We calculate our best estimate of the reserve for losses to provide for the estimated costs of settling claims on loans reported in default, as of the date of our financial statements. Additionally, we provide a reserve for loans in default that are in the process of being reported to us (incurred by not reported) using an estimate based on the percentage of actual reported defaults. Our reserving process incorporates various components in a model that gives effect to current economic conditions and segment defaults by a variety of criteria. The criteria include, among others, policy year, lender, geography and the number of months and number of times the policy has been in default, as well as whether the defaults were underwritten as flow business or as part of a structured bulk transaction.
Other operating expenses for 2006 increased over 2005 due to organizational changes and staff additions to support our growth, expensing of stock options in 2006, and strategic initiatives, including expenses associated with entering the Canadian market. In July 2006, we announced our intention to submit an application to incorporate a Canadian subsidiary to begin operations in Canada. The Canadian company will be a monoline provider of mortgage guaranty insurance and, pending regulatory approvals, could start operations sometime in 2007. We incurred approximately $690,000 of expenses in 2006 relating to legal fees, consulting, personnel and application fees in connection with this process. We expect these expenses to increase during 2007 as we continue to put the necessary personnel and infrastructure into place in anticipation of the commencement of business in that year.
As mentioned earlier, our Modified Pool insurance in force is comprised entirely of structured bulk transactions. Although terms vary, the structured bulk market can be broadly categorized into three different segments, or tiers, depending on the risk characteristics of the loans comprising a transaction. The loan characteristics of the three segments are a) predominantly high credit quality, low LTV, fully underwritten loans that may have niche characteristics such as non-conforming loan balances and risk concentrations related to geography, transaction purpose, or occupancy type; b) loans that generally have high credit quality and low to moderate LTVs that have been underwritten with reduced, streamlined, or no documentation; and c) generally fully underwritten loans with credit impaired borrowers (FICO credit score less than 575). In general, we believe that structured bulk business originated in segments b) and c) will report a higher default rate than our Primary business. However, we also believe that the lower LTVs associated with the structured bulk business originated in segments a) and b) will ultimately generate lower claim rates as a proportion of the reported defaults and lower levels of severity than Primary business. Most of our structured bulk insurance in force is comprised of the first two segments mentioned above, while only approximately 1% of our insurance in force attributable to structured bulk transactions was categorized in segment c) above.
A decline in the percentage of business with prime credit quality
The growth of the percentage of Primary direct insurance in force that was subject to captive reinsurance arrangements in 2006 and in 2005 was the result of the addition of new lenders that participate in captive reinsurance arrangements as well as increased writings with existing lenders that participate in captive reinsurance arrangements. The declines in the percentage of total direct insurance in force subject to captive reinsurance in 2006 and in 2005 reflect the fact that a greater portion of our insurance in force consists of Modified Pool business. None of our Modified Pool insurance in force is subject to captive reinsurance arrangements.
Ceded premium written is comprised of premiums written under excess of loss reinsurance treaties with captive as well as non-captive reinsurance companies. The growth in ceded premium written in 2006 and 2005 was not as large as the increase in direct premium written as a result of Modified Pool business comprising a larger percentage of direct premium written in both years. Further, ceded premium written in 2006 was reduced by a no claims bonus on a terminated excess of loss reinsurance treaty of approximately $840 thousand. The following table provides further data on ceded premiums for the years ended December 31, 2006, 2005 and 2004:
The table below provides the cumulative paid loss ratios by certificate year (calculated as direct losses paid divided by direct premiums received, in each case for a particular policy year) that have developed through December 31, 2006, 2005 and 2004. It excludes the effects of reinsurance.
In addition, the recoverability of DAC carrying value on the balance sheet is tested by calculating an estimated future gross profit on the existing book of business and comparing that to the DAC balance. If this comparison indicates a premium deficiency, the DAC carrying value is reduced to the extent of that deficiency through a charge to expense.
The insurance laws of the State of Illinois impose certain restrictions on dividends that an insurance subsidiary can pay the parent company. These restrictions, based on statutory accounting practices, include requirements that dividends may be paid only out of statutory earned surplus and that limit the amount of dividends that may be paid without prior approval of the Illinois Insurance Department. As of December 31, 2006, there have been no dividends paid by the insurance subsidiaries to the parent company. We are considering, among other alternatives, partial funding of the estimated $45 million initial capital required to commence business in Canada through a dividend from Triad to the parent company. Based upon current Canadian capital requirements and possibilities for growth in that market, we anticipate there may be a need for further capital infusions and dividends from Triad may be considered. As of December 31, 2006 there are no specific restrictions or requirements for capital support arrangements between the parent company and Triad or its subsidiaries.