Loss Reserves

We establish reserves to recognize the estimated liability for losses and loss adjustment expenses (“LAE”) related to defaults on insured mortgage loans. Loss reserves are established by estimating the number of defaulted loans that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity.

Estimation of losses is inherently judgmental. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment, and the current and future strength of local housing markets; exposure on insured loans; the amount of time between default and claim filing; and curtailments. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrower income and thus their ability to make mortgage payments, and a drop in housing values which may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Changes to our estimates could result in a material impact to our results of operations and capital position, even in a stable economic environment.

The following table provides a reconciliation of beginning and ending loss reserves for the three months ended March 31, 2016 and 2015:



	Three months ended March 31,
(In thousands)	2016			2015
Reserve at beginning of period	$	1,893,402		$	2,396,807
Less reinsurance recoverable	44,487			57,841
Net reserve at beginning of period	1,848,915			2,338,966

Losses incurred:
Losses and LAE incurred in respect of defaults related to:
Current year	92,479			109,381
Prior years ⁽¹⁾	(7,467		)	(27,596		)
Subtotal	85,012			81,785

Losses paid:
Losses and LAE paid in respect of defaults related to:
Current year	204			312
Prior years	221,457			231,230
Reinsurance terminations ⁽²⁾	(4		)	—
Subtotal	221,657			231,542

Net reserve at end of period	1,712,270			2,189,209
Plus reinsurance recoverables	41,119			55,415

Reserve at end of period	$	1,753,389		$	2,244,624


⁽¹⁾	A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves.

⁽²⁾

In a termination or commutation, the reinsurance agreement is cancelled, with no future premium ceded and funds for any incurred but unpaid losses transferred to us. The transferred funds result in an increase in our investment portfolio (including cash and cash equivalents) and a decrease in net losses paid (reduction in losses incurred). In addition, there is an offsetting decrease in the reinsurance recoverable (increase in losses incurred), and thus there is no net impact to losses incurred.

The “Losses incurred” section of the table above shows losses incurred on defaults that occurred in the current year and in prior years. The amount of losses incurred relating to defaults that occurred in the current year represents the estimated amount to be ultimately paid on such defaults. The amount of losses incurred relating to defaults received in prior years represents the actual claim rate and severity associated with those defaults resolved in the current year differing from the estimated liability at the prior year-end, as well as a re-estimation of amounts to be ultimately paid on defaults continuing from the end of the prior year. This re-estimation of the estimated claim rate and estimated severity is the result of our review of current trends in the default inventory, such as percentages of defaults that have resulted in a claim, the amount of the claims relative to the average loan exposure, changes in the relative level of defaults by geography and changes in average loan exposure.

Losses incurred on defaults received in the current year decreased in the first three months of 2016 compared to the same period in 2015, primarily due to a decrease in the number of new defaults, net of related cures.

The prior year development of the reserves in the first three months of 2016 and 2015 is reflected in the following table.



	Three months ended March 31,
(In millions)	2016			2015
Decrease in estimated claim rate on primary defaults	$	(26	)	$	(39	)
Increase in estimated severity on primary defaults	22			17
Change in estimates related to pool reserves, LAE reserves and reinsurance	(3		)	(6		)
Total prior year loss development ⁽¹⁾	$	(7	)	$	(28	)


⁽¹⁾	A negative number for prior year loss development indicates a redundancy of prior year loss reserves, and a positive number indicates a deficiency of prior year loss reserves.

For the three months ended March 31, 2016 and 2015 we experienced favorable prior year loss reserve development. This development was, in part, due to the resolution of approximately 28% and 24% of the prior year default inventory during the three months ended March 31, 2016 and 2015, respectively. During the first three months of 2016, we experienced improved cure rates on prior year defaults, which was offset in part by an increase in severity on the prior year defaults. In addition to the resolution of defaults, the first three months of 2015 were also favorably impacted by $20 million due to re-estimation of previously recorded reserves relating to disputes on our claims paying practices and adjustments to incurred but not reported losses (IBNR). The favorable development in the first quarter of 2015 was offset, in part, by an increase in the severity on prior year defaults remaining in the delinquent inventory.

The “Losses paid” section of the table above shows the breakdown between claims paid on new default notices in the current year and claims paid on defaults from prior years. Until a few years ago, it took, on average, approximately twelve months for a default that is not cured to develop into a paid claim. Over the past several years, the average time it takes to receive a claim associated with a default has increased. This is, in part, due to new loss mitigation protocols established by servicers and to changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation processes. It is difficult to estimate how long it may take for current and future defaults that do not cure to develop into paid claims.

During the first quarter of 2016, our losses paid included $47 million associated with settlements for claims paying practices and a nonperforming loan sale. These settlements reduced our delinquent inventory by 1,138 notices. These settlements had no material impact on our losses incurred, net.

The liability associated with our estimate of premiums to be refunded on expected claim payments is accrued for separately at March 31, 2016 and December 31, 2015 and approximated $99 million and $102 million, respectively. This liability was included in “Other liabilities” on our consolidated balance sheets.

A rollforward of our primary default inventory for the three months ended March 31, 2016 and 2015 appears in the following table. The information concerning new notices and cures is compiled from monthly reports received from loan servicers. The level of new notice and cure activity reported in a particular month can be influenced by, among other things, the date on which a servicer generates its report, the number of business days in a month and transfers of servicing between loan servicers.



	Three months ended March 31,
	2016		2015
Default inventory at beginning of period	62,633		79,901
New notices	16,731		18,896
Cures	(19,053	)	(21,767	)
Paids (including those charged to a deductible or captive)	(3,373	)	(4,573	)
Rescissions and denials	(210	)	(221	)
Items removed from inventory resulting from settlements ⁽¹⁾	(1,138	)	—
Default inventory at end of period	55,590		72,236


⁽¹⁾	Includes 732 loans whose insurance was terminated by agreement to settle coverage on certain non-performing loans, and 406 loans for which we had previously suspended rescissions and that were included in a rescission settlement agreement. Both agreements became effective in the first quarter of 2016 and neither had a material financial impact in the quarter.

The decrease in the primary default inventory experienced during 2016 and 2015 was generally across all markets and primarily in book years 2008 and prior. As of March 31, 2016 the percentage of loans in the inventory that have been in default for 12 or more consecutive months remained consistent compared with the prior year end and declined compared to one year prior, as shown in the following table. Historically as a default ages it becomes more likely to result in a claim. The percentage of loans that have been in default for 12 or more consecutive months and the number of loans in our primary claims received inventory have been affected by our suspended rescissions and the resolution of certain of those rescissions discussed below and in Note 5 – “Litigation and Contingencies.”



	March 31, 2016			December 31, 2015			March 31, 2015
Consecutive months in default
3 months or less	10,120	18	%	13,053	21	%	11,604	16	%
4 - 11 months	15,319	28	%	15,763	25	%	18,940	26	%
12 months or more ⁽¹⁾	30,151	54	%	33,817	54	%	41,692	58	%
Total primary default inventory	55,590	100	%	62,633	100	%	72,236	100	%

Primary claims received inventory included in ending default inventory	2,267	4	%	2,769	4	%	4,448	6	%


⁽¹⁾	Approximately 49%, 50%, and 53% of the primary default inventory in default for 12 consecutive months or more has been in default for at least 36 consecutive months as of March 31, 2016, December 31, 2015, and March 31, 2015, respectively.

The number of months a loan is in the default inventory can differ from the number of payments that the borrower has not made or is considered delinquent. These differences typically result from a borrower making monthly payments that do not result in the loan becoming fully current. The number of payments that a borrower is delinquent is shown in the table below.



	March 31, 2016			December 31, 2015			March 31, 2015
Number of payments delinquent
3 payments or less	16,864	30	%	20,360	33	%	19,159	27	%
4 - 11 payments	14,595	26	%	15,092	24	%	18,372	25	%
12 payments or more	24,131	44	%	27,181	43	%	34,705	48	%
Total primary default inventory	55,590	100	%	62,633	100	%	72,236	100	%

Pool insurance default inventory decreased to 2,247 at March 31, 2016 from 2,739 at December 31, 2015. The pool insurance default inventory was 3,350 at March 31, 2015.

Claims paying practices

Our loss reserving methodology incorporates our estimates of future rescissions. A variance between ultimate actual rescission rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses.

The liability associated with our estimate of premiums to be refunded on expected future rescissions is accrued for separately. At March 31, 2016 and December 31, 2015 the estimate of this liability totaled $5 million and $7 million, respectively. This liability was included in “Other liabilities” on our consolidated balance sheets.

For information about discussions and legal proceedings with customers with respect to our claims paying practices, including settlements that we believe are probable, as defined in ASC 450-20, see Note 5 – “Litigation and Contingencies.”