9.	Loss Reserves

As described in Note 3 – “Summary of Significant Accounting Policies – 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 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 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 drop in housing values that could result in, among other things, greater losses on loans that have pool insurance, 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 and capital position, even in a stable economic environment.

The following table provides a reconciliation of beginning and ending loss reserves for each of the past three years:

	2013			2012			2011
	(In thousands)

Reserve at beginning of year	$	4,056,843		$	4,557,512		$	5,884,171
Less reinsurance recoverable		104,848			154,607			275,290
Net reserve at beginning of year (1)		3,951,995			4,402,905			5,608,881

Losses incurred:
Losses and LAE incurred in respect of default notices received in:
Current year		898,413			1,494,133			1,814,035
Prior years (2)		(59,687	)		573,120			(99,328	)
Subtotal (3)		838,726			2,067,253			1,714,707

Losses paid:
Losses and LAE paid in respect of default notices received in:
Current year		73,470			134,509			121,383
Prior years (4)		1,722,923			2,389,985			2,838,069
Reinsurance terminations (5)		(2,988	)		(6,331	)		(38,769	)
Subtotal (6)		1,793,405			2,518,163			2,920,683
Net reserve at end of year (7)		2,997,316			3,951,995			4,402,905
Plus reinsurance recoverables		64,085			104,848			154,607

Reserve at end of year	$	3,061,401		$	4,056,843		$	4,557,512

(1)

At December 31, 2012, 2011 and 2010 the estimated reduction in loss reserves related to rescissions approximated $0.2 billion, $0.7 billion and $1.3 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. See table below regarding prior year loss development.

(3)

Rescissions did not have a significant impact on our losses incurred in 2013 or 2011. Our estimated rescissions were reduced by approximately $0.2 billion in 2012 due to probable settlement agreements (See Note 20 – “Litigation and Contingencies”), other rescissions had no significant impact on our losses incurred in 2012.

(4)

2013 and 2012, include $41 million and $100 million, respectively, paid under the terms of our settlement agreement with Freddie Mac as discussed below.

(5)

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. (See Note 11 – “Reinsurance”)

(6)

Rescissions mitigated our paid losses by an estimated $0.1 billion, $0.3 billion and $0.6 billion in 2013, 2012 and 2011, respectively, which excludes amounts that may have been applied to a deductible.

(7)

At December 31, 2013, 2012 and 2011 the estimated reduction in loss reserves related to rescissions approximated $0.1 billion, $0.2 billion and $0.7 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. 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 the 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.

Losses incurred on default notices received in the current year decreased in 2013 compared to 2012, and in 2012 compared to 2011, primarily due to a decrease in the number of new default notices received, net of cures, as well as a decrease in the estimated claim rate on recently reported delinquencies.

The prior year development of the reserves in 2013, 2012 and 2011 is reflected in the table below.

	2013			2012			2011
	(In millions)
Prior year loss development:

Pool policy settlement (1)	$	-		$	267		$	-

Increase in estimated claim rate on primary defaults		10			260			200
Decrease in estimated severity on primary defaults		(50	)		(70	)		(165	)
Change in estimates related to pool reserves, LAE reserves, reinsurance and other (2)		(20	)		116			(134	)
Total prior year loss development	$	(60	)	$	573		$	(99	)

(1) See below for a discussion of our settlement with Freddie Mac.

(2) Includes approximately $100 million related to probable settlements regarding our claims paying practices in 2012 and ($114) million related to LAE reserves in 2011.

The prior year loss development was based on the resolution of approximately 59%, 55% and 57% for the years ended December 31, 2013, 2012 and 2011, respectively 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. In 2012, lower estimated rescission rates, as well as our experience on defaults that were 12 months or more delinquent increased our estimate of the claim rate. The decrease in the estimated severity in 2013, 2012 and 2011 was based on the resolution of the prior year default inventory. The decrease in estimated loss adjustment expense in 2011 was based on historical trends in the costs associated with resolving a claim.

The “Losses paid” section of the table above shows the breakdown between claims paid on default notices received in the current year, claims paid on default notices received in prior years and the decrease in losses paid related to terminated reinsurance agreements as noted in footnote (5) of that table. Until a few years ago, it took, on average, approximately twelve months for a default that is not cured to develop into a paid claim. Over the past several years, the average time it takes to receive a claim associated with a default has increased. This is, in part, due to new loss mitigation protocols established by servicers and to changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation processes. It is difficult to estimate how long it may take for current and future defaults that do not cure to develop into paid claims.

MGIC and Freddie Mac disagreed on the amount of the aggregate loss limit under certain pool insurance policies (the “Disputed Policies”). On December 1, 2012, an Agreement of Settlement, Compromise and Release (the “Settlement Agreement”) between MGIC, Freddie Mac and the FHFA became effective, settling their dispute regarding the Disputed Policies. Under the Settlement Agreement, MGIC is to pay Freddie Mac a total of $267.5 million in satisfaction of all obligations under the Disputed Policies. Of the total, $100 million was paid in December 2012, as required by the Settlement Agreement, and the remaining $167.5 million is being paid out in 48 equal monthly installments that began on January 2, 2013.

The liability associated with our estimate of premiums to be refunded on expected claim payments is accrued for separately at December 31, 2013 and 2012 and approximated $131 million and $134 million, respectively. Separate components of this liability are included in “Other liabilities” and “Premium deficiency reserve” on our consolidated balance sheet.

A rollforward of our primary default inventory for the years ended December 31, 2013, 2012 and 2011 appears in the table below. The information concerning new notices and cures is compiled from monthly reports received from loan servicers. The level of new notice and cure activity reported in a particular month can be influenced by, among other things, the date on which a servicer generates its report, the number of business days in a month and by transfers of servicing between loan servicers.

	2013			2012			2011


Default inventory at beginning of period		139,845			175,639			214,724
New Notices		106,823			133,232			169,305
Cures		(104,390	)		(120,248	)		(149,643	)
Paids (including those charged to a deductible or captive)		(34,738	)		(45,741	)		(51,138	)
Rescissions and denials		(1,939	)		(3,037	)		(7,609	)
Items removed from inventory resulting from the Countrywide settlement on GSE loans		(2,273	)		-			-
Default inventory at end of period		103,328			139,845			175,639

Pool insurance notice inventory decreased from 8,594 at December 31, 2012 to 6,563 at December 31, 2013. The pool insurance notice inventory was 32,971 at December 31, 2011.

The decrease in the primary default inventory experienced during 2013 and 2012 was generally across all markets and all book years. In 2012, the percentage of loans in the inventory that had been in default for 12 or more consecutive months had increased, as shown in the table below. Historically as a default ages it becomes more likely to result in a claim. The percentage of loans that have been in default for 12 or more consecutive months has been affected by our suspended rescissions discussed below.

Aging of the Primary Default Inventory

	December 31,				December 31,				December 31,
	2013				2012				2011

Consecutive months in default
3 months or less		18,941	18	%		23,282	17	%		31,456	18	%
4 - 11 months		24,514	24	%		34,688	25	%		46,352	26	%
12 months or more		59,873	58	%		81,875	58	%		97,831	56	%

Total primary default inventory		103,328	100	%		139,845	100	%		175,639	100	%

Primary claims received inventory included in ending default inventory (1)		6,948	7	%		11,731	8	%		12,610	7	%

(1) Our claims received inventory includes suspended rescissions, as we have voluntarily suspended rescissions of coverage related to loans that we believed would be included in a potential resolution. As of December 31, 2013, rescissions of coverage on approximately 1,500 loans had been voluntarily suspended.

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

	December 31,				December 31,				December 31,
	2013				2012				2011

3 payments or less		28,095	27	%		34,245	24	%		42,804	24	%
4 - 11 payments		24,605	24	%		34,458	25	%		47,864	27	%
12 payments or more		50,628	49	%		71,142	51	%		84,971	49	%

Total primary default inventory		103,328	100	%		139,845	100	%		175,639	100	%

Claims paying practices

We estimate rescissions mitigated our incurred losses by approximately $2.5 billion in 2009 and $0.2 billion in 2010. 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 2012, we estimate that our rescission benefit in loss reserves was reduced by $0.2 billion due to probable rescission settlement agreements. We estimate that other rescissions had no significant impact on our losses incurred in 2011 through 2013. At December 31, 2013, we estimate that our total loss reserves were benefited from anticipated rescissions by approximately $0.1 billion. Our loss reserving methodology incorporates our estimates of future rescissions and reversals of rescissions. Historically, reversals of rescissions have been immaterial. A variance between ultimate actual rescission and reversal rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses.

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. 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 must be considered together with the various other factors impacting incurred losses and not in isolation.

The liability associated with our estimate of premiums to be refunded on expected future rescissions is accrued for separately. At December 31, 2013 and 2012 the estimate of this liability totaled $15 million and $18 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.

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