(1) On February 28, 2001, the Company acquired Enhance Financial Services Group Inc. The results for 2001 include the results of operations for Enhance Financial Services Group Inc. from the date of acquisition. See Note 1 of Notes to Consolidated Financial Statements.
The following table shows the breakdown of net premiums written and earned by Financial Guaranty’s various product lines for 2004, 2003 and 2002:
Net income attributable to the financial services segment for 2004 was $112.5 million compared to $42.5 million for 2003. Equity in net income of affiliates (pre-tax) was $179.1 million for 2004, compared to $95.5 million for 2003. C-BASS accounted for $95.9 million (pre-tax) of the total net income of affiliates in 2004 compared to $66.1 million (pre-tax) in 2003. This reflected the growth in C-BASS’s assets on their balance sheet and in their off-balance sheet securitizations. These results could vary significantly from period to period because a portion of C-BASS’s income is dependent on its ability to sell mortgage-backed securities in the capital markets. These mortgage capital markets can be volatile, subject to changes in interest rates, credit spreads and liquidity. In addition, C-BASS has the right to call many of its mortgage-backed securities for redemption, and it tends to do so in low interest rate environments, such as have existed recently, which can lead to volatility in its quarterly results. Equity in net income of affiliates included $83.3 million (pre-tax) for Sherman in 2004 compared to $29.4 million (pre-tax) in 2003. This resulted primarily from the growth in Sherman’s portfolio over the past several years and some gains from a favorable seller’s market for charged-off consumer assets and mortgage receivables in 2004.
SEC definition, they are included in the table because they represent management’s estimate of the claims that the Company will be required to pay on its mortgage insurance and financial guaranty contracts. The table also reflects the timing of principal payments on outstanding debt. Additional details regarding these obligations are provided in the Notes to the Consolidated Financial Statements as referenced in the table:
other of short-duration or long-duration contracts under SFAS No. 60, this determination could impact the Company’s accounting for loss reserves, premium revenue and deferred acquisition costs, all of which are covered by SFAS No. 60. Management is unable to estimate what impact, if any, the ultimate resolution of this issue will have on the Company’s financial condition or operating results.
Radian’s management is responsible for establishing and maintaining adequate “internal control over financial reporting” as that term is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934. Radian’s internal control over financial reporting is a process designed under the supervision of Radian’s principal executive and principal financial officers, and effected by Radian’s board of directors, management and other personnel.
On December 30, 2003, the Company announced that it would cease operations of RadianExpress.com Inc. (“RadianExpress,”) an Internet-based settlement company that provided real estate information products and services to the first- and second-mortgage industry. The Company’s decision followed its receipt of an order from the California Superior Court denying the Company’s appeal from a decision by the California Commissioner of Insurance sustaining a California cease-and-desist order applicable to the Company’s offering of its Radian Lien Protection product. The California Superior Court’s denial is on appeal, but the decision significantly reduced the potential for increased revenues at RadianExpress, which was the company through which Radian Lien Protection sales would have been processed. During the first quarter of 2004, RadianExpress ceased processing new orders and is completing the final processing of the remaining transactions. The cessation of operations resulted in a pre-tax charge of $13.0 million in the fourth quarter of 2003, which includes the write-down of the remaining goodwill of $7.2 million and provisions for severance, leasehold commitments, and other charges of approximately $5.8 million. These amounts are included in operating expenses in the Consolidated Statements of Income. This resulted in an after-tax earnings impact of $8.4 million or $.09 per share in 2003. Income and expense from RadianExpress operations for 2004 were immaterial.
At each balance sheet date, the Company also evaluates both the model-generated default factors and its unallocated non-specific reserves against management’s subjective view of qualitative factors to ensure that the default factors and the unallocated non-specific reserves represent management’s best estimate of the expected losses on the Company’s portfolio of credits for which it has not established a case reserve or an allocated non-specific reserve. These qualitative factors include existing economic and business conditions, overall credit quality trends resulting from industry, geographic, economic and political conditions, recent loss experience in particular segments of the portfolio, changes in underwriting policies and procedures and seasoning of the book of business. In addition, a significant change in the size of the Company’s portfolio underlying the unallocated non-specific reserves, such as through the expiration of policies or the refunding or recapture of insured exposures, could require an adjustment to the default factors or the Company’s level of unallocated non-specific reserves. To date, the Company’s evaluation of these qualitative factors has not led the Company to adjust the default factors or its level of unallocated non-specific reserves.
In January and February of 2005, the Company discussed with the SEC staff, both separately and together with other members of the financial guaranty industry, the differences in loss reserve practices followed by different financial guaranty industry participants. The Company understands from those discussions that the Financial Accounting Standards Board (the “FASB”) staff is considering whether additional accounting guidance is necessary to address the financial guaranty industry. When and if the FASB or the SEC reaches a conclusion on this issue, the Company and the rest of the financial guaranty industry may be required to change some aspects of their accounting policies. If the FASB or the SEC were to determine that the Company should account for its financial guaranty contracts differently, for example by requiring them to be treated solely as one or the other of short-duration or long-duration contracts under SFAS No. 60, this determination could impact the Company’s accounting for loss reserves, premium revenue and deferred acquisition costs, all of which are covered by SFAS No. 60. Management is unable to estimate what impact, if any, the ultimate resolution of this issue will have on the Company’s financial condition or operating results.
Deferred policy acquisition costs in the financial guaranty business are comprised of those expenses that vary with, and are primarily related to, the production of insurance premiums, including: commissions paid on reinsurance assumed, salaries and related costs of underwriting and marketing personnel, rating agency fees, premium taxes and certain other underwriting expenses, offset by commission income on premiums ceded to reinsurers. Acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed or are less than recoverable amounts, after considering investment income.
Due to the nature of the Postretirement Welfare Plan, no increase is assumed in the Company’s obligation due to any increases in the per-capita cost of covered healthcare benefits.
The Company leases office space for use in its operations. Net rental expense in connection with these leases totaled $8,124,000, $9,574,000 and $7,086,000 in 2004, 2003 and 2002, respectively. The commitment for non-cancelable operating leases in future years is as follows (in thousands):