Losses and LAE

Our reserve for losses and LAE, as of the dates indicated, consisted of:



(In thousands)	September 30, 2012		December 31, 2011
Mortgage insurance reserves	$	3,046,706	$	3,247,900
Financial guaranty reserves	72,891		63,002
Total reserve for losses and LAE	$	3,119,597	$	3,310,902

The following table presents information relating to our mortgage insurance reserves for losses and LAE as of the dates indicated:



	Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)	2012			2011			2012			2011
Balance at beginning of period	$	3,155,343		$	3,268,582		$	3,247,900		$	3,524,971
Less reinsurance recoverables (1)	97,845			160,664			151,569			223,254
Balance at beginning of period, net of reinsurance recoverables	3,057,498			3,107,918			3,096,331			3,301,717
Add losses and LAE incurred in respect of default notices reported and unreported in:
Current year (2)	248,806			338,360			686,080			775,479
Prior years	(77,001		)	(61,761		)	(71,468		)	185,085
Total incurred	171,805			276,599			614,612			960,564
Deduct paid claims and LAE related to:
Current year (2)	2,912			59,693			3,185			61,894
Prior years	269,486			270,203			750,853			1,145,766
Total paid	272,398			329,896			754,038			1,207,660
Balance at end of period, net of reinsurance recoverables	2,956,905			3,054,621			2,956,905			3,054,621
Add reinsurance recoverables (1)	89,801			160,233			89,801			160,233
Balance at end of period	$	3,046,706		$	3,214,854		$	3,046,706		$	3,214,854

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(1)	Related to ceded losses on captive reinsurance transactions, Smart Home and quota share reinsurance transactions.


(2)	Related to underlying defaulted loans with a most recent date of default notice in the year indicated. For example, if a loan had defaulted in a prior year, but then subsequently cured and later re-defaulted in the current year, that default would be considered a current year default.

Our mortgage insurance loss reserves declined in the third quarter of 2012, primarily as a result of a decrease in our total inventory of defaults, as the volume of paid claims, cures, and insurance rescissions and claim denials outpaced new default notices received during the quarter. Additionally, we experienced positive reserve development on prior year defaults, as described below. Total paid claims declined for the three and nine months ended September 30, 2012, from the comparable periods in 2011, driven by an increase in the number of claims received that we are still reviewing for non-compliance with our insurance policies, which has lengthened the claim resolution period and resulted in an increase in rescissions and denials, as well as by delays created by foreclosure slowdowns, servicer issues, and loan modification programs. We cannot be certain of the ultimate impact of these programs on our business or results of operations, or the timing of this impact. Reserves established for new default notices received in the current quarter were the primary driver of our total incurred loss for the three months ended September 30, 2012. The losses incurred from new default notices in 2012 have been partially mitigated by positive reserve development on prior year defaults, primarily relating to higher actual insurance rescissions and claim denials than previously assumed in our loss reserve estimates. In addition, our results for the nine months ended September 30, 2012, were impacted by a $43.6 million decrease in our estimated reinsurance recoverable from our Smart Home transactions resulting from recent trends of lower claims paid and higher insurance rescissions and claim denials than were previously estimated to occur, which has in turn reduced the estimated amounts recoverable. In the second quarter of 2012, we terminated one of our remaining Smart Home transactions that was scheduled to mature in November 2012. The remaining Smart Home transaction is scheduled to mature in 2013.

For the three and nine months ended September 30, 2012, the incurred losses related primarily to default notices reported in the current year. Partially offsetting those effects in 2012 was positive reserve development on default notices reported in prior years, primarily relating to higher actual insurance rescissions and claim denials than previously assumed in our loss reserve estimates. Due to continuing uncertainty over whether these trends will continue, we did not adjust our estimated rates of future rescissions and denials during this period. For the three months ended September 30, 2011, an increase in our actual and estimated amount of insurance rescissions and claim denials for certain aged defaults positively impacted our losses incurred on prior year defaults. For the nine months ended September 30, 2011, these effects were offset by an increase in both our actual and estimated reinstatements of policies and claims previously rescinded or denied in prior years, as well as a greater than anticipated aging of underlying defaulted loans, which had the effect of increasing our default to claim rate.

While the aging of defaulted loans and other changes in the composition of our delinquent loan inventory, including the rate of claims being submitted, continued to impact our reserves and incurred losses during the three and nine months ended September 30, 2012, the magnitude of such impacts has declined compared to prior periods. Adjustments are made to loss reserves as defaulted loans age, and therefore, are considered to be closer to foreclosure and more likely to result in a claim payment. With continuing declines in home values in certain markets, persistently high unemployment and delays by servicers in either modifying loans or foreclosing on properties, the time it has taken to cure or otherwise resolve a delinquent loan has been prolonged. Consequently, in recent years, our default inventory has experienced an increase in its weighted average age, and because we apply higher estimated default to claim rates on our more aged delinquent loans, this has resulted in a higher reserve per default. As a consequence, our aggregate weighted average default to claim rate assumption (net of rescissions and denials) used in estimating our reserve for losses was 46% at September 30, 2012, compared to 43% at December 31, 2011. Our default to claim rate estimate varies depending on the age of the underlying defaulted loans, as measured by the number of monthly payments missed. As of September 30, 2012, our aggregate weighted average default to claim rate estimate excluding pending claims, net of our estimate for insurance rescissions and claim denials was 39%, and ranged from 20% for insured loans that had missed two to three monthly payments, to 45% for such loans that had missed 12 or more monthly payments.

With respect to loans that are in default, considerable judgment is exercised as to the adequacy of reserve levels. In the past, as the default proceeded towards foreclosure, there was generally more certainty around these estimates. However, in light of existing foreclosure slowdowns and efforts to increase loan modifications among defaulted borrowers, significant uncertainty remains with respect to the ultimate resolution of later stage defaults. This uncertainty requires management to use considerable judgment in estimating the rate at which these loans will result in claims.

Our reserve for losses includes the impact of our estimate of future rescissions and denials, which remain elevated compared to levels experienced before 2009. The elevated levels of our rate of insurance rescissions and claim denials have reduced our paid losses and have resulted in a significant reduction in our loss reserves. The impact of our estimate of future rescissions and denials reduced our loss reserves as of September 30, 2012 and December 31, 2011, by approximately $477 million and $631 million, respectively. Conversely, the impact of our estimate of future reinstatements of previously rescinded policies and denied claims increased our loss reserves as of September 30, 2012 and December 31, 2011, by approximately $239 million and $129 million, respectively, as further described below. The amount of estimated rescissions and denials incorporated into our reserve analysis at any point in time is affected by a number of factors, including not only our estimated rate of rescissions and denials on future claims, but also the volume and attributes of our defaulted insured loans, our estimated default to claim rate, and our estimated claim severity, among other assumptions. We expect the amount of estimated rescissions and denials embedded within our reserve analysis to decrease over time, as the defaults related to the poor underwriting periods of 2005 through 2008 decline as a proportion of our total default portfolio and as we realize the results through actual rescissions and denials, or the commutations of insured loans. In the event that we experience a more rapid than expected decrease in the level of future insurance rescissions and claim denials from the current levels, it could have a material adverse effect on our paid losses and loss reserves.

Our reported rescission and denial activity in any given period is subject to future challenges by our lender customers. Recent insurance rescission and claim denial activity reflects a significant relative shift toward more claim denials, which has resulted primarily from the failure of our lender customers to provide the documentation required to perfect a claim. Subsequent to our initial claim denials, lenders have demonstrated an ability to produce the additional information needed to perfect a claim for a significant portion of previously denied claims. As a result of these trends and recent increases in claim denial activity, we expect that a large portion of previously rescinded policies will be reinstated and previously denied claims will be resubmitted with the required documentation and ultimately paid, and we have considered this expectation in developing our incurred but not reported (“IBNR”) reserve estimate. This IBNR estimate, which consists primarily of our estimate of the future reinstatements of previously rescinded policies and denied claims, was $261.6 million and $170.6 million at September 30, 2012 and December 31, 2011, respectively.

The following table illustrates the amount of first-lien claims submitted to us for payment that were rescinded or denied, during the periods indicated, net of reinstatements within each period:



	Three Months Ended September 30,				Nine Months Ended September 30,
(In millions)	2012		2011		2012		2011
Rescissions—first loss position	$	75.8	$	93.2	$	164.1	$	313.6
Denials—first loss position	105.8		35.4		456.6		74.2
Total first loss position (1)	181.6		128.6		620.7		387.8
Rescissions—second loss position	20.0		28.5		29.6		100.7
Denials—second loss position	26.1		8.4		80.5		22.1
Total second loss position (2)	46.1		36.9		110.1		122.8
Total first-lien claims submitted for payment that were rescinded or denied (3)	$	227.7	$	165.5	$	730.8	$	510.6

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(1)	Related to claims from policies in which we were in a first loss position and would have paid the claim absent the rescission or denial.


(2)	Related to claims from policies in which we were in a second loss position. These claims may not have resulted in a claim payment obligation absent the rescission or denial, due to deductibles and other exposure limitations included in our policies.


(3)	Includes an amount related to a small number of submitted claims that were subsequently withdrawn by the insured.

The following table illustrates the total amount of first-lien claims submitted to us for payment that have been rescinded since January 1, 2009, and then subsequently were challenged (“rebutted”) by the lenders and policyholders, but have not been reinstated, for the period from January 1, 2009 through September 30, 2012. Prior to January 1, 2009, rebutted claims were not material.



(In millions)	As of September 30, 2012
First loss position	$	566.9
Second loss position	201.8
Total non-overturned rebuttals on rescinded first-lien claims	$	768.7

While the total potential claim amount of non-overturned rebuttals outstanding represents all challenged rescissions for which coverage has not been reinstated, our ongoing, active discussions with our lender customers typically involve only a small number of these non-overturned rebuttals. Accordingly, we expect that only some portion of these rescinded claims may be reinstated in future periods. Absent litigation or other legal proceedings in which we are not successful, we do not expect that these discussions are likely to result in settlements that would materially impact our liquidity or results of operations.

We also accrue for the premiums that we expect to refund to our lender customers in connection with our estimated insurance rescission activity. Our accrued liability for such refunds, which is included within accounts payable and accrued expenses on our condensed consolidated balance sheets, was $50.6 million and $57.2 million as of September 30, 2012 and December 31, 2011, respectively.

Rescission and denial rates in 2011 and 2012 have been affected by an increase in the number of claims received that we are reviewing for potential non-compliance with our insurance policies. The following table shows the projected net cumulative denial and rescission rates in our total first-lien portfolio, net of both actual and expected reinstatements, as of September 30, 2012, with respect to claims received in each quarter indicated below:



Claim Received Quarter	Projected Net Cumulative Rescission/Denial Rates for Each Quarter (1)	Percentage of Claims Resolved (2)
Q1 2010	18.3%	100%
Q2 2010	17.4%	100%
Q3 2010	15.7%	100%
Q4 2010	17.1%	99%
Q1 2011	20.6%	99%
Q2 2011	24.4%	97%
Q3 2011	29.5%	95%
Q4 2011	28.4%	90%
Q1 2012	25.7%	76%

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(1)

Projected net cumulative rescission/denial rates represent the ratio of claims rescinded or denied to claims received (by claim count). Rescissions and denials are net of actual reinstatements, plus our current estimate for expected reinstatements of previously rescinded or denied claims. These amounts represent the cumulative rates for each quarter as of September 30, 2012. Until all of the claims received during the periods shown have been internally resolved, the rescission/denial rates for each quarter will be subject to change. As discussed in footnote (2) below, these rates also will remain subject to change based on differences between estimated and actual reinstatements of previously rescinded policies or denied claims.

(2)

The percentage of claims resolved for each quarter presented in the table above, represents the number of claims that have been internally resolved as a percentage of the total number of claims received for that specific quarter. A claim is considered internally resolved when it is either paid or it is concluded that the claim should be denied or rescinded, though such denials or rescissions could be challenged and, potentially reinstated or overturned, respectively. For the second and third quarters of 2012, a significant portion of claims received for those quarters have not been internally resolved; therefore, we do not believe the cumulative rescission/denial rates for those periods are presently meaningful and therefore they are not presented.

We considered the sensitivity of first-lien loss reserve estimates at September 30, 2012, by assessing the potential changes resulting from a parallel shift in severity and default to claim rate. For example, assuming all other factors remain constant, for every one percentage point change in primary claim severity (which we estimate to be 27% of unpaid principal balance at September 30, 2012), we estimated that our loss reserves would change by approximately $88 million at September 30, 2012. For every one percentage point change in pool claim severity (which we estimate to be 45% of unpaid principal balance at September 30, 2012), we estimated that our loss reserves would change by approximately $4 million at September 30, 2012. For every one percentage point change in our overall default to claim rate (which we estimate to be 46% at September 30, 2012, including our assumptions related to rescissions and denials), we estimated a $56 million change in our loss reserves at September 30, 2012.

Estimating our loss reserves involves significant reliance upon assumptions and estimates with regard to the likelihood, magnitude and timing of each potential loss. The models, assumptions and estimates that we use to establish loss reserves 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. As such, we cannot be certain that our reserve estimate will be adequate to cover ultimate losses on incurred defaults.

See Note 10 for information regarding our financial guaranty net claim liabilities.