Financial Guaranty Insurance Contracts

The risk management function is structured by area of expertise and includes the following areas: risk analytics, public finance, structured finance, and portfolio management.

Our public finance and structured finance groups utilize several tools to monitor our directly insured portfolio. We generally require, for each of our directly insured transactions, the delivery of periodic financial information, including covenant compliance reports that are reviewed by the risk manager assigned to the particular credit. For substantially all of our direct public finance credits, each risk manager prepares regular written surveillance summaries for each credit that contain financial analysis of the credits. For our larger direct credits and for those credits for which our initial analysis indicates that a more comprehensive review is warranted, the risk manager prepares a more detailed surveillance report that includes additional financial analysis, together with the manager's reassessment of the internal rating for the transaction. For our directly insured corporate CDO, TruPs CDO and CMBS CDO transactions, we perform quarterly stress analyses and we update our financial analysis on our TruPs CDO and CMBS CDO transactions at least quarterly. We monitor not only the nominal exposure for each obligor for which we provide protection in our corporate CDO transactions, but also risk-adjusted measures, taking into account, among other factors, our assessment of the relative risk that would be represented by direct exposure to the particular obligor and the remaining subordination in the transactions in which we are exposed to a particular obligor.

Upon continued performance deterioration, we may conduct additional or more frequent reviews of a credit, downgrade the internal credit rating for a credit, or if appropriate, move the credit to the financial guaranty Watch List. All amendments, consents and waivers related to a transaction are also reviewed and evaluated by the appropriate risk manager. In addition to individual credit analysis, the risk management department is responsible for following economic, environmental and regulatory trends and for determining their potential impact on our insured portfolio.

The portfolio management group oversees all portfolio level analysis and reporting of our insured financial guaranty portfolio. This group is also primarily responsible for the analysis of our assumed financial guaranty portfolio and the oversight of the credit risk relationship with our ceding companies. The head of the portfolio management team directs the “Watch and Reserve” process (which is more fully described below), and chairs the quarterly Watch and Reserve meetings, at which reserve recommendations are made on the portfolio.

The risk analytics team is responsible for the analysis of market risk factors and their potential impact on our loss estimates. Key market risk factors, including interest-rate risk and credit spreads, are assessed on an individual credit and insured portfolio basis. The risk analytics team has developed quantitative tools and models to measure these risks, which incorporate the risk assessments and internal ratings assigned by each of the teams within risk management. Additionally, we use an internal economic capital methodology to attribute economic capital to each individual credit exposure within our insured portfolio. This methodology relies heavily on our ability to quantify the individual risks of default and prepayment underlying each transaction in our insured portfolio. Economic capital is also the basis for calculating risk-adjusted returns on our capital, which allows us to evaluate the credit risk relative to the premium received.

In our financial guaranty reinsurance business, the primary obligation for assessing and mitigating claims rests with our ceding companies. To help align the ceding company's interests with ours, we generally have required that the ceding company retain a significant portion of the exposure on any single risk that we reinsure. Our portfolio management group is responsible for the periodic diligence and evaluation of the underwriting and surveillance capabilities of the ceding companies. Each of the ceding companies is obligated to provide us with quarterly updates to their own watch and reserve lists, including reserve information. In the event that we have identified a potential deficiency in the surveillance activities of a ceding company, appropriate personnel in our risk management department may conduct an independent analysis to the extent adequate information is available. We also may have an independent view on assumed credits where we also have direct exposure based on the information obtained through our independent credit review. As a result, we may assess credits and establish reserves based upon information in addition to that received from the ceding company.

Our risk management department reviews both performing and under-performing transactions. Performing credits generally have investment-grade internal ratings, denoting nominal to moderate credit risk. However, claim liabilities may be established for performing credits if the expected losses on the credit exceed the unearned premium revenue for the contract based on the present value of the expected net cash outflows. If our risk management department concludes that a directly insured transaction should no longer be considered performing, it is placed in one of three designated watch list categories for deteriorating credits: Special Mention, Intensified Surveillance or Case Reserve. Assumed exposures in financial guaranty's reinsurance portfolio are generally placed in one of these categories if the ceding company for such transaction downgrades it to an equivalent watch list classification. However, should our financial guaranty risk management group disagree with the risk rating assigned by the ceding company, we may assign our own risk rating rather than use the risk rating assigned by the ceding company.

Our financial guaranty business has a Watch and Reserve Committee that meets at least quarterly to review under-performing credits and establish reserves for transactions. The Watch and Reserve Committee is chaired by the head of the portfolio management group and includes senior management, credit, legal and finance personnel from both the financial guaranty business and Radian Group. Radian Group’s board of directors has formed a Credit Committee of independent directors to assist the board in its oversight responsibilities for our credit risk management policies and procedures, including heightening board-level awareness of the impact of developing risk trends in our portfolio. Our risk management group updates this committee, no less frequently than on a quarterly basis, on all aspects of risk management, including portfolio/sector analysis, risk management policies and Watch and Reserve Committee recommendations and decisions. The following is additional information regarding financial guaranty's categories for deteriorating credits:

Special Mention. This category includes insured transactions that are internally rated no more than two rating levels below investment-grade. Although these insured transactions typically are not performing as expected, we have determined that such transactions are not expected to have severe, prolonged stress and we do not believe that claim payments are imminent. The credits in this category could have all or some of the following characteristics:


•	non-investment-grade obligations with increasing credit risk, but with the possibility of recovering and returning to investment-grade levels;


•	slight probability of payment default due to current adverse economic conditions and operating challenges;


•	limited capacity for absorbing volatility and uncertainty;


•	vulnerability to further downward pressure, which could lead to difficulty in covering future debt obligations; and


•	requires additional monitoring by the risk manager to evaluate developing, potentially adverse credit trends.

Direct and assumed exposures in this category that satisfy certain criteria, including minimum outstanding par thresholds, are typically reviewed annually or more frequently if there is a change to the credit profile. Other exposures that do not satisfy applicable criteria are reviewed at the discretion of the risk manager, senior management, the Watch and Reserve Committee Chairperson or the Chief Risk Officer for our financial guaranty business.

Due to the additional efforts involved in monitoring Special Mention credits, consultants and/or legal counsel may be engaged to assist in claim prevention or loss mitigation strategies.

Intensified Surveillance. This category includes transactions in financial guaranty's insured portfolio that are internally rated below investment-grade and indicate a severe and often permanent adverse change in the transaction's credit profile. Transactions in this category are still performing, meaning they have not yet defaulted on a payment, but our risk management department has determined that there is a substantial likelihood of default. Transactions that are placed in this category may have some or all of the following characteristics:


•	non-investment-grade transactions with high credit risk and low possibility of recovery back to performing levels;


•	impaired ability to satisfy future payments;


•	debtors or servicers with distressed operations that we believe have a questionable ability to continue operating in the future without external assistance from government and/or private third parties;


•	requires frequent monitoring and risk management action to prevent and mitigate possible claims; and


•	requires the allocation of claim liability reserves.

Insured transactions are generally elevated into this category from the Special Mention list as a result of continuing declining credit trends. Occasionally, however, transactions may enter this category directly due to an unexpected financial event that leads to rapid and severe deterioration. Direct and assumed exposures in this category that satisfy certain criteria, including minimum outstanding par thresholds, are generally reviewed quarterly. Other exposures that do not satisfy applicable criteria are reviewed at the discretion of the risk manager, senior management, the Watch and Reserve Committee Chairperson or the Chief Risk Officer for our financial guaranty business.

Consultants and/or legal counsel are regularly engaged in connection with these transactions to assist in claim prevention and loss mitigation strategies due to the remediation efforts necessary to prevent or minimize losses.

Case Reserve. This category consists of insured transactions where a payment default on the insured obligation has occurred. LAE reserves are normally required as remediation efforts often continue for credits classified at this level to mitigate claims. Direct and assumed exposures in this category that satisfy certain criteria, including minimum outstanding par thresholds, are generally reviewed quarterly.

In our directly insured financial guaranty business, we establish loss and LAE reserves on our non-derivative financial guaranty contracts. The assumptions used to determine reserves for directly insured credits are based upon the analysis as more fully described above. In our financial guaranty reinsurance business, the primary obligation for assessing and mitigating claims rests with the ceding company. We generally establish reserves for our assumed Watch List credits based upon information provided by the ceding company.

In general, in response to deterioration in the credit performance of a transaction, risk management works with the appropriate parties in an attempt to avoid a default or to minimize the claims that we may be obligated to pay on our policy. Loss mitigation can consist of:


•	restructuring the obligation;


•	enforcing available security arrangements;


•	working with the issuer to work through or to find alternatives to mitigate the impact of financial management or potential political problems;


•	when appropriate, exercising applicable rights to replace servicers, trustees, advisers or the other parties responsible for the performance of the transaction; and


•	purchasing the insured obligation.

Issuers typically are under no obligation to restructure insured transactions to prevent losses, but often will cooperate to avoid being associated with an obligation that experiences losses. When appropriate, we discuss potential settlement options regarding particular obligations with appropriate parties. On occasion, loss mitigation may include an early termination of our obligations, which could result in payments to or from us. To determine the appropriate loss mitigation approach, we generally consider various factors relevant to such insured transaction, which may include:


•	the current and projected performance of the underlying obligation (both on an expected case basis and stressed for more adverse performance and/or market circumstances than we expect);


•	the likelihood that we will pay a claim in light of credit deterioration and reductions in available payment reserves and existing subordination;


•	our total exposure to the obligation;


•	expected future premium payments from the credit;


•	the potential impact on our capital position; and


•	the cost to us of pursuing mitigation remedies.

The following table includes information as of December 31, 2011, regarding our financial guaranty claim liabilities, segregated by the surveillance categories that we use in monitoring the risks related to these contracts:



	Surveillance Categories
($ in millions)	Performing		Special Mention		Intensified Surveillance		Case Reserve		Total
Number of policies	16		135		61		106		318
Remaining weighted-average contract period (in years)	23		18		21		25		20
Insured contractual payments outstanding:
Principal	$	58.1	$	1,080.3	$	370.8	$	358.8	$	1,868.0
Interest	12.6		624.6		198.8		184.4		1,020.4
Total	$	70.7	$	1,704.9	$	569.6	$	543.2	$	2,888.4
Gross claim liability	$	0.4	$	15.7	$	114.5	$	103.9	$	234.5
Less:
Gross potential recoveries	—		0.7		60.0		83.2		143.9
Discount, net	0.1		3.3		10.8		2.2		16.4
Net claim liability	$	0.3	$	11.7	$	43.7	$	18.5	$	74.2
Unearned premium revenue	$	0.2	$	25.3	$	7.7	$	—	$	33.2
Claim liability reported in the balance sheet	$	0.2	$	3.6	$	38.2	$	18.5	$	60.5
Reinsurance recoverables	$	—	$	—	$	—	$	—	$	—

Included in accounts and notes receivable and unearned premiums on our consolidated balance sheets are the present value of premiums receivable and unearned premiums that are received on an installment basis. The premiums receivable is net of commissions on assumed reinsurance business. The present values of premiums receivable and unearned premiums that are received on an installment basis as of December 31, 2011 and 2010 are as follows:



	December 31,
(In millions)	2011		2010
Premiums receivable	$	34.3	$	44.0
Unearned premiums	39.8		60.5

The accretion of these balances is included either in premiums written and premiums earned for premiums receivable or policy acquisition costs for commissions on our consolidated statements of operations. The amount of the accretion included in premiums written, premiums earned and policy acquisition costs for the years ended December 31, 2011 and 2010 was as follows:



	December 31,
(In millions)	2011		2010
Premiums written	$	1.2	$	1.5
Premiums earned	1.2		1.5
Policy acquisition costs	0.3		0.3

The weighted-average risk-free rate used to discount the premiums receivable and premiums to be collected was 2.6% at December 31, 2011.

The following table shows the nominal (non-discounted) premiums, net of commissions that are expected to be collected on financial guaranty contracts with installment premiums, included in premiums receivable as of December 31, 2011. See Note 21 for the financial impact of the Assured Transaction executed in January 2012.



(In millions)	Future Expected Premium Payments
1st quarter 2012	$	1.1
2nd quarter 2012	1.8
3rd quarter 2012	1.4
4th quarter 2012	0.7
2012	5.0
2013	3.9
2014	1.5
2015	2.9
2016	2.6
2012 - 2016	15.9
2017 - 2021	10.1
2022 - 2026	6.8
2027 - 2031	4.4
After 2031	5.9
Total	$	43.1

The following table shows the rollforward of the net present value of premiums receivable as of December 31, 2011 and 2010:



	December 31,
(In millions)	2011			2010
Balance at January 1	$	44.0		$	54.4
Payments received	(5.0		)	(7.1		)
Accretion	0.9			1.3
Adjustments to installment premiums	(0.4		)	(1.5		)
Foreign exchange revaluation	0.8			(1.3		)
Recaptures/commutation	(6.0		)	(1.8		)
Balance at December 31	$	34.3		$	44.0

Premiums earned were affected by the following for the years ended December 31, 2011 and 2010:



	December 31,
(In millions)	2011		2010
Refundings	$	27.2	$	35.8
Recaptures/Commutations	2.8		—
Adjustments to installment premiums, gross of commissions	0.4		0.4
Unearned premium acceleration upon establishment of case reserves	3.2		1.4
Foreign exchange revaluation, gross of commissions	1.1		(1.4		)
Policy cancellations	—		2.3
Total adjustment to premiums earned	$	34.7	$	38.5

The following table shows the expected contractual premium revenue from our existing financial guaranty portfolio, assuming no prepayments or refundings of any financial guaranty obligations, as of December 31, 2011. See Note 21 for the financial impact of the Assured Transaction executed in January 2012.



(In millions)	Ending Net Unearned Premiums		Unearned Premium Amortization		Accretion		Total Premium Revenue
1^st quarter 2012	$	394.4	$	9.5	$	0.3	$	9.8
2^nd quarter 2012	385.5		8.9		0.3		9.2
3^rd quarter 2012	376.8		8.7		0.3		9.0
4^th quarter 2012	368.3		8.5		0.3		8.8
2012	368.3		35.6		1.2		36.8
2013	333.1		35.2		0.9		36.1
2014	300.8		32.3		0.9		33.2
2015	271.9		28.9		0.8		29.7
2016	245.7		26.2		0.7		26.9
2012 – 2016	245.7		158.2		4.5		162.7
2017 – 2021	137.8		107.9		2.9		110.8
2022 – 2026	66.4		71.4		1.9		73.3
2027 – 2031	27.0		39.4		1.2		40.6
After 2031	—		27.0		1.3		28.3
Total	$	—	$	403.9	$	11.8	$	415.7

The following table shows the significant components of changes in our financial guaranty claim liability for the years ended December 31, 2011, 2010 and 2009, excluding $2.5 million, $4.3 million and $6.6 million, respectively, related to our trade credit reinsurance and surety business, which is excluded from the accounting standard regarding accounting for financial guaranty insurance contracts by insurance enterprises.



	Year Ended December 31,
(In millions)	2011			2010			2009
Claim liability at January 1	$	67.4		$	121.8		$	211.5
Incurred losses and LAE:
Increase/(decrease) in gross claim liability	68.1			86.2			(6.0		)
Increase in gross potential recoveries	(76.1		)	(74.2		)	(42.6		)
Decrease/(increase) in discount	7.5			(1.9		)	69.6
Decrease/(increase) in unearned premiums	4.6			(1.1		)	20.7
Incurred losses and LAE	4.1			9.0			41.7
Paid losses and LAE:
Current year	—			(1.6		)	(25.4		)
Prior years	(11.0		)	(61.8		)	(106.0		)
Paid losses and LAE	(11.0		)	(63.4		)	(131.4		)
Claim liability at December 31	$	60.5		$	67.4		$	121.8
Components of incurred losses and LAE:
Claim liability established in current period	$	2.2		$	1.7		$	54.1
Changes in existing claim liabilities	1.9			7.3			(12.4		)
Total incurred losses and LAE	$	4.1		$	9.0		$	41.7
Components of decrease/(increase) in discount:
Decrease/(increase) in discount related to claim liabilities established in current period	$	0.2		$	(6.3	)	$	(4.7	)
Decrease in discount related to existing claim liabilities	7.3			4.4			74.3
Total decrease/(increase) in discount	$	7.5		$	(1.9	)	$	69.6

Our financial guaranty loss reserve estimate involves significant judgment surrounding the estimated probability of the likelihood, magnitude and timing of each potential loss based upon different loss scenarios. The probabilities, assumptions and estimates we use to establish our financial guaranty loss reserves are subject to uncertainties, particularly given the current economic and credit environments, including uncertainties regarding our public finance municipal exposures and international sovereign risk exposures. We continue to monitor the uncertainties surrounding our portfolio, and it is possible that the actual losses paid could differ materially from our present estimates.

As of December 31, 2011, we have $3.2 billion of net par outstanding related to international public finance obligations, including $495.4 million of sovereign risk. Our sovereign risk to the Stressed Eurozone Countries was as follows: Spain $47.0 million, Greece $30.1 million, Italy $22.4 million and Portugal $1.3 million. We had no exposure to Ireland at December 31, 2011. We have reserves for our exposure to Greece of $4.4 million at December 31, 2011.

The weighted-average risk-free rates used to discount the gross claim liability and gross potential recoveries were as follows, as of the dates indicated:



December 31, 2011	2.80	%
December 31, 2010	3.69	%
December 31, 2009	3.81	%
December 31, 2008	2.53	%