10-Q 1 form10q.htm MGIC INVESTMENT CORP 10-Q 3-31-2011 form10q.htm


FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 
x         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended March 31, 2011
o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
              For the transition period from                   to  ________
              Commission file number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
 
 WISCONSIN     39-1486475
 (State or other jurisdiction of  incorporation or organization)           (I.R.S. Employer Identification No.)
 
 
 250 E. KILBOURN AVENUE    53202
 MILWAUKEE, WISCONSIN      (Zip Code)
 (Address of principal executive offices)    
      
(414) 347-6480
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
YES x        NO o
                                                           
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
YES x        NO o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x    Accelerated filer o     Non-accelerated filer o    Smaller reporting companyo(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
YES o        NO x
                                                                      
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
 CLASS OF STOCK  PAR VALUE  DATE    NUMBER OF SHARES
 Common stock  $1.00  04/30/11  201,142,536
                                                                                                                                                                                                                       


 
 

 
 
PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2011 (Unaudited) and December 31, 2010
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
ASSETS
 
(In thousands)
 
Investment portfolio (notes 7 and 8):
           
Securities, available-for-sale, at fair value:
           
Fixed maturities (amortized cost, 2011 - $7,137,265; 2010 - $7,366,808)
  $ 7,200,355     $ 7,455,238  
Equity securities
    3,063       3,044  
  Total investment portfolio
    7,203,418       7,458,282  
                 
Cash and cash equivalents
    1,112,334       1,304,154  
Accrued investment income
    73,687       70,305  
Reinsurance recoverable on loss reserves (note 4)
    238,039       275,290  
Reinsurance recoverable on paid losses
    38,448       34,160  
Prepaid reinsurance premiums
    2,138       2,637  
Premium receivable
    75,835       79,567  
Home office and equipment, net
    28,883       28,638  
Deferred insurance policy acquisition costs
    8,096       8,282  
Other assets
    67,094       72,327  
                 
  Total assets
  $ 8,847,972     $ 9,333,642  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Liabilities:
               
Loss reserves (note 12)
  $ 5,471,494     $ 5,884,171  
Premium deficiency reserve (note 13)
    169,948       178,967  
Unearned premiums
    200,661       215,157  
Senior notes (note 3)
    376,386       376,329  
Convertible senior notes (note 3)
    345,000       345,000  
Convertible junior debentures (note 3)
    322,313       315,626  
Other liabilities
    353,863       349,337  
                 
  Total liabilities
    7,239,665       7,664,587  
                 
Contingencies (note 5)
               
                 
Shareholders' equity:
               
Common stock ($1 par value, shares authorized 460,000,000; shares issued, 2011 - 205,046,780; 2010 - 205,046,780; shares outstanding, 2011 - 201,142,536; 2010 - 200,449,588)
    205,047       205,047  
Paid-in capital
    1,129,024       1,138,942  
Treasury stock (shares at cost, 2011 - 3,904,244; 2010 - 4,597,192)
    (163,809     (222,632
Accumulated other comprehensive (loss) income, net of tax (note 9)
    (2,551 )     22,136  
Retained earnings
    440,596       525,562  
                 
  Total shareholders' equity
    1,608,307       1,669,055  
                 
  Total liabilities and shareholders' equity
  $ 8,847,972     $ 9,333,642  
 
See accompanying notes to consolidated financial statements.
 
 
2

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2011 and 2010
(Unaudited)
 
   
Three Months Ended
March 31,
   
2011
   
2010
   
(In thousands, except per share data)
 
Revenues:
         
Premiums written:
         
Direct
  $ 287,717     $ 275,134  
Assumed
    730       797  
Ceded
    (13,984 )     (19,873 )
Net premiums written
    274,463       256,058  
Decrease in unearned premiums, net
    14,083       15,894  
Net premiums earned
    288,546       271,952  
Investment income, net of expenses
    56,543       68,859  
Realized investment gains, net
    5,761       32,954  
Total other-than-temporary impairment losses
    -       (6,052 )
Portion of losses recognized in other comprehensive income, before taxes
    -       -  
Net impairment losses recognized in earnings
    -       (6,052 )
Other revenue
    2,263       3,057  
Total revenues
    353,113       370,770  
                 
Losses and expenses:
               
Losses incurred, net (note 12)
    310,431       454,511  
Change in premium deficiency reserve (note 13)
    (9,018 )     (13,566 )
Amortization of deferred policy acquisition costs
    1,725       1,723  
Other underwriting and operating expenses, net
    55,825       58,222  
Interest expense
    26,042       21,018  
Total losses and expenses
    385,005       521,908  
Loss before tax
    (31,892 )     (151,138 )
Provision for (benefit from) income taxes (note 11)
    1,769       (1,047 )
                 
Net loss
  $ (33,661 )   $ (150,091 )
                 
Loss per share (note 6):
               
Basic
  $ (0.17 )   $ (1.20 )
Diluted
  $ (0.17 )   $ (1.20 )
                 
Weighted average common shares outstanding - diluted (note 6)
    200,744       124,889  
 
See accompanying notes to consolidated financial statements.
 
 
3

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Year Ended December 31, 2010 and Three Months Ended March 31, 2011 (unaudited)
 
   
Common
stock
   
Paid-in
capital
   
Treasury
stock
   
Accumulated
other
comprehensive
income (loss)
   
Retained
earnings
   
Comprehensive
loss
 
   
(In thousands)
 
                                     
 Balance, December 31, 2009
  $ 130,163     $ 443,294     $ (269,738 )   $ 74,155     $ 924,707        
                                               
 Net loss
    -       -       -       -       (363,735 )   $ (363,735 )
 Change in unrealized investment gains and losses, net
    -       -       -       (69,074 )     -       (69,074 )
 Common stock shares issued
    74,884       697,492       -       -       -          
 Reissuance of treasury stock, net
    -       (14,425 )     47,106       -       (35,410 )        
 Equity compensation
    -       12,581       -       -       -          
 Defined benefit plan adjustments, net
    -       -       -       6,390       -       6,390  
 Unrealized foreign currency translation adjustment, net
    -       -       -       10,665       -       10,665  
 Comprehensive loss
    -       -       -       -       -     $ (415,754 )
                                                 
 Balance, December 31, 2010
  $ 205,047     $ 1,138,942     $ (222,632 )   $ 22,136     $ 525,562          
                                                 
                                                 
 Net loss
    -       -       -       -       (33,661 )   $ (33,661 )
 Change in unrealized investment gains and losses, net
    -       -       -       (25,604 )     -       (25,604 )
 Reissuance of treasury stock, net
    -       (13,299 )     58,823       -       (51,305 )        
 Equity compensation
    -       3,381       -       -       -          
 Unrealized foreign currency translation adjustment
    -       -       -       917       -       917  
 Comprehensive loss (note 9)
    -       -       -       -       -     $ (58,348 )
                                                 
 Balance, March 31, 2011
  $ 205,047     $ 1,129,024     $ (163,809 )   $ (2,551 )   $ 440,596          
                                   
 
See accompanying notes to consolidated financial statements
 
 
4

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2011 and 2010
(Unaudited)
 
   
Three Months Ended
March 31,
 
             
   
2011
   
2010
 
   
(In thousands)
 
Cash flows from operating activities:
           
Net loss
  $ (33,661 )   $ (150,091 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    19,560       12,627  
Decrease in deferred insurance policy acquisition costs
    186       333  
(Increase) decrease in accrued investment income
    (3,382 )     1,543  
Decrease (increase) in reinsurance recoverable on loss reserves
    37,251       (7,200 )
Increase in reinsurance recoverable on paid losses
    (4,288 )     (5,101 )
Decrease in prepaid reinsurance premiums
    499       212  
Decrease in premium receivable
    3,732       3,390  
Decrease in loss reserves
    (412,677 )     (56,884 )
Decrease in premium deficiency reserve
    (9,019 )     (13,566 )
Decrease in unearned premiums
    (14,496 )     (15,686 )
Deferred tax benefit
    (25 )     (3,146 )
Increase in income taxes payable (current)
    1,345       8,546  
Realized investment gains, excluding impairment losses
    (5,761 )     (32,954 )
Net investment impairment losses
    -       6,052  
Other
    (197 )     54,876  
Net cash used in operating activities
    (420,933 )     (197,049 )
                 
Cash flows from investing activities:
               
Purchase of fixed maturities
    (900,110 )     (1,330,501 )
Purchase of equity securities
    (38 )     (30 )
Proceeds from sale of fixed maturities
    625,893       986,547  
Proceeds from maturity of fixed maturities
    498,726       157,828  
Net increase in payable for securities
    4,642       15,589  
Net cash provided by (used in) investing activities
    229,113       (170,567 )
                 
                 
Net cash provided by financing activities
    -       -  
                 
Net decrease in cash and cash equivalents
    (191,820 )     (367,616 )
Cash and cash equivalents at beginning of period
    1,304,154       1,185,739  
Cash and cash equivalents at end of period
  $ 1,112,334     $ 818,123  
 
See accompanying notes to consolidated financial statements.
 
 
5

 
 
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011
(Unaudited)

Note 1 - Basis of presentation

The accompanying unaudited consolidated financial statements of MGIC Investment Corporation and its wholly-owned subsidiaries have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (“SEC”) for interim reporting and do not include all of the other information and disclosures required by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2010 included in our Annual Report on Form 10-K. As used below, “we,” “our” and “us” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as the context requires.

In the opinion of management the accompanying financial statements include all adjustments, consisting primarily of normal recurring accruals, necessary to fairly state our financial position and results of operations for the periods indicated. The results of operations for the interim period may not be indicative of the results that may be expected for the year ending December 31, 2011.
 
Capital

The insurance laws or regulations of 16 jurisdictions, including Wisconsin, require a mortgage insurer to maintain a minimum amount of statutory capital relative to the risk in force (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the risk-to-capital requirement. While formulations of minimum capital may vary in certain jurisdictions, the most common measure applied allows for a maximum permitted risk-to-capital ratio of 25 to 1. At March 31, 2011, MGIC’s risk-to-capital ratio was 19.7 to 1 and the risk-to-capital ratio of our combined insurance operations (which includes reinsurance affiliates) was 23.0 to 1. Also, at March 31, 2011, MGIC’s policyholders position (policyholders position is the insurer’s net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums) exceeded the required regulatory minimum of our domiciliary state by approximately $237 million, and we exceeded the required minimum by approximately $306 million on a combined statutory basis. A high risk-to-capital ratio on a combined basis could affect MGIC’s ability to utilize reinsurance arrangements with its subsidiaries or subsidiaries of our holding company, absent a contribution of capital to such subsidiaries.  These reinsurance arrangements permit MGIC to write insurance with a higher coverage percentage than it could on its own under certain state-specific requirements.  Based upon internal company estimates, MGIC’s risk-to-capital ratio over the next few years, after giving effect to any contribution to MGIC of the proceeds from our April 2010 common stock and convertible notes offerings beyond the contribution already made, could reach 40 to 1 or even higher under a stress loss scenario.  

In December 2009, the Office of the Commissioner of Insurance of the State of Wisconsin (“OCI”) issued an order waiving, until December 31, 2011, its risk-to-capital requirement. MGIC has also applied for waivers in all other jurisdictions that have risk-to-capital requirements. MGIC has received waivers from some of these jurisdictions which expire at various times.  One waiver expired on December 31, 2010 and was not immediately renewed because the need for a waiver was not considered imminent.  MGIC may reapply for the waiver.  Some jurisdictions have denied the request and others may deny the request. The OCI and insurance departments of other jurisdictions, in their sole discretion, may modify, terminate or extend their waivers. If the OCI or another insurance department modifies or terminates its waiver, or if it fails to renew its waiver after expiration, depending on the circumstances, MGIC could be prevented from writing new business anywhere, in the case of the waiver from the OCI, or in the particular jurisdiction, in the case of the other waivers, if MGIC’s risk-to-capital ratio exceeds 25 to 1 unless MGIC obtained additional capital to enable it to comply with the risk-to-capital requirement. New insurance written in the jurisdictions that have risk-to-capital requirements represented approximately 50% of new insurance written in 2010 and the first quarter of 2011. If we were prevented from writing new business in all jurisdictions, our insurance operations in MGIC would be in run-off (meaning no new loans would be insured but loans previously insured would continue to be covered, with premiums continuing to be received and losses continuing to be paid on those loans) until MGIC either met the applicable risk-to-capital requirement or obtained a necessary waiver to allow it to once again write new business.

 
6

 
 
We cannot assure you that the OCI or any other jurisdiction that has granted a waiver of its risk-to-capital requirements will not modify or revoke the waiver, that it will renew the waiver when it expires or that MGIC could obtain the additional capital necessary to comply with the risk-to-capital requirement. Depending on the circumstances, the amount of additional capital we might need could be substantial.

We have implemented a plan to write new mortgage insurance in MGIC Indemnity Corporation (“MIC”) in selected jurisdictions in order to address the likelihood that in the future MGIC will not meet the minimum regulatory capital requirements discussed above and may not be able to obtain appropriate waivers of these requirements in all jurisdictions in which minimum requirements are present.  MIC has received the necessary approvals, including from the OCI, to write business in all of the jurisdictions in which MGIC would be prohibited from continuing to write new business in the event of MGIC’s failure to meet applicable regulatory capital requirements and obtain waivers of those requirements.

In October 2009, we, MGIC and MIC entered into an agreement with Fannie Mae (the “Fannie Mae Agreement”) under which MGIC agreed to contribute $200 million to MIC (which MGIC has done) and Fannie Mae approved MIC as an eligible mortgage insurer through December 31, 2011 subject to the terms of the Fannie Mae Agreement. Under the Fannie Mae Agreement, MIC will be eligible to write mortgage insurance only in those jurisdictions (other than Wisconsin) in which MGIC cannot write new insurance due to MGIC’s failure to meet regulatory capital requirements and if MGIC fails to obtain relief from those requirements or a specific waiver of them.

On February 11, 2010, Freddie Mac notified MGIC that it may utilize MIC to write new business in jurisdictions in which MGIC does not meet minimum regulatory capital requirements to write new business and does not obtain appropriate waivers of those requirements. This conditional approval to use MIC as a “Limited Insurer” (the “Freddie Mac Notification”) will expire December 31, 2012. This conditional approval includes terms substantially similar to those in the Fannie Mae Agreement.

Under the Fannie Mae Agreement, Fannie Mae approved MIC as an eligible mortgage insurer only through December 31, 2011.   Freddie Mac has approved MIC as a “Limited Insurer” only through December 31, 2012. Unless Fannie Mae and Freddie Mac extend or modify the terms of their approvals of MIC, whether MIC will continue as an eligible mortgage insurer after these dates will be determined by the applicable GSE’s mortgage insurer eligibility requirements then in effect. Further, under the Fannie Mae Agreement and the Freddie Mac Notification, MGIC cannot capitalize MIC with more than the $200 million contribution already made without prior approval from each GSE, which, in future years, may limit the amount of business MIC would otherwise write. Depending on the level of losses that MGIC experiences in the future, however, it is possible that regulatory action by one or more jurisdictions, including those that do not have specific regulatory capital requirements applicable to mortgage insurers, may prevent MGIC from continuing to write new insurance in some or all of the jurisdictions in which MIC is not an eligible mortgage insurer.

 
7

 
 
A failure to meet the specific minimum regulatory capital requirements to insure new business does not necessarily mean that MGIC does not have sufficient resources to pay claims on its insurance liabilities. While we believe that MGIC has sufficient claims paying resources to meet its claim obligations on its insurance in force, even in scenarios in which it fails to meet regulatory capital requirements, we cannot assure you that the events that led to MGIC failing to meet regulatory capital requirements would not also result in it not having sufficient claims paying resources. Furthermore, our estimates of MGIC’s claims paying resources and claim obligations are based on various assumptions. These assumptions include our anticipated rescission activity, future housing values and future unemployment rates. These assumptions are subject to inherent uncertainty and require judgment by management. Current conditions in the domestic economy make the assumptions about housing values and unemployment rates highly volatile in the sense that there is a wide range of reasonably possible outcomes. Our anticipated rescission activity is also subject to inherent uncertainty due to the difficulty of predicting the amount of claims that will be rescinded and the outcome of any legal proceedings related to rescissions that we make, including those with Countrywide (for more information about the Countrywide legal proceedings, see Note 5 – “Litigation and contingencies”).

Historically, rescissions of policies for which claims have been submitted to us were not a material portion of our claims resolved during a year. However, beginning in 2008, our rescissions of policies have materially mitigated our paid losses. In each of 2009 and 2010, rescissions mitigated our paid losses by approximately $1.2 billion and in the first quarter of 2011, rescissions mitigated our paid losses by approximately $0.2 billion (in each case, the figure includes amounts that would have either resulted in a claim payment or been charged to a deductible under a bulk or pool policy, and may have been charged to a captive reinsurer). While we have a substantial pipeline of claims investigations that we expect will eventually result in future rescissions, we expect that rescissions will not continue at the same rates (as a percentage of claims received) we have previously experienced. 

In addition, our loss reserving methodology incorporates the effects we expect rescission activity to have on the losses we will pay on our delinquent inventory. A variance between ultimate actual rescission rates and these estimates, as a result of the outcome of claims investigations, litigation, settlements or other factors, could materially affect our losses. We estimate rescissions mitigated our incurred losses by approximately $2.5 billion in 2009 and $0.2 billion in 2010.  For the first quarter of 2011, we estimate that rescissions had no material impact on our losses incurred.  All of these figures include the benefit of claims not paid in the period as well as the impact of changes in our estimated expected rescission activity on our loss reserves in the period. In recent quarters, between 20% and 28% of claims received in a quarter have been resolved by rescissions. At March 31, 2011, we had 195,885 loans in our primary delinquency inventory; the resolution of a significant portion of these loans will not involve paid claims.

 
8

 
 
If the insured disputes our right to rescind coverage, the outcome of the dispute ultimately would be determined by legal proceedings. Legal proceedings disputing our right to rescind coverage may be brought up to three years after the lender has obtained title to the property (typically through a foreclosure) or the property was sold in a sale that we approved, whichever is applicable, although in a few jurisdictions there is a longer time to bring such an action. For nearly all of our rescissions that are not subject to a settlement agreement, the period in which a dispute may be brought has not ended. We consider a rescission resolved for reporting purposes even though legal proceedings have been initiated and are ongoing.  Although it is reasonably possible that, when the proceedings are completed, there will be a determination that we were not entitled to rescind in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability.  Under Accounting Standards Codification (“ASC”) 450-20, an estimated loss from such proceedings is accrued for only if we determine that the loss is probable and can be reasonably estimated.  Therefore, when establishing our loss reserves, we do not include additional loss reserves that would reflect an adverse outcome from ongoing legal proceedings, including those with Countrywide.  Countrywide has filed a lawsuit against MGIC alleging that MGIC has denied, and continues to deny, valid mortgage insurance claims.  MGIC has filed an arbitration case against Countrywide regarding rescissions and Countrywide has responded seeking damages, including exemplary damages. For more information about this lawsuit and arbitration case, see Note 5 – “Litigation and contingencies.”

In 2010, we entered into a settlement agreement with a lender-customer regarding our rescission practices and we may enter into additional settlement agreements with other lenders in the future.

We continue to discuss with other lenders their objections to material rescissions.  In addition to the proceedings involving Countrywide, we are involved in legal proceedings with respect to rescissions that we do not consider to be collectively material in amount.  Although it is reasonably possible that, when these discussions or proceedings are completed, there will be a conclusion or determination that we were not entitled to rescind in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability.
 
Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2010 amounts to conform to 2011 presentation.
 
Subsequent events

We have considered subsequent events through the date of this filing.
 
Note 2 - New Accounting Guidance

In October 2010, new guidance was issued on accounting for costs associated with acquiring or renewing insurance contracts. The new guidance will likely change how insurance companies account for acquisition costs, particularly in determining what costs are deferrable. The new requirements are effective for fiscal years beginning after December 15, 2011, either prospectively or by retrospective adjustment. We are currently evaluating the provisions of this guidance and the impact on our financial statements and disclosures.
 
 
9

 
 
Note 3 – Debt

Senior Notes

At March 31, 2011 and December 31, 2010 we had outstanding $77.4 million, 5.625% Senior Notes due in September 2011 and $300 million, 5.375% Senior Notes due in November 2015. Covenants in the Senior Notes include the requirement that there be no liens on the stock of the designated subsidiaries unless the Senior Notes are equally and ratably secured; that there be no disposition of the stock of designated subsidiaries unless all of the stock is disposed of for consideration equal to the fair market value of the stock; and that we and the designated subsidiaries preserve our corporate existence, rights and franchises unless we or such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the Senior Notes.  A designated subsidiary is any of our consolidated subsidiaries which has shareholders’ equity of at least 15% of our consolidated shareholders’ equity. We were in compliance with all covenants at March 31, 2011.

If we fail to meet any of the covenants of the Senior Notes discussed above; there is a failure to pay when due at maturity, or a default results in the acceleration of maturity of, any of our other debt in an aggregate amount of $40 million or more; or we fail to make a payment of principal of the Senior Notes when due or a payment of interest on the Senior Notes within thirty days after due and we are not successful in obtaining an agreement from holders of a majority of the applicable series of Senior Notes to change (or waive) the applicable requirement or payment default, then the holders of 25% or more of either series of our Senior Notes each would have the right to accelerate the maturity of that series.  In addition, the trustee, U.S. Bank National Association, of these two issues of Senior Notes could, independent of any action by holders of Senior Notes, accelerate the maturity of the Senior Notes.

At March 31, 2011 and December 31, 2010, the fair value of the amount outstanding under our Senior Notes was $361.3 million and $355.6 million, respectively. The fair value was determined using publicly available trade information.

Interest payments on the Senior Notes were $2.2 million for each of the three months ended March 31, 2011 and 2010.

Convertible Senior Notes

At March 31, 2011 and December 31, 2010 we had outstanding $345 million principal amount of 5% Convertible Senior Notes due in 2017. Interest on the Convertible Senior Notes is payable semi-annually in arrears on May 1 and November 1 of each year. We do not have the right to defer interest payments on the Convertible Senior Notes. The Convertible Senior Notes will mature on May 1, 2017, unless earlier converted by the holders or repurchased by us. Covenants in the Convertible Senior Notes include a requirement to notify holders in advance of certain events and that we and the designated subsidiaries (defined above) preserve our corporate existence, rights and franchises unless we or such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the Convertible Senior Notes.

 
10

 
 
If we fail to meet any of the covenants of the Convertible Senior Notes; there is a failure to pay when due at maturity, or a default results in the acceleration of maturity of, any of our other debt in an aggregate amount of $40 million or more; a final judgment for the payment of $40 million or more (excluding any amounts covered by insurance) is rendered against us or any of our subsidiaries which judgment is not discharged or stayed within certain time limits; or we fail to make a payment of principal of the Convertible Senior Notes when due or a payment of interest on the Convertible Senior Notes within thirty days after due and we are not successful in obtaining an agreement from holders of a majority of the Convertible Senior Notes to change (or waive) the applicable requirement or payment default, then the holders of 25% or more of the Convertible Senior Notes would have the right to accelerate the maturity of those notes. In addition, the trustee of the Convertible Senior Notes could, independent of any action by holders, accelerate the maturity of the Convertible Senior Notes.

The Convertible Senior Notes are convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount at any time prior to the maturity date. This represents an initial conversion price of approximately $13.44 per share. These Convertible Senior Notes will be equal in right of payment to our existing Senior Notes, discussed above, and will be senior in right of payment to our existing Convertible Junior Debentures, discussed below. Debt issuance costs are being amortized to interest expense over the contractual life of the Convertible Senior Notes. The provisions of the Convertible Senior Notes are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the notes, which are contained in the Supplemental Indenture, dated as of April 26, 2010, between us and U.S. Bank National Association, as trustee, and the Indenture dated as of October 15, 2000, between us and the trustee.

At March 31, 2011 and December 31, 2010, the fair value of the amount outstanding under our Convertible Senior Notes was $377.8 million and $400.5 million, respectively. The fair value was determined using publicly available trade information.

There were no interest payments on the Convertible Senior Notes in the three months ended March 31, 2011 or 2010.

Convertible Junior Subordinated Debentures

At March 31, 2011 and December 31, 2010 we had outstanding $389.5 million principal amount of 9% Convertible Junior Subordinated Debentures due in 2063 (the “debentures”). The debentures have an effective interest rate of 19% that reflects our non-convertible debt borrowing rate at the time of issuance. At March 31, 2011 and December 31, 2010 the amortized value of the principal amount of the debentures is reflected as a liability on our consolidated balance sheet of $322.3 million and $315.6 million, respectively, with the unamortized discount reflected in equity. The debentures rank junior to all of our existing and future senior indebtedness.

Interest on the debentures is payable semi-annually in arrears on April 1 and October 1 of each year. As long as no event of default with respect to the debentures has occurred and is continuing, we may defer interest, under an optional deferral provision, for one or more consecutive interest periods up to ten years without giving rise to an event of default. Deferred interest will accrue additional interest at the rate then applicable to the debentures. During an optional deferral period we may not pay or declare dividends on our common stock. Violations of the covenants under the Indenture governing the debentures, including covenants to provide certain documents to the trustee, are not events of default under the Indenture and would not allow the acceleration of amounts that we owe under the debentures.  Similarly, events of default under, or acceleration of, any of our other obligations, including those described above, would not allow the acceleration of amounts that we owe under the debentures.  However, violations of the events of default under the Indenture, including a failure to pay principal when due under the debentures and certain events of bankruptcy, insolvency or receivership involving our holding company would allow acceleration of amounts that we owe under the debentures.

 
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Interest on the debentures that would have been payable on the scheduled interest payment dates of April 1, 2009, October 1, 2009 and April 1, 2010 had been deferred for up to 10 years past the scheduled payment date. During this deferral period the deferred interest continued to accrue and compound semi-annually at an annual rate of 9%.

On October 1, 2010 we paid each of those deferred interest payments, including the compound interest on each.  The interest payments, totaling approximately $57.5 million, were made from the net proceeds of our April 2010 common stock offering.  We also paid the regular October 1, 2010 interest payment due on the debentures of approximately $17.5 million. We continue to have the right to defer interest that is payable on subsequent scheduled interest payment dates if we give the required 15 day notice. Any deferral of such interest would be on terms equivalent to those described above.

When interest on the debentures is deferred, we are required, not later than a specified time, to use reasonable commercial efforts to begin selling qualifying securities to persons who are not our affiliates. The specified time is one business day after we pay interest on the debentures that was not deferred, or if earlier, the fifth anniversary of the scheduled interest payment date on which the deferral started. Qualifying securities are common stock, certain warrants and certain non-cumulative perpetual preferred stock. The requirement to use such efforts to sell such securities is called the Alternative Payment Mechanism.

The net proceeds of Alternative Payment Mechanism sales are to be applied to the payment of deferred interest, including the compound portion. We cannot pay deferred interest other than from the net proceeds of Alternative Payment Mechanism sales, except at the final maturity of the debentures or at the tenth anniversary of the start of the interest deferral. The Alternative Payment Mechanism does not require us to sell common stock or warrants before the fifth anniversary of the interest payment date on which that deferral started if the net proceeds (counting any net proceeds of those securities previously sold under the Alternative Payment Mechanism) would exceed the 2% cap. The 2% cap is 2% of the average closing price of our common stock times the number of our outstanding shares of common stock. The average price is determined over a specified period ending before the issuance of the common stock or warrants being sold, and the number of outstanding shares is determined as of the date of our most recent publicly released financial statements.

We are not required to issue under the Alternative Payment Mechanism a total of more than 10 million shares of common stock, including shares underlying qualifying warrants. In addition, we may not issue under the Alternative Payment Mechanism qualifying preferred stock if the total net proceeds of all issuances would exceed 25% of the aggregate principal amount of the debentures.

The Alternative Payment Mechanism does not apply during any period between scheduled interest payment dates if there is a “market disruption event” that occurs over a specified portion of such period. Market disruption events include any material adverse change in domestic or international economic or financial conditions.

 
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The provisions of the Alternative Payment Mechanism are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the debentures, which are contained in the Indenture, dated as of March 28, 2008, between us and U.S. Bank National Association, as trustee.

We may redeem the debentures prior to April 6, 2013, in whole but not in part, only in the event of a specified tax or rating agency event, as defined in the Indenture. In any such event, the redemption price will be equal to the greater of (1) 100% of the principal amount of the debentures being redeemed and (2) the applicable make-whole amount, as defined in the Indenture, in each case plus any accrued but unpaid interest. On or after April 6, 2013, we may redeem the debentures in whole or in part from time to time, at our option, at a redemption price equal to 100% of the principal amount of the debentures being redeemed, plus any accrued and unpaid interest, if the closing sale price of our common stock exceeds 130% of the then prevailing conversion price of the debentures for at least 20 of the 30 trading days preceding notice of the redemption. We will not be able to redeem the debentures, other than in the event of a specified tax event or rating agency event, during an optional deferral period.

The debentures are currently convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.0741 common shares per $1,000 principal amount of debentures at any time prior to the maturity date. This represents an initial conversion price of approximately $13.50 per share. If a holder elects to convert their debentures, deferred interest owed on the debentures being converted is also converted into shares of our common stock. The conversion rate for any deferred interest is based on the average price that our shares traded at during a 5-day period immediately prior to the election to convert. In lieu of issuing shares of common stock upon conversion of the debentures occurring after April 6, 2013, we may, at our option, make a cash payment to converting holders equal to the value of all or some of the shares of our common stock otherwise issuable upon conversion.

The fair value of the debentures was approximately $404.1 million and $432.4 million, respectively, at March 31, 2011 and December 31, 2010, as determined using available pricing for these debentures or similar instruments.

There were no interest payments on the debentures for the three months ended March 31, 2011 and 2010.

Note 4 – Reinsurance
 
The reinsurance recoverable on loss reserves as of March 31, 2011 and December 31, 2010 was $238.0 million and $275.3 million, respectively. Within those amounts, the reinsurance recoverable on loss reserves related to captive agreements was approximately $214 million at March 31, 2011 and $248 million at December 31, 2010. The total fair value of the trust fund assets under our captive agreements at March 31, 2011 was $486 million, compared to $510 million at December 31, 2010.  Trust fund assets of $1 million were transferred to us as a result of captive terminations during the first three months of 2011.
 
 
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Note 5 – Litigation and contingencies

In addition to the matters described below, we are involved in legal proceedings in the ordinary course of business. In our opinion, based on the facts known at this time, the ultimate resolution of these ordinary course legal proceedings will not have a material adverse effect on our financial position or results of operations.

Consumers are bringing a growing number of lawsuits against home mortgage lenders and settlement service providers. Mortgage insurers, including MGIC, have been involved in litigation alleging violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA. MGIC settled class action litigation against it under RESPA in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in December 2004 following denial of class certification in June 2004. Since December 2006, class action litigation has been brought against a number of large lenders alleging that their captive mortgage reinsurance arrangements violated RESPA. On November 29, 2010, six mortgage insurers (including MGIC) and a large mortgage lender (which was the named plaintiffs’ lender) were named as defendants in a complaint, alleged to be a class action, filed in Federal District Court for the District of Columbia.  The complaint alleges various causes of action related to the captive mortgage reinsurance arrangements of this mortgage lender, including that the defendants violated RESPA by paying the lender’s captive reinsurer excessive premiums in relation to the risk assumed by that captive. The named plaintiffs’ loan was not insured by MGIC and it is our understanding that it was not reinsured by this mortgage lender’s captive reinsurance affiliates.  In March 2011, the complaint was voluntarily dismissed by the plaintiffs as to MGIC and all of the other mortgage insurers.  There can be no assurance that we will not be subject to future litigation under RESPA (or FCRA) or that the outcome of any such litigation would not have a material adverse effect on us.

We are subject to comprehensive, detailed regulation by state insurance departments. These regulations are principally designed for the protection of our insured policyholders, rather than for the benefit of investors. Although their scope varies, state insurance laws generally grant broad supervisory powers to agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business. Given the recent significant losses incurred by many insurers in the mortgage and financial guaranty industries, our insurance subsidiaries have been subject to heightened scrutiny by insurance regulators. State insurance regulatory authorities could take actions, including changes in capital requirements or termination of waivers of capital requirements, that could have a material adverse effect on us. In addition, the Dodd-Frank Act, the financial reform legislation that was passed in July 2010, establishes the Bureau of Consumer Financial Protection to regulate the offering and provision of consumer financial products or services under federal law. We are uncertain whether this Bureau will issue any rules or regulations that affect our business. Such rules and regulations could have a material adverse effect on us.

In June 2005, in response to a letter from the New York Insurance Department, we provided information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation. In February 2006, the New York Insurance Department requested MGIC to review its premium rates in New York and to file adjusted rates based on recent years’ experience or to explain why such experience would not alter rates. In March 2006, MGIC advised the New York Insurance Department that it believes its premium rates are reasonable and that, given the nature of mortgage insurance risk, premium rates should not be determined only by the experience of recent years. In February 2006, in response to an administrative subpoena from the Minnesota Department of Commerce (the “MN Department”), which regulates insurance, we provided the MN Department with information about captive mortgage reinsurance and certain other matters. We subsequently provided additional information to the MN Department, and beginning in March 2008 the MN Department has sought additional information as well as answers to questions regarding captive mortgage reinsurance on several occasions. In addition, beginning in June 2008, we have received subpoenas from the Department of Housing and Urban Development, commonly referred to as HUD, seeking information about captive mortgage reinsurance similar to that requested by the MN Department, but not limited in scope to the state of Minnesota. Other insurance departments or other officials, including attorneys general, may also seek information about or investigate captive mortgage reinsurance.

 
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The anti-referral fee provisions of RESPA provide that HUD as well as the insurance commissioner or attorney general of any state may bring an action to enjoin violations of these provisions of RESPA. The insurance law provisions of many states prohibit paying for the referral of insurance business and provide various mechanisms to enforce this prohibition. While we believe our captive reinsurance arrangements are in conformity with applicable laws and regulations, it is not possible to predict the outcome of any such reviews or investigations nor is it possible to predict their effect on us or the mortgage insurance industry.

Five previously-filed purported class action complaints filed against us and several of our executive officers were consolidated in March 2009 in the United States District Court for the Eastern District of Wisconsin and Fulton County Employees’ Retirement System was appointed as the lead plaintiff. The lead plaintiff filed a Consolidated Class Action Complaint (the “Complaint”) on June 22, 2009. Due in part to its length and structure, it is difficult to summarize briefly the allegations in the Complaint but it appears the allegations are that we and our officers named in the Complaint violated the federal securities laws by misrepresenting or failing to disclose material information about (i) loss development in our insurance in force, and (ii) C-BASS, including its liquidity. Our motion to dismiss the Complaint was granted on February 18, 2010. On March 18, 2010, plaintiffs filed a motion for leave to file an amended complaint. Attached to this motion was a proposed Amended Complaint (the “Amended Complaint”). The Amended Complaint alleged that we and two of our officers named in the Amended Complaint violated the federal securities laws by misrepresenting or failing to disclose material information about C-BASS, including its liquidity, and by failing to properly account for our investment in C-BASS. The Amended Complaint also named two officers of C-BASS with respect to the Amended Complaint’s allegations regarding C-BASS. The purported class period covered by the Amended Complaint began on February 6, 2007 and ended on August 13, 2007. The Amended Complaint sought damages based on purchases of our stock during this time period at prices that were allegedly inflated as a result of the purported violations of federal securities laws. On December 8, 2010, the plaintiffs’ motion to file an amended complaint was denied and the Complaint was dismissed with prejudice.  On January 6, 2011, the plaintiffs appealed the February 18, 2010 and December 8, 2010 decisions to the United States Court of Appeals for the Seventh Circuit.  We are unable to predict the outcome of these consolidated cases or estimate our associated expenses or possible losses. Other lawsuits alleging violations of the securities laws could be brought against us.

Several law firms have issued press releases to the effect that they are investigating us, including whether the fiduciaries of our 401(k) plan breached their fiduciary duties regarding the plan’s investment in or holding of our common stock or whether we breached other legal or fiduciary obligations to our shareholders. We intend to defend vigorously any proceedings that may result from these investigations.

 
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With limited exceptions, our bylaws provide that our officers and 401(k) plan fiduciaries are entitled to indemnification from us for claims against them.

On December 17, 2009, Countrywide filed a complaint for declaratory relief in the Superior Court of the State of California in San Francisco (the “California State Court”) against MGIC. This complaint alleges that MGIC has denied, and continues to deny, valid mortgage insurance claims submitted by Countrywide and says it seeks declaratory relief regarding the proper interpretation of the insurance policies at issue. On January 19, 2010, we removed this case to the United States District Court for the Northern District of California (the “District Court”). On March 30, 2010, the District Court ordered the case remanded to the California State Court. We have appealed this decision to the United States Court of Appeals for the Ninth Circuit (the “Court of Appeals”) and asked the Court of Appeals to vacate the remand and stay proceedings in the District Court. On May 17, 2010, the Court of Appeals denied a stay of the District Court’s remand order. On May 28, 2010, Countrywide filed an amended complaint substantially similar to the original complaint in the California State Court. On July 2, 2010, we filed a petition in the California State Court to compel arbitration and stay the litigation in that court.  On August 26, 2010, Countrywide filed an opposition to our petition.  Countrywide’s opposition states that there are thousands of loans for which it disputes MGIC’s interpretation of the flow insurance policies at issue. On September 16, 2010, we filed a reply to Countrywide’s opposition.  On October 1, 2010, the California State Court stayed the litigation in that court pending a final ruling on our appeal.

In connection with the Countrywide dispute discussed above, on February 24, 2010, we commenced an arbitration action against Countrywide seeking a determination that MGIC was entitled to deny and/or rescind coverage on the loans involved in the arbitration action, which were insured through the flow channel and numbered more than 1,400 loans as of the filing of the action.  On March 16, 2010, Countrywide filed a response to our arbitration action objecting to the arbitrator’s jurisdiction in view of the case initiated by Countrywide in the California State Court and asserting various defenses to the relief sought by MGIC in the arbitration. On December 20, 2010, we filed an amended demand in the arbitration proceeding.  This amended demand increased the number of loans for which we denied and/or rescinded coverage and which were insured through the flow channel to more than 3,300.  We continue to rescind insurance coverage on additional Countrywide loans.  On December 20, 2010 Countrywide filed an amended response. In the amended response, Countrywide is seeking relief for rescissions on loans insured by MGIC through the flow channel and more than 30 bulk insurance policies.   In April 2011, Countrywide indicated that it believes MGIC has improperly rescinded coverage on more than 5,000 loans. The amended response also seeks damages as a result of purported breaches of insurance policies issued by MGIC and additional damages, including exemplary damages, on account of MGIC’s purported breach of an implied covenant of good faith and fair dealing. The amended response states that Countrywide seeks damages “well-exceeding” $150 million; the original response sought damages of at least $150 million.  On January 17, 2011, Countrywide filed an answer to MGIC’s amended demand and MGIC filed an answer to Countrywide’s amended response.  Countrywide and MGIC have each selected 12 loans for which a three-member arbitration panel will determine coverage.  While the panel’s determination will not be binding on the other loans at issue, the panel will identify the issues for these 24 “bellwether” loans and strive to set forth findings of fact and conclusions of law in such a way as to aid the parties to apply them to the other loans at issue.  The hearing before the panel on the bellwether loans that had previously been scheduled to begin in October 2011 has been postponed to May 2012.

 
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From January 1, 2008 through March 31, 2011, rescissions of Countrywide-related loans mitigated our paid losses on the order of $360 million. This amount is the amount we estimate we would have paid had the loans not been rescinded.  On a per loan basis, the average amount that we would have paid had the loans not been rescinded was approximately $72 thousand.  At March 31, 2011, 41,696 loans in our primary delinquency inventory were Countrywide-related loans (approximately 21% of our primary delinquency inventory).  Of these 41,696 loans, some will cure their delinquency and the remainder will either become paid claims or will be rescinded.  From January 1, 2008 through March 31, 2011, of the claims on Countrywide-related loans that were resolved (a claim is resolved when it is paid or rescinded; claims that are submitted but which are under review are not resolved until one of these two outcomes occurs), approximately 72% were paid and the remaining 28% were rescinded.

The flow policies at issue with Countrywide are in the same form as the flow policies that we use with all of our customers, and the bulk policies at issue vary from one another, but are generally similar to those used in the majority of our Wall Street bulk transactions. Because our rescission practices with Countrywide do not differ from our practices with other servicers with which we have not entered into settlement agreements, an adverse result in the Countrywide proceeding may adversely affect the ultimate result of rescissions involving other servicers and lenders.  From January 1, 2008 through March 31, 2011, we estimate that total rescissions mitigated our incurred losses by approximately $3.1 billion, which included approximately $2.2 billion of mitigation on paid losses, excluding amounts that would have been applied to a deductible. At March 31, 2011, we estimate that our total loss reserves were benefited from rescissions by approximately $1.1 billion.

We intend to defend MGIC against Countrywide’s complaint and arbitration response, and to pursue MGIC’s claims in the arbitration, vigorously. However, we are unable to predict the outcome of these proceedings or their effect on us. Also, although it is reasonably possible that, when the proceedings are completed, there will be a determination that we were not entitled to rescind in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. Under ASC 450-20, an estimated loss is accrued for only if we determine that the loss is probable and can be reasonably estimated. Therefore, we have not accrued any reserves that would reflect an adverse outcome in this proceeding.  An accrual for an adverse outcome in this (or any other) proceeding would be a reduction to our capital.

In addition to the rescissions at issue with Countrywide, we have a substantial pipeline of claims investigations (including investigations involving loans related to Countrywide) that we expect will eventually result in future rescissions. In 2010, we entered into a settlement agreement with a lender-customer regarding our rescission practices. We continue to discuss with other lenders their objections to material rescissions.  In addition to the proceedings involving Countrywide, we are involved in legal proceedings with respect to rescissions that we do not consider to be collectively material in amount.  

Our mortgage insurance business utilizes its underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. As part of our contract underwriting activities, we are responsible for the quality of our underwriting decisions in accordance with the terms of the contract underwriting agreements with customers. We may be required to provide certain remedies to our customers if certain standards relating to the quality of our underwriting work are not met, and we have an established reserve for such obligations. Through March 31, 2011, the cost of remedies provided by us to customers for failing to meet the standards of the contracts has not been material. However, a generally positive economic environment for residential real estate that continued until approximately 2007 may have mitigated the effect of some of these costs, and claims for remedies may be made a number of years after the underwriting work was performed. A material portion of our new insurance written through the flow channel in recent years, including for 2006 and 2007, has involved loans for which we provided contract underwriting services. We believe the rescission of mortgage insurance coverage on loans for which we provided contract underwriting services may make a claim for a contract underwriting remedy more likely to occur. Beginning in the second half of 2009, we experienced an increase in claims for contract underwriting remedies, which continued into the first three months of 2011. Hence, there can be no assurance that contract underwriting remedies will not be material in the future.
 
 
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See Note 11 – “Income taxes” for a description of federal income tax contingencies.
 
Note 6 – Earnings (loss) per share

Our basic EPS is based on the weighted average number of common shares outstanding, which excludes participating securities of 1.3 million and 1.8 million for the three months ended March 31, 2011 and 2010, respectively, because they were anti-dilutive due to our reported net loss.  Typically, diluted EPS is based on the weighted average number of common shares outstanding plus common stock equivalents which include certain stock awards, stock options and the dilutive effect of our convertible debt. In accordance with accounting guidance, if we report a net loss from continuing operations then our diluted EPS is computed in the same manner as the basic EPS. In addition if any common stock equivalents are anti-dilutive they are always excluded from the calculation. The following includes a reconciliation of the weighted average number of shares; however for the three months ended March 31, 2011 and 2010 common stock equivalents of 55.6 million and 34.1 million, respectively, were not included because they were anti-dilutive.
 
   
Three Months Ended
March 31,
 
             
   
2011
   
2010
 
   
(In thousands, except per share data)
 
             
Basic earnings per share:
           
             
Average common shares outstanding
    200,744       124,889  
                 
Net loss
  $ (33,661 )   $ (150,091 )
                 
Basic (loss) earnings per share
  $ (0.17 )   $ (1.20 )
                 
                 
Diluted earnings per share:
               
                 
Weighted-average shares - Basic
    200,744       124,889  
Common stock equivalents
    -       -  
                 
Weighted-average shares - Diluted
    200,744       124,889  
                 
Net loss
  $ (33,661 )   $ (150,091 )
                 
Diluted (loss) earnings per share
  $ (0.17 )   $ (1.20 )
 
 
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Note 7 – Investments

The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at March 31, 2011 and December 31, 2010 are shown below.

March 31, 2011
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses (1)
   
Fair
Value
 
   
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 1,050,169     $ 12,039     $ (9,045 )   $ 1,053,163  
Obligations of U.S. states and political subdivisions
    3,427,750       77,439       (57,468 )     3,447,721  
Corporate debt securities
    2,367,780       47,360       (11,845 )     2,403,295  
Commercial mortgage-backed securities
    52,204       42       (92 )     52,154  
Residential mortgage-backed securities
    89,641       3,055       (23 )     92,673  
Debt securities issued by foreign sovereign governments
    149,721       2,328       (700 )     151,349  
   Total debt securities
  $ 7,137,265     $ 142,263     $ (79,173 )   $ 7,200,355  
Equity securities
    3,087       25       (49 )     3,063  
                                 
   Total investment portfolio
  $ 7,140,352     $ 142,288     $ (79,222 )   $ 7,203,418  

 
December 31, 2010
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses (1)
   
Fair
Value
 
   
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 1,092,890     $ 16,718     $ (6,822 )   $ 1,102,786  
Obligations of U.S. states and political subdivisions
    3,549,355       85,085       (54,374 )     3,580,066  
Corporate debt securities
    2,521,275       54,975       (11,291 )     2,564,959  
Residential mortgage-backed securities
    53,845       3,255       -       57,100  
Debt securities issued  by foreign sovereign governments
    149,443       1,915       (1,031 )     150,327  
   Total debt securities
  $ 7,366,808     $ 161,948     $ (73,518 )   $ 7,455,238  
Equity securities
    3,049       40       (45 )     3,044  
                                 
   Total investment portfolio
  $ 7,369,857     $ 161,988     $ (73,563 )   $ 7,458,282  
 
(1) At March 31, 2011 and December 31, 2010, there were no other-than-temporary impairment losses recorded in other comprehensive income.

The amortized cost and fair values of debt securities at March 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Because most auction rate and mortgage-backed securities provide for periodic payments throughout their lives, they are listed below in separate categories.

 
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March 31, 2011
 
Amortized
Cost
   
Fair
Value
 
   
(In thousands)
 
             
Due in one year or less
  $ 770,094     $ 773,418  
Due after one year through five years
    2,957,778       3,007,384  
Due after five years through ten years
    1,438,797       1,463,656  
Due after ten years
    1,481,303       1,476,765  
                 
    $ 6,647,972     $ 6,721,223  
                 
Commercial mortgage-backed securities
    52,204       52,154  
Residential mortgage-backed securities
    89,641       92,673  
Auction rate securities (1)
    347,448       334,305  
                 
Total at March 31, 2011
  $ 7,137,265     $ 7,200,355  
 
     (1) At March 31, 2011, approximately 97% of auction rate securities had a contractual maturity greater than 10 years.
 
At March 31, 2011 and December 31, 2010, the investment portfolio had gross unrealized losses of $79.2 million and $73.6 million, respectively.  For those securities in an unrealized loss position, the length of time the securities were in such a position, as measured by their month-end fair values, is as follows:

 
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Less Than 12 Months
 
12 Months or Greater
 
Total
 
March 31, 2011
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 461,019     $ 9,045     $ -     $ -     $ 461,019     $ 9,045  
Obligations of U.S. states and political subdivisions
    1,008,292       34,360       321,560       23,108       1,329,852       57,468  
Corporate debt securities
    686,693       10,652       43,997       1,193       730,690       11,845  
Commercial mortgage-backed securities
    31,876       92       -       -       31,876       92  
Residential mortgage-backed securities
    37,193       23       -       -       37,193       23  
Debt issued by foreign sovereign governments
    47,315       368       4,551       332       51,866       700  
Equity securities
    1,371       49       -       -       1,371       49  
  Total investment portfolio
  $ 2,273,759     $ 54,589     $ 370,108     $ 24,633     $ 2,643,867     $ 79,222  
 
 
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
December 31, 2010
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
(In thousands)
 
U.S. Treasury securities and obligations of U.S.government corporations and agencies
  $ 258,235     $ 6,822     $ -     $ -     $ 258,235     $ 6,822  
Obligations of U.S. states and political subdivisions
    1,160,877       32,415       359,629       21,959       1,520,506       54,374  
Corporate debt securities
    817,471       9,921       28,630       1,370       846,101       11,291  
Residential mortgage-backed securities
    -       -       -       -       -       -  
Debt issued by foreign sovereign governments
    105,724       1,031       -       -       105,724       1,031  
Equity securities
    2,723       45       -       -       2,723       45  
  Total investment portfolio
  $ 2,345,030     $ 50,234     $ 388,259     $ 23,329     $ 2,733,289     $ 73,563  
 
The unrealized losses in all categories of our investments were primarily caused by the difference in interest rates at March 31, 2011 and December 31, 2010, compared to the interest rates at the time of purchase as well as the discount rate applied in our auction rate securities discounted cash flow model. The securities in an unrealized loss position for 12 months or greater are primarily auction rate securities (“ARS”) backed by student loans. See further discussion of these securities below. One security was in an unrealized loss position greater than 12 months at March 31, 2011 with a fair value less than 80% of amortized cost.

We held $334.3 million in ARS backed by student loans at March 31, 2011. ARS are intended to behave like short-term debt instruments because their interest rates are reset periodically through an auction process, most commonly at intervals of 7, 28 and 35 days. The same auction process has historically provided a means by which we may rollover the investment or sell these securities at par in order to provide us with liquidity as needed.  The ARS we hold are collateralized by portfolios of student loans, substantially all of which are ultimately 97% guaranteed by the United States Department of Education.  At March 31, 2011, approximately 89% of our ARS portfolio was rated AAA/Aaa by one or more of the following major rating agencies: Moody’s, Standard & Poor’s and Fitch Ratings.

 
21

 
 
In mid-February 2008, auctions began to fail due to insufficient buyers, as the amount of securities submitted for sale in auctions exceeded the aggregate amount of the bids.  For each failed auction, the interest rate on the security moves to a maximum rate specified for each security, and generally resets at a level higher than specified short-term interest rate benchmarks.  At March 31, 2011, our entire ARS portfolio, consisting of 32 investments, was subject to failed auctions; however, from the period when the auctions began to fail through March 31, 2011, $190.4 million in par value of ARS was either sold or called, with the average amount we received being approximately 98% of par which approximated the aggregate fair value prior to redemption. To date, we have collected all interest due on our ARS.

As a result of the persistent failed auctions, and the uncertainty of when these investments could be liquidated at par, the investment principal associated with failed auctions will not be accessible until successful auctions occur, a buyer is found outside of the auction process, the issuers establish a different form of financing to replace these securities, or final payments come due according to the contractual maturities of the debt issues. However, we continue to believe we will have liquidity to our ARS portfolio by December 31, 2014.

Under the current guidance a debt security impairment is deemed other than temporary if we either intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery or we do not expect to collect cash flows sufficient to recover the amortized cost basis of the security. During the first three months of 2011 there were no other-than-temporary impairments (“OTTI”) recognized compared to $6.1 million during the first three months of 2010.

The following table provides a rollforward of the amount related to credit losses recognized in earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income (loss) for the three months ended March 31, 2011 and 2010.

   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
   
(In thousands)
 
             
Beginning balance
  $ -       1,021  
  Addition for the amount related to the credit loss for which an OTTI was not previously recognized
    -       -  
  Additional increases to the amount related to the credit loss for which an OTTI was previously recognized
    -       -  
  Reductions for securities sold during the period (realized)
    -       -  
Ending balance
  $ -     $ 1,021  
 
The net realized investment gains (losses) and OTTI on the investment portfolio are as follows:

 
22

 
 
   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
 
(In thousands)
 
Net realized investment gains (losses) and OTTI on investments:
           
      Fixed maturities
  $ 5,729     $ 26,636  
      Equity securities
    32       38  
      Other
    -       228  
                 
    $ 5,761     $ 26,902  
 
 
   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
 
(In thousands)
 
Net realized investment gains (losses) and OTTI on investments:
           
      Gains on sales
  $ 8,392     $ 35,980  
      Losses on sales
    (2,631 )     (3,026 )
      Impairment losses
    -       (6,052 )
                 
    $ 5,761     $ 26,902  
 
The net realized gains on investments during the first three months of 2010 and 2011 were a result of the continued restructuring of the portfolio into shorter duration, taxable securities.  Such sales were made to reduce the proportion of our investment portfolio held in tax-exempt municipal securities and to increase the proportion held in taxable securities principally since the tax benefits of holding tax exempt municipal securities are no longer available based on our recent net operating losses and to shorten the duration of the portfolio to provide liquidity to meet our anticipated claim payment obligations.
 
Note 8 – Fair value measurements
 
In accordance with fair value guidance, we applied the following fair value hierarchy in order to measure fair value for assets and liabilities:

Level 1 – Quoted prices for identical instruments in active markets that we have the ability to access. Financial assets utilizing Level 1 inputs primarily include certain U.S. Treasury securities and obligations of the U.S. government.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and inputs, other than quoted prices, that are observable in the marketplace for the financial instrument. The observable inputs are used in valuation models to calculate the fair value of the financial instruments. Financial assets utilizing Level 2 inputs primarily include certain municipal and corporate bonds.

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable. Level 3 inputs reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Financial assets utilizing Level 3 inputs include certain state and auction rate (backed by student loans) securities. Non-financial assets which utilize Level 3 inputs include real estate acquired through claim settlement.

 
23

 

To determine the fair value of securities available-for-sale in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model.  Quality controls are performed throughout this process, which include reviewing tolerance reports, trading information and data changes, and directional moves compared to market moves. This model combines all inputs to arrive at a value assigned to each security.  In addition, on a quarterly basis, we perform quality controls over values received from the pricing sources which include reviewing tolerance reports, trading information and data changes, and directional moves compared to market moves. We have not made any adjustments to the prices obtained from the independent pricing sources.

Assets classified as Level 3 are as follows:

·
Securities available-for-sale classified in Level 3 are not readily marketable and are valued using internally developed models based on the present value of expected cash flows. Our Level 3 securities primarily consist of auction rate securities as observable inputs or value drivers are unavailable due to events described in Note 7 – “Investments”. Due to limited market information, we utilized a discounted cash flow (“DCF”) model to derive an estimate of fair value of these assets at March 31, 2011 and December 31, 2010. The assumptions used in preparing the DCF model included estimates with respect to the amount and timing of future interest and principal payments, the probability of full repayment of the principal considering the credit quality and guarantees in place, and the rate of return required by investors to own such securities given the current liquidity risk associated with them. The DCF model is based on the following key assumptions:

 
o
Nominal credit risk as substantially all of the underlying collateral of these securities is ultimately guaranteed by the United States Department of Education;
 
o
Liquidity by December 31, 2012 through December 31, 2014;
 
o
Continued receipt of contractual interest; and
 
o
Discount rates ranging from 2.25% to 4.25%, which include a spread for liquidity risk.

·
Real estate acquired through claim settlement is fair valued at the lower of our acquisition cost or a percentage of appraised value. The percentage applied to appraised value is based upon our historical sales experience adjusted for current trends.
 
Fair value measurements for items measured at fair value included the following as of March 31, 2011 and December 31, 2010:

   
Fair Value
   
Quoted Prices in
 Active Markets for
 Identical Assets
 (Level 1)
   
Significant Other
 Observable Inputs
(Level 2)
   
Significant
 Unobservable
 Inputs
(Level 3)
 
   
(In thousands)
 
March 31, 2011
                       
Assets
                       
                                 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 1,053,163     $ 1,053,163     $ -     $ -  
Obligations of U.S. states and political subdivisions
    3,447,721       -       3,176,990       270,731  
Corporate debt securities
    2,403,295       2,623       2,330,399       70,273  
Commercial mortgage-backed securities
    52,154       -       52,154       -  
Residential mortgage-backed securities
    92,673       -       92,673       -  
Debt securities issued by foreign sovereign governments
    151,349       137,234       14,115       -  
   Total debt securities
    7,200,355       1,193,020       5,666,331       341,004  
Equity securities
    3,063       2,742       -       321  
   Total investments
  $ 7,203,418     $ 1,195,762     $ 5,661,331     $ 341,325  
                                 
Real estate acquired (1)
  $ 4,876     $ -     $ -     $ 4,876  
                                 
December 31, 2010
                               
Assets
                               
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 1,102,786     $ 1,102,786     $ -     $ -  
Obligations of U.S. states and political subdivisions
    3,580,066       -       3,284,376       295,690  
Corporate debt securities
    2,564,959       2,563       2,492,343       70,053  
Residential mortgage-backed securities
    57,100       -       57,100       -  
Debt securities issued by foreign sovereign governments
    150,327       135,457       14,870       -  
   Total debt securities
    7,455,238       1,240,806       5,848,689       365,743  
Equity securities
    3,044       2,723       -       321  
   Total investments
  $ 7,458,282     $ 1,243,529     $ 5,848,689     $ 366,064  
                                 
Real estate acquired (1)
  $ 6,220     $ -     $ -     $ 6,220  
 
(1) Real estate acquired through claim settlement, which is held for sale, is reported in Other Assets on the consolidated balance sheet
 
 
24

 
 
There were no significant transfers of securities between Level 1 and Level 2 during the first three months of 2011 or 2010.

For assets measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the three months ended March 31, 2011 and 2010 is as follows:

   
Obligations of U.S.
 States and Political
Subdivisions
   
Corporate Debt
 Securities
   
Equity
 Securities
   
Total
Investments
   
Real Estate
 Acquired
 
   
(In thousands)
 
Balance at December 31, 2010
  $ 295,690     $ 70,053     $ 321     $ 366,064     $ 6,220  
   Total realized/unrealized gains (losses):
                                       
                                         
Included in earnings and reported as losses incurred, net
    -       -       -       -       7  
                                         
Included in other comprehensive income
    533       220       -       753       -  
                                         
Purchases
    -       -       -       -       1,369  
Sales
    (25,492 )     -       -       (25,492 )     (2,720 )
Transfers in and/or out of Level 3
    -       -       -       -       -  
Balance at March 31, 2011
  $ 270,731     $ 70,273     $ 321     $ 341,325     $ 4,876  
                                         
Amount of total losses included in earnings for the three months ended March 31, 2011 attributable to the change in unrealized losses on assets still held at March 31, 2011
  $ -     $ -     $ -     $ -     $ -  
 
 
25

 
 
   
Obligations of U.S. States and Political Subdivisions
   
Corporate Debt Securities
   
Equity
Securities
   
Total
Investments
   
Real Estate
Acquired
 
   
(In thousands)
 
Balance at December 31, 2009
  $ 370,341     $ 129,338     $ 321     $ 500,000     $ 3,830  
   Total realized/unrealized gains (losses):
                                       
                                         
Included in earnings and reported as losses incurred, net
    -       -       -       -       (376 )
                                         
Included in other comprehensive income
    907       728       -       1,635       -  
                                         
Purchases, issuances and settlements
    (3,332 )     -       -       (3,332 )     1,299  
Transfers in and/or out of Level 3
    -       -       -       -       -  
Balance at March 31, 2010
  $ 367,916     $ 130,066     $ 321     $ 498,303     $ 4,753  
                                         
Amount of total losses included in earnings for the three months ended March 31, 2010 attributable to the change in unrealized losses on assets still held at March 31, 2010
  $ -     $ -     $ -     $ -     $ -  
 
Additional fair value disclosures related to our investment portfolio are included in Note 7. Fair value disclosures related to our debt are included in Note 3.
 
Note 9 - Comprehensive income

Our total comprehensive income for the three months ended March 31, 2011 and 2010 was as follows:

   
Three Months Ended
 
   
March 31,
 
             
   
2011
   
2010
 
   
(In thousands)
 
             
Net loss
  $ (33,661 )   $ (150,091 )
Other comprehensive (loss) income
    (24,687 )     5,790  
                 
   Total comprehensive loss
  $ (58,348 )   $ (144,301 )
                 
Other comprehensive (loss) income (net of tax):
               
   Change in unrealized gains and losses
               
     on investments
  $ (25,604 )   $ 6,206  
   Unrealized foreign currency translation adjustment
    917       (416 )
                 
Other comprehensive (loss) income
  $ (24,687 )   $ 5,790  
 
 
26

 

The tax expense on other comprehensive income was $0.7 million (adjusted for the valuation allowance, see Note 11 – “Income taxes”) and $2.9 million for the three months ended March 31, 2011 and 2010, respectively.

At March 31, 2011, accumulated other comprehensive loss of $2.6 million included a $30.8 million loss relating to defined benefit plans, offset by $6.9 million of net unrealized gains on investments and $21.3 million of gains related to foreign currency translation adjustment. At December 31, 2010, accumulated other comprehensive income of $22.1 million included $32.5 million of net unrealized gains on investments and $20.4 million of gains related to foreign currency translation adjustment, offset by a $30.8 million loss relating to defined benefit plans.

Note 10 - Benefit Plans

The following table provides the components of net periodic benefit cost for the pension, supplemental executive retirement and other postretirement benefit plans:

   
Three Months Ended
March 31,
 
   
Pension and Supplemental
Executive Retirement Plans
 
Other Postretirement
Benefits
 
   
2011
   
2010
   
2011
   
2010
 
   
(In thousands)
 
                         
Service cost
  $ 2,172     $ 2,184     $ 254     $ 324  
Interest cost
    4,122       3,821       354       340  
Expected return on plan assets
    (4,194 )     (3,597 )     (823 )     (720 )
Recognized net actuarial loss
    1,217       1,438       187       256  
Amortization of prior service cost
    162       140       (1,554 )     (1,535 )
                                 
Net periodic benefit cost
  $ 3,479     $ 3,986     $ (1,582 )   $ (1,335 )


In April 2011 we contributed approximately $10.0 million to our pension plan. We currently do not intend to make any further contributions to the plan during 2011.

Note 11 – Income Taxes

We review the need to establish a deferred tax asset valuation allowance on a quarterly basis. We analyze several factors, among which are the severity and frequency of operating losses, our capacity for the carryback or carryforward of any losses, the expected occurrence of future income or loss and available tax planning alternatives. Based on our analysis and the level of cumulative operating losses, we have reduced our benefit from income tax by establishing a valuation allowance.

For the three months ended March 31, 2010, our deferred tax valuation allowance was reduced by the change in the deferred tax liability related to $9.2 million of unrealized gains on investments that were recorded in other comprehensive income.  For the three months ended March 31, 2011, our deferred tax valuation allowance was increased by the change in the deferred tax liability related to $26.2 million of unrealized losses on investments that were recorded in other comprehensive income.  In the event of future operating losses, it is likely that the valuation allowance will be adjusted by any taxes recorded to equity for changes in unrealized gains or losses or other items in other comprehensive income.
 
 
27

 
 
   
Three Months Ended
March 31,
 
   
2011
   
2010
 
   
(In millions)
 
Benefit from income taxes
  $ (19.2 )   $ (60.7 )
Change in valuation allowance
    21.0       59.7  
                 
Tax provision (benefit)
  $ 1.8     $ (1.0 )
 
The increase in the valuation allowance that was included in other comprehensive income was $9.2 million for the three months ended March 31, 2011. There was no valuation allowance within other comprehensive income in the first three months of 2010. The total valuation allowance as of March 31, 2011 and December 31, 2010 was $440.5 million and $410.3 million, respectively.

Legislation enacted in 2009 expanded the carryback period for certain net operating losses from 2 years to 5 years. A total benefit for income taxes of $282.0 million was recorded during 2009 in the consolidated statement of operations for the carryback of 2009 losses. The refund related to these benefits was received in the second quarter of 2010.

Giving full effect to the carryback of net operating losses for federal income tax purposes, we have approximately $1,331 million of net operating loss carryforwards on a regular tax basis and $505 million of net operating loss carryforwards for computing the alternative minimum tax as of March 31, 2011. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2031.

The Internal Revenue Service (“IRS”) completed separate examinations of our federal income tax returns for the years 2000 through 2004 and 2005 through 2007 and issued assessments for unpaid taxes, interest and penalties. The primary adjustment in both examinations related to our treatment of the flow-through income and loss from an investment in a portfolio of residual interests of Real Estate Mortgage Investment Conduits (“REMICs”). This portfolio has been managed and maintained during years prior to, during and subsequent to the examination period. The IRS indicated that it did not believe that, for various reasons, we had established sufficient tax basis in the REMIC residual interests to deduct the losses from taxable income. We appealed those adjustments and, in August 2010, we reached a tentative settlement agreement with the IRS.  The settlement agreement is subject to review by the Joint Committee on Taxation of Congress because net operating losses incurred in 2009 were carried back to taxable years that were included in the agreement.  A final agreement is expected to be entered into when the review is complete, although we do not expect there will be any substantive change in the terms of a final agreement from those in the tentative agreement.  We adjusted our tax provision and liabilities for the effects of this agreement in 2010 and believe that they accurately reflect our exposure in regard to this issue.

The IRS is currently conducting an examination of our federal income tax returns for the years 2008 and 2009, which is scheduled to be completed in 2011.

 
28

 

Note 12 – Loss Reserves

We establish reserves to recognize the estimated liability for losses and loss adjustment expenses related to defaults on insured mortgage loans. Loss reserves are established by estimating the number of loans in our inventory of delinquent 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 that we will pay in the future 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. Current conditions in the housing and mortgage industries make these assumptions more volatile than they would otherwise be. 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 further deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, and a further drop in housing values, which expose us to greater losses on resale of properties obtained through the claim settlement process and 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, 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, 2011 and 2010:

 
29

 
 
   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
   
(In thousands)
 
             
Reserve at beginning of year
  $ 5,884,171     $ 6,704,990  
Less reinsurance recoverable
    275,290       332,227  
Net reserve at beginning of year (1)
    5,608,881       6,372,763  
                 
Losses incurred:
               
  Losses and LAE incurred in respect of default notices received in:
               
       Current year
    347,399       512,461  
       Prior years (2)
    (36,968 )     (57,950 )
          Subtotal (3)
    310,431       454,511  
                 
Losses paid:
               
  Losses and LAE paid in respect of default notices received in:
               
       Current year
    26       188  
       Prior years
    686,748       518,407  
       Reinsurance terminations (4)
    (917 )     -  
          Subtotal (5)
    685,857       518,595  
                 
Net reserve at end of period (6)
    5,233,455       6,308,679  
Plus reinsurance recoverables
    238,039       339,427  
                 
Reserve at end of period
  $ 5,471,494     $ 6,648,106  
 
(1)
At December 31, 2010 and 2009, the estimated reduction in loss reserves related to rescissions approximated $1.3 billion and $2.1 billion, respectively.
(2)
A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves, and a positive number for prior year losses incurred indicates a deficiency of prior year loss reserves.
(3)
Rescissions did not have a material impact on incurred losses in the three months ended March 31, 2011. Rescissions mitigated our incurred losses by an estimated $0.6 billion in the three months ended March 31, 2010.
(4)
In a termination, 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 to 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.
(5)
Rescissions mitigated our paid losses by an estimated $0.2 billion and $0.3 billion in three months ended March 31, 2011 and 2010, respectively, which excludes amounts that may have been applied to a deductible.
(6)
At March 31, 2011 and 2010, the estimated reduction in loss reserves related to rescissions approximated $1.1 billion and $2.4 billion, respectively.

The “Losses incurred” section of the table above shows losses incurred on default notices received in the current year and in prior years, respectively.  The amount of losses incurred relating to default notices received in the current year represents the estimated amount to be ultimately paid on such default notices.  The amount of losses incurred relating to default notices received in prior years represents the actual claim rate and severity associated with those defaults notices 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 remaining in inventory 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 default inventory, such as percentages of defaults that have resulted in a claim, the amount of the claims, changes in the relative level of defaults by geography and changes in average loan exposure.
 
 
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Current year losses incurred decreased in the first quarter of 2011 compared to the same period in 2010 primarily due to a decrease in the number of new notices received, from 53,393 in the first quarter of 2010 to 43,195 in the first quarter of 2011.

The development of the reserves in the first quarter of 2011 and 2010 is reflected in the “Prior years” line in the table above. The $37 million decrease in losses incurred in the first quarter of 2011 was related to defaults that occurred in prior periods. This decrease in losses incurred primarily related to a slight decrease in severity on primary defaults which approximated $28 million as well as a slight decrease in the expected claim rate on primary defaults which accounted for a decrease of approximately $16 million. The decrease in the severity and claim rate was based on the resolution of approximately 22% of the prior year default inventory, as well as a re-estimation of amounts to be ultimately paid on defaults remaining in inventory from the end of the prior year. The offsetting increase in losses incurred related to prior years of approximately $7 million related to pool reserves, LAE reserves and reinsurance.

The $58 million decrease in losses incurred in the first quarter of 2010 was related to defaults that occurred in prior periods. This decrease in losses incurred primarily related to a decrease in the claim rate on primary and pool defaults which approximated $206 million. The decrease in the claim rate was based on the resolution of approximately 19% of the prior year default inventory, as well as a re-estimation of amounts to be ultimately paid on defaults remaining in inventory from the end of the prior year. The decrease in the claim rate was due to greater cures experienced during the first quarter of 2010, a portion of which resulted from loan modifications. The decrease in the claim rate on prior year defaults was offset by an increase in severity on primary and pool defaults which approximated $151 million. The increase in severity was based on the resolution of defaults that occurred in prior periods with higher claim amounts, as well as a re-estimation of amount to be ultimately paid on defaults remaining in inventory from the end of the prior year. The additional decrease in losses incurred related to prior years of approximately $3 million related to LAE reserves and reinsurance.

The “Losses paid” section of the table above shows the breakdown between claims paid on default notices received in the current year and default notices received in prior years. It has historically taken, on average, approximately twelve months for a default which is not cured to develop into a paid claim, therefore, most losses paid relate to default notices received in prior years. Due to a combination of reasons that have slowed the rate at which claims are received and paid, including foreclosure moratoriums and suspensions, servicing delays, court delays, loan modifications, our fraud investigations and our claim rescissions and denials for misrepresentation, it is difficult to estimate how long it may take for current and future defaults that do not cure to develop into paid claims. The “Losses paid” section of the table also includes a decrease in losses paid related to terminated reinsurance agreements as noted in footnote (4) of the table above.

The liability associated with our estimate of premiums to be refunded on expected claim payments is accrued for separately at March 31, 2011 and December 31, 2010 and approximated $112 million and $113 million, respectively. Separate components of this liability are included in “Other liabilities” and “Premium deficiency reserve” on our consolidated balance sheet.

 
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The decrease in the primary default inventory experienced during the first quarter of 2011 was generally across all markets and all book years. However the number of consecutive months a loan remains in the primary default inventory (the age of the item in default) has continued to increase, as shown in the table below. Historically as a default ages it becomes more likely to result in a claim.
 
Aging of the Primary Default Inventory
 
   
March 31,
2011
   
December 31,
2010
   
March 31,
2010
 
                                     
Consecutive months in the default inventory
                                   
 3 months or less
    27,744       14 %     37,640       18 %     36,256       15 %
 4 - 11 months
    57,319       29 %     58,701       27 %     90,816       38 %
12 months or more
    110,822       57 %     118,383       55 %     114,172       47 %
                                                 
    Total primary default inventory     195,885       100 %     214,724       100 %     241,244       100 %
                                                 
Loans in our default inventory  in our claims received inventory
    17,686       9 %     20,898       10 %     17,384       7 %
 
The length of time 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

   
March 31,
2011
   
December 31,
2010
   
March 31,
2010
 
                                     
                                     
 3 payments or less
    40,680       21 %     51,003       24 %     50,045       21 %
 4 - 11 payments
    61,060       31 %     65,797       31 %     98,753       41 %
12 payments or more
    94,145       48 %     97,924       45 %     92,446       38 %
                                                 
Total primary default inventory
    195,885       100 %     214,724       100 %     241,244       100 %

Before paying a claim, we can review the loan file to determine whether we are required, under the applicable insurance policy, to pay the claim or whether we are entitled to reduce the amount of the claim. For example, all of our insurance policies provide that we can reduce or deny a claim if the servicer did not comply with its obligation to mitigate our loss by performing reasonable loss mitigation efforts or diligently pursuing a foreclosure or bankruptcy relief in a timely manner. We also do not cover losses resulting from property damage that has not been repaired. We are currently reviewing the loan files for the majority of the claims submitted to us.

 
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In addition, subject to rescission caps in certain of our Wall Street bulk transactions, all of our insurance policies allow us to rescind coverage under certain circumstances. Because we can review the loan origination documents and information as part of our normal processing when a claim is submitted to us, rescissions occur on a loan by loan basis most often after we have received a claim. Historically, claim rescissions and denials, which we collectively refer to as rescissions, were not a material portion of our claims resolved during a year. However, beginning in 2008 our rescissions of policies have materially mitigated our paid and incurred losses. While we have a substantial pipeline of claims investigations that we expect will eventually result in future rescissions, we expect that rescissions will not continue to mitigate paid and incurred losses at the same level we have recently experienced. In addition, if an insured disputes our right to rescind coverage, the outcome of the dispute ultimately would be determined by legal proceedings. In each of 2009 and 2010, rescissions mitigated our paid losses by approximately $1.2 billion, and in the first quarter of 2011, rescissions mitigated our paid losses by approximately $0.2 billion. These figures include amounts that would have resulted in either a claim payment or been charged to a deductible or aggregate loss limit under a bulk or pool policy, and may have been charged to a captive reinsurer. The amounts that would have been applied to a deductible do not take into account previous rescissions that may have been applied to a deductible.

Our loss reserving methodology incorporates the effect that rescission activity is expected to have on the losses we will pay on our delinquent inventory. We do not utilize an explicit rescission rate in our reserving methodology, but rather our reserving methodology incorporates the effects rescission activity has had on our historical claim rate and claim severities. A variance between ultimate actual rescission rates and these estimates could materially affect our losses incurred. Our estimation process does not include a direct correlation between claim rates and severities to projected rescission activity or other economic conditions such as changes in unemployment rates, interest rates or housing values. Our experience is that analysis of that nature would not produce reliable results, as the change in one condition cannot be isolated to determine its sole effect on our ultimate paid losses as our ultimate paid losses are also influenced at the same time by other economic conditions. The estimation of the impact of rescissions on incurred losses, as shown in the table below, must be considered together with the various other factors impacting incurred losses and not in isolation.

The table below represents our estimate of the impact rescissions have had on reducing our loss reserves, paid losses and losses incurred.
 
 
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Three Months Ended
March 31,
 
   
2011
   
2010
 
 
(In billions)
 
             
Estimated rescission reduction - beginning reserve
  $ 1.3     $ 2.1  
                 
Estimated rescission reduction - losses incurred
    -       0.6  
                 
Rescission reduction - paid claims