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 nine months ended September 30, 2016 and 2015:



	Nine months ended September 30,
(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	292,090			338,611
Prior years ⁽¹⁾	(99,591		)	(90,130		)
Subtotal	192,499			248,481

Losses paid:
Losses and LAE paid in respect of defaults related to:
Current year	5,942			9,227
Prior years	549,706			652,465
Reinsurance terminations ⁽²⁾	(2,854		)	(15,440		)
Subtotal	552,794			646,252

Net reserve at end of period	1,488,620			1,941,195
Plus reinsurance recoverables	46,863			38,748

Reserve at end of period	$	1,535,483		$	1,979,943


⁽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 that occurred 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 claim rate and 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 that occurred in the current year decreased in the first nine 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 nine months of 2016 and 2015 is reflected in the following table.



	Nine months ended September 30,
(In millions)	2016			2015
Decrease in estimated claim rate on primary defaults	$	(108	)	$	(95	)
Increase in estimated severity on primary defaults	12			12
Change in estimates related to pool reserves, LAE reserves and reinsurance	(4		)	(7		)
Total prior year loss development ⁽¹⁾	$	(100	)	$	(90	)


⁽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 nine months ended September 30, 2016 and 2015 we experienced favorable prior year loss reserve development. This development was, in part, due to the resolution of approximately 54% and 52% of the prior year default inventory during the nine months ended September 30, 2016 and 2015, respectively. During the first nine 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 nine months of 2015 were also favorably impacted by $21 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 nine months 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 nine months of 2016, our losses paid included $52 million associated with settlements for claims paying practices and nonperforming loan sales. These settlements reduced our delinquent inventory by 1,273 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 September 30, 2016 and December 31, 2015 and approximated $91 million and $102 million, respectively. This liability was included in “Other liabilities” on our consolidated balance sheets.

Delinquent inventory

A rollforward of our primary default inventory for the three and nine months ended September 30, 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 September 30,				Nine months ended September 30,
	2016		2015		2016		2015
Default inventory at beginning of period	52,558		66,357		62,633		79,901
New notices	17,607		19,509		50,418		55,856
Cures	(15,556	)	(17,036	)	(50,249	)	(56,700	)
Paids (including those charged to a deductible or captive)	(3,051	)	(3,958	)	(9,619	)	(12,671	)
Rescissions and denials	(125	)	(230	)	(477	)	(623	)
Other items removed from inventory	—		—		(1,273	)	(1,121	)
Default inventory at end of period	51,433		64,642		51,433		64,642

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 September 30, 2016 the percentage of loans in the inventory that have been in default for 12 or more consecutive months has declined compared with the prior year end and 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.”

Consecutive months in default

	September 30, 2016			December 31, 2015			September 30, 2015
3 months or less	12,333	24	%	13,053	21	%	13,991	22	%
4 - 11 months	12,648	25	%	15,763	25	%	14,703	23	%
12 months or more ⁽¹⁾	26,452	51	%	33,817	54	%	35,948	55	%
Total primary default inventory	51,433	100	%	62,633	100	%	64,642	100	%

Primary claims received inventory included in ending default inventory	1,636	3	%	2,769	4	%	2,982	5	%


⁽¹⁾	Approximately 48%, 50%, and 50% 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 September 30, 2016, December 31, 2015, and September 30, 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.

Number of payments delinquent

	September 30, 2016			December 31, 2015			September 30, 2015
3 payments or less	18,374	36	%	20,360	33	%	20,637	32	%
4 - 11 payments	12,282	24	%	15,092	24	%	14,890	23	%
12 payments or more	20,777	40	%	27,181	43	%	29,115	45	%
Total primary default inventory	51,433	100	%	62,633	100	%	64,642	100	%

Pool insurance default inventory decreased to 1,979 at September 30, 2016 from 2,739 at December 31, 2015. and 2,950 at September 30, 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 September 30, 2016 and December 31, 2015 the estimate of this liability totaled $6 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 see Note 5 – “Litigation and Contingencies.”