and therefore certain loans that cure and re-default may be included as a reported default in multiple periods. Included in this amount for the year ended December 31, 2018 and December 31, 2017 are 3,776 and 8,862 notices, respectively, of new primary defaults related to the FEMA Designated Areas associated with Hurricanes Harvey and Irma.
The carrying value of our senior notes at December 31, 2018 and 2017 was as follows:
Repurchases of Convertible Senior Notes due 2017 and 2019. During the second quarter of 2017, we purchased an aggregate principal amount of $21.6 million of our outstanding Convertible Senior Notes due 2017. We funded the purchases with $31.6 million in cash (plus accrued and unpaid interest due on the purchased notes). These purchases of Convertible Senior Notes due 2017 resulted in a loss on induced conversion and debt extinguishment of $1.2 million.
Senior Notes due 2024. In September 2017, we issued $450 million aggregate principal amount of Senior Notes due 2024 and received net proceeds of $442.2 million. These notes mature on October 1, 2024 and bear interest at a rate of 4.500% per annum, payable semi-annually on April 1 and October 1 of each year, with interest payments commencing on April 1, 2018.
The following table shows the components of other liabilities as of the dates indicated:
We participate in a securities lending program through which we loan certain securities in our investment portfolio to Borrowers for short periods of time. These securities lending agreements, whereby we transfer securities to third parties through an intermediary in exchange for cash or other securities, are considered collateralized financing arrangements. Amounts payable on the return of cash collateral under securities lending agreements are classified as other liabilities in our consolidated balance sheets. See Note 6 for additional information.
On October 16, 2017, Radian Group entered into a three-year, $225.0 million unsecured revolving credit facility with a syndicate of bank lenders. Terms of the credit facility include an accordion feature that allows Radian Group, at its option, to increase the total borrowing capacity during the term of the agreement, subject to our obtaining the necessary increased commitments from lenders (which may include then existing or other lenders), up to a total of $300 million. Effective October 26, 2018, Radian Group exercised its rights under the accordion feature to add another global bank to the existing syndicate of bank lenders and to increase the amount of total commitments under the credit facility by $42.5 million, bringing the aggregate unsecured revolving credit facility to $267.5 million.
Subject to certain limitations, borrowings under the credit facility may be used for working capital and general corporate purposes, including capital contributions to Radian Group’s insurance and reinsurance subsidiaries as well as growth initiatives. The credit facility contains customary representations, warranties, covenants, terms and conditions. Our ability to borrow under the credit facility is conditioned on the satisfaction of certain financial and other covenants, including covenants related to
As described in Note 10, on September 4, 2014 we received formal Notices of Deficiency from the IRS related to certain losses and deductions resulting from our investment in a portfolio of non-economic REMIC residual interests. As previously disclosed, we contested adjustments resulting from the examination by the IRS of our 2000 through 2007 consolidated federal income tax returns. In July 2018, we finalized a settlement with the IRS related to the adjustments we had been contesting. This settlement with the IRS resolved the issues and concluded all disputes related to the IRS Matter. In 2018, under the terms of the settlement, Radian utilized its “qualified deposits” with the U.S. Treasury to settle its $31 million obligation to the IRS, and in 2019, the Company expects the IRS to refund to Radian the remaining $58 million that was previously on deposit.
On December 22, 2016, Ocwen Loan Servicing, LLC and Homeward Residential, Inc. (collectively, “Ocwen”) filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Radian Guaranty (the “Complaint”) alleging breach of contract and bad faith claims and seeking monetary damages and declaratory relief. Ocwen has also initiated similar legal proceedings against several other mortgage insurers. On December 17, 2016, Ocwen separately filed a parallel arbitration petition against Radian Guaranty before the American Arbitration Association (“AAA”) asserting substantially the same allegations (the “Arbitration”). Ocwen’s filings together listed 9,420 mortgage insurance certificates issued under multiple insurance policies, including Pool Insurance policies, as subject to the dispute. On June 5, 2017, Ocwen filed an amended complaint and an amended petition (collectively, the “Amended Filings”) with both the court and the AAA, respectively, together listing 8,870 certificates as subject to the dispute. On April 11, 2018, the parties entered into a confidential agreement with respect to all certificates subject to the dispute. The confidential agreement resolved certain categories of claims involved in the dispute and, on April 12, 2018, the parties filed a stipulation of voluntary dismissal of the federal court proceeding and the trial judge issued an Order dismissing all claims and counterclaims subject to the parties’ agreement. Radian Guaranty was not required to make any payment in connection with this confidential agreement. Pursuant to the confidential agreement, the parties: (1) dismissed the federal court proceeding; (2) narrowed the scope of the dispute to Ocwen’s breach of contract claims
seeking payment of insurance benefits on approximately 2,500 certificates that Ocwen was previously pursuing through the Amended Filings; and (3) agreed to resolve the remaining dispute through the Arbitration. Radian Guaranty believes that Ocwen’s allegations and claims in the legal proceedings described above are without merit and legally deficient, and plans to defend these claims vigorously. We are not able to estimate a reasonably possible loss, if any, or range of loss in this matter because of the current preliminary stage of the Arbitration.
We provide contract underwriting as an outsourced service to our customers. Under our current contract underwriting program the remedy we offer is limited indemnification to our contract underwriting customers only with respect to those loans that we simultaneously underwrite for both secondary market compliance and for potential mortgage insurance eligibility. In 2018, payments for losses related to contract underwriting remedies were de minimis. In 2018, our provision for contract underwriting expenses was de minimis and our reserve for contract underwriting obligations at December 31, 2018 was $0.2 million. We monitor this risk and negotiate our underwriting fee structure and recourse agreements on a client-by-client basis. We also routinely audit the performance of our contract underwriters.
We lease office space for use in our operations. The lease agreements, which expire periodically through August 2032, contain provisions for scheduled periodic rent increases. Net rental expense in connection with these leases totaled $9.7 million in 2018, $5.7 million in 2017 and $5.0 million in 2016. The commitment for non-cancelable operating leases in future years is as follows:
On August 9, 2017, Radian Group’s board of directors authorized a share repurchase program to spend up to $50 million to repurchase Radian Group common stock in the open market or in privately negotiated transactions, based on market and business conditions, stock price and other factors. Radian established a trading plan under Rule 10b5-1 of the Exchange Act to implement the program. The Company completed this program during the first half of 2018 by purchasing 3.0 million shares of Radian Group common stock at an average price of $16.56 per share, including commissions.
to fund certain 401(k) matches. In addition, upon the vesting of certain restricted stock awards under our equity compensation plans, we may withhold from such vested awards shares of our common stock to satisfy the tax liability of the award recipients.
On May 10, 2017, our stockholders approved the Amended and Restated Equity Compensation Plan, which amended and restated the 2014 Equity Plan. In addition to the Amended and Restated Equity Compensation Plan, we also have awards outstanding under our 2008 Equity Plan and 1995 Equity Plan. The last awards granted pursuant to the 2008 Equity Plan and 1995 Equity Plan were granted in 2014 and 2008, respectively. All awards granted under the Equity Plans have been performance-based or time-vested awards in the form of non-qualified stock options, restricted stock, RSUs, phantom stock, or stock appreciation rights. The maximum contractual term for stock options and similar instruments under the Equity Plans is 10 years, although awards of these instruments may be granted with shorter terms.
Most awards vest at the end of the performance or service period. In the event of a grantee’s death or disability, awards generally vest immediately. Upon retirement, awards generally vest immediately or at the end of the performance period, if any. Awards granted under the Equity Plans to officers and our non-employee directors provide for “double trigger” vesting in the event of a change of control. As a result, awards granted to officers will vest in connection with a change of control only in the event the grantee’s employment is terminated by us without cause or the grantee terminates employment for “good reason,” in each case within 90 days before or one year after the change of control. Awards to our non-employee directors will vest in connection with a change of control only in the event the grantee fails to be appointed to the board of directors of the surviving entity or is not nominated for reelection, or fails to be reelected after nomination, to the board of directors of the Company or the surviving entity, in each case at any time beginning upon the change of control and ending 90 days following the first meeting of the stockholders of the Company or the surviving entity after the change in control. In the event of a hypothetical change of control as of December 31, 2018, we estimate that the vesting of awards, assuming for purposes of this hypothetical that “double trigger” vesting occurred, would have resulted in a pretax accounting charge to us of approximately $19.7 million, representing the acceleration of compensation expense.
We use the Monte Carlo valuation model to determine the fair value of all cash-settled awards where stock price is a factor in determining the vesting, as well as for cash- or equity-settled performance awards where there exists a similar stock price-based market condition. The Monte Carlo valuation model incorporates multiple input variables, including expected life, volatility, risk-free rate of return and dividend yield for each award to estimate the probability that a vesting condition will be achieved. In determining these assumptions for the Monte Carlo valuations, we consider historic and observable market data.
Time-Vested RSUs- At December 31, 2015, a total of 262,694 time-vested RSUs (to be settled in cash), originally granted to our non-employee directors during 2009 and 2010, remained outstanding. On February 10, 2016, these time-vested RSUs (to be settled in cash) were converted into time-vested RSUs to be settled in common stock. Upon the director’s termination of service with us, the non-employee director generally will be entitled to the equivalent number of shares of common stock.
Included in unvested amounts are certain awards to employees and non-employee directors that are exercisable upon termination or retirement.
The weighted-average grant date fair value of RSUs granted during 2017 and 2016 was $16.84 and $11.79, respectively. The total fair value of RSUs vested during 2018, 2017 and 2016 was $3.3 million, $1.4 million, and $5.8 million, respectively.
Performance-Based RSUs-In 2018, 2017 and 2016, executive and non-executive officers were granted performance-based RSUs to be settled in common stock with target awards totaling 595,320, 456,510, and 701,110; respectively. The maximum payout at the end of the three-year performance period is 200% of a grantee’s target number of RSUs. The maximum payout for awards based on the TSR Measures described below is generally subject to a maximum cap of six times the value of the grantee’s target award on the grant date.
The grant date fair value of the performance-based RSUs that are based on TSR Measures is determined using a Monte Carlo valuation model using the following assumptions:
Volatility of Radian’s stock is used in the calculation of the grant date fair value of the portion of the awards based on TSR Measures, as described above. Volatility is determined at the date of grant using the historical share price volatility and the expected life of each award.
A discount is applied to executive officer awards to reflect illiquidity during the one-year post-vesting holding period.
Also in 2017, 123,496 performance-based RSUs to be settled in common stock were granted to the Company’s former chief executive officer pursuant to the terms of his retirement agreement. Vesting for these performance-based RSUs only occurs if a stock price hurdle is met during the performance period, which begins 10 days prior to the first anniversary of the grant date and ends on the fifth anniversary of the grant date, or upon the death of the grantee or a change in control of the Company. The stock price hurdle requires that the closing price of our common stock on the New York Stock Exchange equals or exceeds 120% of the grant date share price, or $22.46, for 10 consecutive trading days during the performance period.
The time-vested RSU awards granted in 2018 and 2017 are scheduled to vest in: (i) pro rata installments on each of the first three anniversaries of the grant date or (ii) generally at the end of three years.
The time-vested RSU awards granted in 2016 generally are subject to three-year cliff vesting.
The time-vested RSU awards granted in 2018 to non-employee directors generally are subject to one-year cliff vesting.
Based on the market price of $16.36 at December 31, 2018.
The following table summarizes additional information concerning stock option activity for the periods indicated:
We use the Monte Carlo valuation model in determining the grant date fair value of stock options issued to executives and non-executives using the assumptions noted in the following table:
Generally, the stock option awards have a four-year vesting period, with 50% of the award vesting on or after the third anniversary of the grant date and the remaining 50% of the award vesting on or after the fourth anniversary of the grant date, provided the applicable stock price performance hurdle is met, as described below. The fair value of stock options vested during the year ended December 31, 2018 was $1.3 million, as compared to $3.3 million in 2017 and $1.3 million in 2016.
There were no stock options granted in 2017 and 2018. For stock option awards granted in 2016, in addition to the time-based vesting requirements, the options contain a performance hurdle whereby the options will only vest if the closing price of our common stock on the New York Stock Exchange exceeds approximately $15.20 (125% of the option exercise price) for 10 consecutive trading days ending on or after the third anniversary of the date of grant.
On May 9, 2018, stockholders of Radian approved the Amended and Restated Radian Group Inc. ESPP, which amended and restated the Radian Group Inc. 2008 Employee Stock Purchase Plan. Under this plan, we issued 103,668; 105,476; and
151,121 shares to employees during the years ended December 31, 2018, 2017 and 2016, respectively, and when amended in 2018, an additional 1,250,000 shares of our authorized but unissued common stock were reserved for issuance. In January 2019, we issued 51,187 shares from the shares available for issuance under our Amended and Restated Radian Group Inc. ESPP. As a result, 1,997,613 shares currently remain available for issuance under the Amended and Restated Radian Group Inc. ESPP.
The Radian Group Inc. Savings Incentive Plan (“Savings Plan”) covers substantially all of our full-time and our part-time employees. Participants can contribute up to 100% of their base earnings as pretax and/or after-tax (Roth IRA) contributions up to a maximum amount of $18,500 for 2018. The Savings Plan also includes a catch-up contribution provision whereby participants who are or will be age 50 and above during the Savings Plan year may contribute an additional contribution. The maximum catch-up contribution for the Savings Plan in 2018 was $6,000. Effective January 1, 2018, we match up to 100% of the first 6.0% of base earnings contributed in any given year. Previously, in 2016 and 2017 the match was up to 100% of the first 4.5% of annual base earnings. Our expense for matching funds for the years ended December 31, 2018, 2017 and 2016 was $6.1 million, $4.8 million and $4.9 million, respectively.
allows for the immediate eligibility of new hire participation and provides for the automatic enrollment of eligible employees;
permits Radian Group to make discretionary, pro rata (based on eligible pay) cash allocations to each eligible participant’s account, with vesting upon completion of three years of service with us.
Included in net gains (losses) on investments and other financial instruments in our consolidated statements of operations.
The ability of Radian’s mortgage insurance subsidiaries to pay dividends on their common stock is restricted by certain provisions of the insurance laws of Pennsylvania, their state of domicile. Under Pennsylvania’s insurance laws, dividends and other distributions may only be paid out of an insurer’s positive unassigned surplus, measured as of the end of the prior fiscal year, unless the Pennsylvania Insurance Commissioner approves the payment of dividends or other distributions from another source.
Radian Guaranty and, as such, Radian Guaranty’s Available Assets and Minimum Required Assets were determined on an aggregate basis, taking into account the assets and insured risk of Radian Guaranty and any exclusive affiliated reinsurers. However, effective in the third quarter of 2017, Radian Reinsurance is no longer considered an exclusive affiliated reinsurer of Radian Guaranty, due to its participation in the credit risk transfer programs with Fannie Mae and Freddie Mac. Although this change impacted Radian Guaranty’s Available Assets and Minimum Required Assets under the PMIERs, it did not affect Radian Guaranty’s compliance with the PMIERs financial requirements.
Radian Guaranty was in compliance with the Statutory RBC Requirements or MPP Requirements, as applicable, in each of the RBC States as of December 31, 2018. The NAIC is in the process of developing a new Model Act for mortgage insurers, which is expected to include, among other items, new capital adequacy requirements for mortgage insurers. In May 2016, a working group of state regulators released an exposure draft of this Model Act. The process for developing this framework is ongoing. While the outcome and timing of this process are uncertain, the new Model Act, if and when finalized by the NAIC, has the potential to increase capital requirements in those states that adopt the Model Act. However, we continue to believe the changes to the Model Act will not result in financial requirements that require greater capital than the level currently required under the PMIERs financial requirements. See Note 1 for information regarding the PMIERs, which set requirements for private mortgage insurers to remain approved insurers of loans purchased by the GSEs.
Radian Guaranty’s statutory capital increased by $56.0 million in 2018, primarily due to Radian Guaranty’s statutory net income of $501.9 million during the year, partially offset by the $450 million in distribution of capital to Radian Group, as described above.
Through EnTitle Insurance, we maintain escrow deposits as a service to our customers. Amounts held in escrow and excluded from assets and liabilities in our consolidated balance sheets totaled $4.7 million as of December 31, 2018. These amounts were held at third-party financial institutions and not considered assets of the Company. Should one or more of the financial institutions at which escrow deposits are maintained fail, there is no guarantee that we would recover the funds deposited, whether through Federal Deposit Insurance Corporation coverage or otherwise. In the event of any such failure, we could be held liable for the disposition of these funds owned by third parties.
Under SAPP, insurance policy acquisition costs are charged against operations in the year incurred, and considered in the recognition of unearned premiums. Under GAAP, such costs are generally deferred and amortized.
Diluted net income per share is computed independently for each period presented. Consequently, the sum of the quarters may not equal the total net income per share for the year.