Reserve for Premium Deficiency

We perform a quarterly evaluation of the expected profitability of our existing mortgage insurance portfolio, by business line, over the remaining life of the portfolio. A premium deficiency reserve ("PDR") is established when the present value of expected losses and expenses for a particular product line exceeds the present value of expected future premiums and existing reserves for that product line. Expenses include consideration of maintenance costs associated with maintaining records relating to insurance contracts and with the processing of premium collections. We consider our first-lien and second-lien mortgage ("second-lien") insured portfolios to be separate lines of business because they are managed separately, priced differently and have a different customer base.

Numerous factors affect our ultimate default to claim rates, including home price changes, unemployment, the impact of our loss mitigation efforts and interest rates, as well as potential benefits associated with lender and governmental initiatives to modify loans and ultimately reduce foreclosures. To assess the need for a PDR on our first-lien insurance portfolio, we develop loss projections based on modeled loan defaults related to our current risk in force. This projection is based on recent trends in default experience, severity, and rates of defaulted loans moving to claim (such default to claim rates are net of our estimates of rescissions and denials), as well as recent trends in the rate at which loans are prepaid. As of September 30, 2011, our modeled loan default projections for our first-lien insured portfolio assume that the rate at which current loans will default will remain consistent with those rates observed during the fourth quarter of 2010, for the next twelve months, and then gradually return to more normal historical levels over the subsequent three years.

Because we increased our estimated losses on current loans, our net projected premium excess decreased during the quarter ended September 30, 2011. If actual losses are higher than our loss projections, we could be required to establish a premium deficiency, which could have a material negative impact on our financial results in future periods.

The following table illustrates our net projected premium excess on our first-lien portfolio, and the discount rate used in estimating the net present value of expected premiums and losses, as of the dates indicated:



(In millions):	September 30, 2011			December 31, 2010
First-lien portfolio
Net present value of expected premiums	$	2,627		$	2,806
Net present value of expected losses and expenses	(4,629		)	(4,537		)
Reserve for premiums and losses established, net of reinsurance recoverables	3,045			3,276
Net projected premium excess	$	1,043		$	1,545

Discount rate	2.6		%	2.4		%

For our first-lien insurance business, because the combination of the net present value of expected premiums and already established reserves (net of reinsurance recoverables) exceeds the net present value of expected losses and expenses, a first-lien PDR was not required as of September 30, 2011. Expected losses are based on an assumed paid claim rate of approximately 12.3% on our total first-lien insurance portfolio (6.8% on performing loans and 42.4% on defaulted loans). Assuming all other factors remained constant, a 10% change in our overall default to claim rate as applied at the loan level on defaulted loans (with a maximum claim rate of 100% on pending claims) would result in an increase in our default to claim rate from 42.4% at September 30, 2011, to 45.7%. This increase in our default to claim rate would increase our expected losses by approximately $189 million, and have a negative effect on our projected premium excess. New business originated since the beginning of 2009 is expected to be profitable, which has contributed to the overall expected net profitability of our first-lien portfolio. In addition, estimated rescissions and denials on insured loans are expected to partially offset the impact of expected defaults and claims.

In the third quarter of 2007, we established a reserve for premium deficiency on our second-lien business. We were required to establish a PDR because the net present value of the expected future losses and expenses exceeded our expected future premiums and existing reserves. Since that time, our PDR has been reduced as the risk has been reduced (through either attrition or terminations of transactions), claims have been paid, or changes have occurred to our initial assumptions.

Evaluating the expected profitability of our existing mortgage insurance business and the need for a premium deficiency reserve for our first-lien business involves significant reliance upon assumptions and estimates with regard to the likelihood, magnitude and timing of potential losses and premium revenues. The models, assumptions and estimates we use to evaluate the need for a premium deficiency reserve may not prove to be accurate, especially during an extended economic downturn or a period of extreme market volatility and uncertainty such as currently exists. We cannot be certain that we have correctly estimated the expected profitability of our existing first-lien mortgage portfolio or that the second-lien PDR established will be adequate to cover the ultimate losses on our second-lien business.