Note 12 – Loss Reserves

We establish reserves to recognize the estimated liability for losses and loss adjustment expenses (“LAE”) related to defaults on insured mortgage loans. Loss reserves are established by estimating the number of 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 nine months ended September 30, 2011 and 2010:

	Nine Months Ended
	September 30,
	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		1,328,906			1,463,509
Prior years (2)		(96,269	)		(304,343	)
Subtotal (3)		1,232,637			1,159,166

Losses paid:
Losses and LAE paid in respect of default notices received in:
Current year		37,111			11,437
Prior years		2,218,490			1,675,759
Reinsurance terminations (4)		(38,769	)		(35,120	)
Subtotal (5)		2,216,832			1,652,076

Net reserve at end of period (6)		4,624,686			5,879,853
Plus reinsurance recoverables		166,874			299,239

Reserve at end of period	$	4,791,560		$	6,179,092

(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 significant impact on incurred losses in the nine months ended September 30, 2011. Rescissions mitigated our incurred losses by an estimated $0.5 billion in the nine months ended September 30, 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 $0.5 billion in the nine months ended September 30, 2011 and by an estimated $0.7 billion in the nine months ends September 30, 2010, which excludes amounts that may have been applied to a deductible.

(6)	At September 30, 2011 and 2010, the estimated reduction in loss reserves related to rescissions approximated $0.8 billion and $1.9 billion, respectively.

The “Losses incurred” section of the table above shows losses incurred on defaults that occurred in the current year and in prior years. The amount of losses incurred relating to defaults that occurred in the current year represents the estimated amount to be ultimately paid on such defaults. The amount of losses incurred relating to defaults that occurred in prior years represents the actual claim rate and severity associated with those defaults resolved in the current year differing from the estimated liability at the prior year-end, as well as a re-estimation of amounts to be ultimately paid on defaults 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.

Current year losses incurred decreased slightly in the first nine months of 2011 compared to the same period in 2010 primarily due to a decrease in the number of new default notices received, net of cures, from 14,882 in the first nine months of 2010 to 11,703 in the first nine months of 2011.

The development of the reserves in the first nine months of 2011 and 2010 is reflected in the “Prior years” line in the table above. The $96 million decrease in losses incurred in the first nine months of 2011 was related to defaults that occurred in prior periods. This decrease in losses incurred primarily related to a decrease in the estimated severity on primary defaults which approximated $105 million as well as a decrease in estimated severity on pool defaults which approximated $50 million. The decrease in losses incurred related to prior years was also related to a decrease in estimated loss adjustment expenses which approximated $121 million. These decreases were offset by an increase in the estimated claim rate on primary defaults which approximated $180 million. The decrease in the severity was based on the resolution of approximately 49% of the prior year default inventory. The decrease in estimated loss adjustment expense was based on recent historical trends in the costs associated with resolving a claim. The increase in the claim rate was also based on the resolution 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 and estimated incurred but not reported items from the end of the prior year.

The $304 million decrease in losses incurred in the first nine months 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 defaults which approximated $355 million. The decrease in the claim rate was based on the resolution of approximately 46% of the prior year default inventory. The decrease in the claim rate was due to greater cures experienced during the first nine months 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 primary severity which approximated $40 million and pool defaults which approximated $60 million. The increase in severity was based on the re-estimation of amounts 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 $49 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 liability associated with our estimate of premiums to be refunded on expected claim payments is accrued for separately at September 30, 2011 and December 31, 2010 and approximated $115 million and $113 million, respectively. Separate components of this liability are included in “Other liabilities” and “Premium deficiency reserve” on our consolidated balance sheet. Changes in the liability affect premiums written and earned and change in premium deficiency reserve.

The decrease in the primary default inventory experienced during the first nine months of 2011 was generally across all markets and all book years. However the percentage of loans in the inventory that have been in default for 12 or more consecutive months has increased, 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

	September 30,				December 31,				September 30,
	2011				2010				2010

Consecutive months in default
3 months or less		33,167	18	%		37,640	18	%		39,516	18	%
4 - 11 months		45,110	25	%		58,701	27	%		60,472	27	%
12 months or more		102,617	57	%		118,383	55	%		123,385	55	%

Total primary default inventory		180,894	100	%		214,724	100	%		223,373	100	%

Primary claims received inventory included in ending default inventory		13,799	8	%		20,898	10	%		21,306	10	%

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

	September 30,				December 31,				September 30,
	2011				2010				2010


3 payments or less		43,312	24	%		51,003	24	%		52,056	23	%
4 - 11 payments		47,929	26	%		65,797	31	%		70,681	32	%
12 payments or more		89,653	50	%		97,924	45	%		100,636	45	%


Total primary default inventory		180,894	100	%		214,724	100	%		223,373	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.

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, 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 three quarters of 2011, rescissions mitigated our paid losses by approximately $0.5 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). In recent quarters, 18% to 21% of claims received in a quarter have been resolved by rescissions, down from the peak of approximately 28% in the first half of 2009. While we have a substantial pipeline of claims investigations that we expect will eventually result in future rescissions, we expect that the percentage of claims that will be resolved through rescissions will continue to decline.

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.

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2011		2010			2011		2010
	(In billions)

Estimated rescission reduction - beginning reserve	$	0.9	$	2.3		$	1.3	$	2.1

Estimated rescission reduction - losses incurred		-		(0.1	)		-		0.5

Rescission reduction - paid claims		0.1		0.3			0.5		0.9
Amounts that may have been applied to a deductible		-		-			-		(0.2	)
Net rescission reduction - paid claims		0.1		0.3			0.5		0.7

Estimated rescission reduction - ending reserve	$	0.8	$	1.9		$	0.8	$	1.9

The decrease in the estimated rescission reduction to losses incurred in the first nine months of 2011 compared to the same period in 2010 is due to a decline in the expected rescission rate for loans in our default inventory, compared to an increasing expected rescission rate in the first nine months of 2010.

At September 30, 2011, our loss reserves continued to be significantly impacted by expected rescission activity. We expect that the reduction of our loss reserves due to rescissions will continue to decline because our recent experience indicates new notices in our default inventory have a lower likelihood of being rescinded than those already in the inventory.

The liability associated with our estimate of premiums to be refunded on expected future rescissions is accrued for separately. At September 30, 2011 and December 31, 2010 the estimate of this liability totaled $70 million and $101 million, respectively. Separate components of this liability are included in “Other liabilities” and “Premium deficiency reserve” on our consolidated balance sheet. Changes in the liability affect premiums written and earned and change in premium deficiency reserve.

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. For more information about these legal proceedings, 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, subject to GSE approval, enter into additional settlement agreements with other lenders in the future. In April 2011, Freddie Mac advised its servicers that they must obtain its prior approval for rescission settlements and Fannie Mae advised its servicers that they are prohibited from entering into such settlements. In addition, in April 2011, Fannie Mae notified us that we must obtain its prior approval to enter into certain settlements. We continue to discuss with other lenders their objections to material rescissions and have reached settlement terms with several of our significant lender customers. Any definitive agreement with these customers would be subject to GSE approval. There can be no assurances that the GSEs will approve any settlement agreements and we are not aware that they have approved any settlement agreements after April 2011.

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.

A rollforward of our primary default inventory for the three and nine months ended September 30, 2011 and 2010 appears in the table below. The information concerning new default notices and cures is compiled from monthly reports received from loan servicers. The level of new notice and cure activity reported in a particular month can be influenced by, among other things, the date on which a servicer generates its report and by transfers of servicing between loan servicers.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010


Default inventory at beginning of period		184,452			228,455			214,724			250,440
Plus: New Notices		44,342			53,134			127,509			154,708
Less: Cures		(34,335	)		(43,326	)		(115,806	)		(139,826	)
Less: Paids (including those charged to a deductible or captive)		(12,033	)		(11,722	)		(39,052	)		(31,569	)
Less: Rescissions and denials		(1,532	)		(3,168	)		(6,481	)		(10,380	)
Default inventory at end of period		180,894			223,373			180,894			223,373

Pool insurance notice inventory decreased from 43,329 at December 31, 2010 to 33,792 at September 30, 2011. The pool insurance notice inventory was 43,168 at September 30, 2010.