

NOTE 9		Reinsurance

Our consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to the acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance involves transferring certain insurance risks (along with the related earned premiums) we have underwritten to other insurance companies who agree to share these risks. The purpose of ceded reinsurance is to protect us, at a cost, against losses arising from our mortgage guaranty policies covered by the agreement and to manage our capital requirements under PMIERs. Reinsurance is currently placed on a quota-share and excess of loss basis, but we also have immaterial captive reinsurance agreements that remain in effect.

Table 9.1 below shows the effect of all reinsurance agreements on premiums earned and losses incurred as reflected in the consolidated statements of operations.



Reinsurance
Table	9.1
		Years ended December 31,
(In thousands)		2018			2017			2016
Premiums earned:
Direct		$	1,084,748		$	1,059,973		$	1,058,545
Assumed		1,805			509			662
Ceded		(111,391		)	(125,735		)	(133,981		)
Net premiums earned		$	975,162		$	934,747		$	925,226

Losses incurred:
Direct		$	43,060		$	74,727		$	273,207
Assumed		331			183			1,138
Ceded		(6,829		)	(21,201		)	(34,188		)
Net losses incurred		$	36,562		$	53,709		$	240,157

QUOTA SHARE REINSURANCE

Each of the reinsurers under our quota share reinsurance agreements described below has an insurer financial strength rating of A- or better by Standard and Poor's Rating Services, A.M. Best, or both.

2018 QSR Transaction. Our 2018 quota share reinsurance agreement ("2018 QSR Transaction") provides coverage on eligible new business written in 2018. Under the 2018 QSR Transaction, we cede losses incurred and premiums on or after the effective date through December 31, 2029, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021, and annually thereafter, for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.

The structure of the 2018 QSR Transaction is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2018 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 62%.

2017 QSR Transaction. Our 2017 quota share reinsurance agreement ("2017 QSR Transaction") provides coverage on eligible new business written in 2017. Under our 2017 QSR Transaction we cede losses incurred and premiums on or after the effective date through December 31, 2028, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.

2015 QSR Transaction. Our 2015 quota share reinsurance agreement ("2015 QSR Transaction") provides coverage on eligible business written before 2017. Under the 2015 QSR Transaction we cede losses incurred and premiums through December 31, 2024, at which time the agreement expires. Early termination of the agreement can be elected by us for a fee on a bi-annual basis, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period. Our next early termination option is at June 30, 2019 and requires 90 days' prior written notice.

The structure of both the 2017 QSR Transaction and 2015 QSR Transactions is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2017 and 2015 QSR Transactions, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%.

Table 9.2 provides a summary of our quota share reinsurance agreements, excluding captive agreements, for 2018, 2017 and 2016.



Quota share reinsurance
Table	9.2
		Years ended December 31,
(In thousands)		2018		2017		2016
Ceded premiums written and earned, net of profit commission ⁽¹⁾		$	108,337	$	120,974	$	125,460
Ceded losses incurred		6,543		22,336		30,201
Ceding commissions ⁽²⁾		51,201		49,321		47,629
Profit commission		147,667		125,629		112,685


⁽¹⁾	Under our QSR Transactions, premiums are ceded on an earned and received basis as defined in our agreements.


⁽²⁾	Ceding commissions are reported within Other underwriting and operating expenses, net on the consolidated statements of operations.

Under the terms of our QSR Transactions currently in effect, reinsurance premiums, ceding commission and profit commission are settled net on a quarterly basis. The reinsurance premium due after deducting the related ceding commission and profit commission is reported within "Other liabilities" on the consolidated balance sheets.

The reinsurance recoverable on loss reserves was $33.2 million as of December 31, 2018 and $39.3 million as of December 31, 2017. The reinsurance recoverable balance is secured by funds on deposit from the reinsurers which are based on the funding requirements of PMIERs that address ceded risk.

2019 QSR Transaction. We have agreed to terms on a QSR Transaction with a group of unaffiliated reinsurers with an effective date of January 1, 2019 ("2019 QSR Transaction"), which provides coverage on eligible new business written in 2019. Under the 2019 QSR Transaction, we cede losses incurred and premiums on or after the effective date through December 31, 2030, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021, and bi-annually thereafter, for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.

The structure of the 2019 QSR Transaction is a 30% quota share, with a one-time option, elected by us, to reduce the cede rate to either 25% or 20% effective July 1, 2020, or bi-annually thereafter, for a fee, for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2019 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 62%.

EXCESS OF LOSS REINSURANCE

On October 30, 2018, MGIC entered into a fully collateralized reinsurance agreement with Home Re 2018-1 Ltd. (“Home Re”), an unaffiliated special purpose insurer domiciled in Bermuda, that provides for up to $318.6 million of aggregate excess-of-loss reinsurance coverage as of August 1, 2018 on a portfolio of mortgage insurance policies having an insurance coverage in force date on or after July 1, 2016 and before January 1, 2018. For the reinsurance coverage period, MGIC will retain the first layer of $168.7 million of aggregate losses, and Home Re will then provide second layer coverage up to the outstanding reinsurance coverage amount. The premiums ceded to the reinsurer, Home Re, are composed of coverage premiums, initial expense and supplemental premiums. The coverage premiums are generally calculated as the difference between the amount of interest payable by Home Re on the notes it issued to raise funds to collateralize its reinsurance obligations to us, and the investment income collected on the collateral assets.

The aggregate excess of loss reinsurance coverage decreases over a ten-year period, subject to certain conditions, as the underlying covered mortgages amortize, principal is prepaid, or mortgage insurance losses are paid. MGIC has rights to terminate the reinsurance agreement, which includes an option to terminate on or after October 25, 2025. Home Re financed the coverage by issuing mortgage insurance-linked notes in an aggregate amount of $318.6 million to unaffiliated investors. The notes have ten-year legal maturities and are non-recourse to any assets of MGIC or its affiliates. The proceeds of the notes were deposited into a reinsurance trust for the benefit of MGIC that will be the source of reinsurance claim payments to MGIC and principal repayments on the mortgage insurance-linked notes.

The amount of monthly reinsurance coverage premium ceded will fluctuate due to change in one-month LIBOR and changes in money market rates that affect investment income collected on the assets in the reinsurance trust. As the reinsurance premium will vary based on changes in these rates, we concluded that the reinsurance agreement contains an embedded derivative that will be accounted for separately as a freestanding derivative. The fair value of the derivative at December 31, 2018, and the change in fair value from inception of the reinsurance agreement to December 31, 2018, was not material to our consolidated balance sheet and consolidated statement of operations, respectively. Total ceded premiums were $2.8 million for the year ended December 31, 2018.

In connection with entering into the reinsurance agreement with Home Re, we concluded that the risk transfer requirements for reinsurance accounting were met as Home Re is assuming significant insurance risk and a reasonable possibility of significant loss. In addition, we assessed whether Home Re was a variable interest entity (“VIE”). A VIE is a legal entity that does not have sufficient equity at risk to finance its activities without additional subordinated financial support or is structured such that equity investors lack the ability to make sufficient decisions relating to the entity’s operations through voting rights or do not substantively participate in gains and losses of the entity. We concluded that Home Re is a VIE. However, given that MGIC (1) does not have the unilateral power to direct the activities that most significantly affect Home Re’s economic performance and (2) does not have the obligation to absorb losses or the right to receive benefits of Home Re, consolidation of Home Re is not required.

We are required to disclose our maximum exposure to loss, which we consider to be an amount that we could be required to record in our statement of operations, as a result of our involvement with this VIE. As of December 31, 2018, we did not have exposure to the VIE as we have no investment in the VIE and had no reinsurance claim payments due from the VIE under our reinsurance agreement. We are unable to determine the timing or extent of losses that may be ceded under the reinsurance agreement. The VIE assets are deposited in a reinsurance trust for the benefit of MGIC that will be the source of reinsurance claim payments to MGIC. The purpose of the reinsurance trust is to provide security to MGIC for the obligations of the VIE under the reinsurance agreement. The trustee of the reinsurance trust, a recognized provider of corporate trust services, has established a segregated account within the reinsurance trust for the benefit of MGIC, pursuant to the trust agreement. The trust agreement is governed by, and construed in accordance with, the laws of the State of New York. If the trustee of the reinsurance trust failed to distribute claim payments to us as provided in the reinsurance trust, we would incur a loss related to our losses ceded under the reinsurance agreement and deemed unrecoverable. We are also unable to determine the impact such possible failure by the trustee to perform pursuant to the reinsurance trust agreement may have on our consolidated financial statements. As a result, we are unable to quantify our maximum exposure to loss related to our involvement with the VIE. MGIC has certain termination rights under the reinsurance agreement should its claims not be paid. We consider our exposure to loss from our reinsurance agreement with the VIE to be remote.

The following presents the total assets of Home Re as of December 31, 2018.



Home Re total assets
Table	9.3

(In thousands)		Total VIE Assets
Home Re 2018-1 Ltd.		$	318,636

The reinsurance trust agreement provides that the trust assets may generally only be invested in certain money market funds that (i) invest at least 99.5% of their total assets in cash or direct U.S. federal government obligations, such as U.S. Treasury bills, as well as other short-term securities backed by the full faith and credit of the U.S. federal government or issued by an agency of the U.S. federal government, (ii) have a principal stability fund rating of “AAAm” by S&P or a money market fund rating of “Aaa-mf” by Moody’s as of the Closing Date and thereafter maintain any rating with either S&P or Moody’s, and (iii) are permitted investments under the applicable credit for reinsurance laws and applicable PMIERs credit for reinsurance requirements.

The assets of Home Re provide capital credit under the PMIERs financial requirements (see Note 1 - "Nature of Business"). A decline in the assets available to pay claims would reduce the capital credit available to MGIC.