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Note 12 - Financial Guaranty Insurance Contracts Level 1 (Notes)
12 Months Ended
Dec. 31, 2012
Financial Guaranty Insurance Contracts [Abstract]  
Financial Guarantee Insurance Contracts [Text Block]
Financial Guaranty Insurance Contracts
The financial guaranty 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, net 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.
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.
 
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 and/or potential political factors;
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 at a discount to its net par outstanding.
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, 2012 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 thousands)
Performing
 
Special
Mention
 
Intensified
Surveillance
 
Case
Reserve
 
Total
Number of policies
10

 
121

 
73

 
111

 
315

Remaining weighted-average contract period (in years)
21

 
18

 
20

 
27

 
20

Insured contractual payments outstanding:
 
 
 
 
 
 
 
 
 
Principal
$
2,313

 
$
951,361

 
$
669,083

 
$
339,556

 
$
1,962,313

Interest
232

 
543,648

 
365,705

 
169,268

 
1,078,853

Total
$
2,545

 
$
1,495,009

 
$
1,034,788

 
$
508,824

 
$
3,041,166

Gross claim liability
$

 
$
16,884

 
$
266,977

 
$
86,032

 
$
369,893

Less:
 
 
 
 
 
 
 
 
 
Gross potential recoveries

 
678

 
293,175

 
66,351

 
360,204

Discount, net

 
2,586

 
(71,939
)
 
1,199

 
(68,154
)
Net claim liability (prior to reduction for unearned premium)
$

 
$
13,620

 
$
45,741

 
$
18,482

 
$
77,843

Unearned premium revenue
$
31

 
$
22,675

 
$
12,142

 
$

 
$
34,848

Net claim liability reported in the balance sheet
$

 
$
6,541

 
$
39,268

 
$
18,482

 
$
64,291

Reinsurance recoverables
$

 
$

 
$

 
$

 
$


A net claim liability is established for a performing credit if there is evidence that credit deterioration has occurred and the expected loss on the credit exceeds the unearned premium revenue for the contract based on the present value of the expected net cash outflows. 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, 2012 and 2011 are as follows:
    
 
December 31,
(In thousands)
2012
 
2011
Premiums receivable
$
28,929

 
$
34,287

Unearned premiums
33,605

 
39,773

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 accretion included in premiums written, premiums earned and policy acquisition costs for the years ended December 31, 2012 and 2011 was as follows:
    
 
December 31,
(In thousands)
2012
 
2011
Premiums written
$
999

 
$
1,174

Premiums earned
999

 
1,174

Policy acquisition costs
212

 
243

The weighted-average risk-free rate used to discount the premiums receivable and premiums to be collected was 2.6% at December 31, 2012.
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, 2012.
    
(In thousands)
Future Expected Premium Payments
1st quarter 2013
$
1,391

2nd quarter 2013
769

3rd quarter 2013
976

4th quarter 2013
567

2013
3,703

2014
2,822

2015
2,729

2016
2,339

2017
2,166

2013 - 2017
13,759

2018 - 2022
8,627

2023 - 2027
5,753

2028 - 2032
3,736

After 2032
4,725

Total
$
36,600


The following table shows the rollforward of the net present value of premiums receivable as of December 31, 2012 and 2011:
        
 
December 31,
(In thousands)
2012
 
2011
Balance at January 1
$
34,287

 
$
43,966

Payments received
(4,033
)
 
(4,882
)
Accretion
787

 
931

Adjustments to installment premiums
(1,007
)
 
(508
)
Foreign exchange revaluation
40

 
813

Recaptures/commutation
(1,145
)
 
(6,033
)
Balance at December 31
$
28,929

 
$
34,287


 
Premiums earned were affected by the following for the years ended December 31, 2012 and 2011:
     
 
December 31,
(In thousands)
2012
 
2011
Refundings
$
33,985

 
$
27,187

Recaptures/Commutations
(16,269
)
 
2,829

Adjustments to installment premiums, gross of commissions
(2,277
)
 
406

Unearned premium acceleration upon establishment of case reserves
1,109

 
3,155

Foreign exchange revaluation, gross of commissions
46

 
1,129

Reinsurance agreements
(5,996
)
 

Total adjustment to premiums earned
$
10,598

 
$
34,706



The following table shows the expected contractual premium revenue from our existing financial guaranty portfolio, assuming no refundings of any financial guaranty obligations, as of December 31, 2012.
(In thousands)
Ending Net
Unearned
Premiums
 
Unearned
Premium
Amortization
 
Accretion
 
Total
Premium
Revenue
1st quarter 2013
$
241,736

 
$
5,489

 
$
225

 
$
5,714

2nd quarter 2013
234,372

 
7,364

 
221

 
7,585

3rd quarter 2013
227,437

 
6,935

 
216

 
7,151

4th quarter 2013
218,854

 
8,583

 
212

 
8,795

2013
218,854

 
28,371

 
874

 
29,245

2014
195,816

 
23,038

 
807

 
23,845

2015
177,146

 
18,670

 
763

 
19,433

2016
160,821

 
16,325

 
705

 
17,030

2017
145,589

 
15,232

 
652

 
15,884

2013 - 2017
145,589

 
101,636

 
3,801

 
105,437

2018 - 2022
82,917

 
62,672

 
2,571

 
65,243

2023 - 2027
41,422

 
41,495

 
1,657

 
43,152

2028 - 2032
17,766

 
23,656

 
1,022

 
24,678

After 2032

 
17,766

 
1,161

 
18,927

Total
$

 
$
247,225

 
$
10,212

 
$
257,437


The following table shows the significant components of changes in our financial guaranty claim liability for the years ended December 31, 2012, 2011 and 2010, excluding $2.0 million, $2.5 million and $4.3 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 thousands)
2012
 
2011
 
2010
Claim liability at January 1
$
60,550

 
$
67,447

 
$
121,833

Incurred losses and LAE:
 
 
 
 
 
Increase in gross claim liability
188,222

 
68,082

 
86,224

Increase in gross potential recoveries
(235,787
)
 
(76,105
)
 
(74,157
)
Decrease/(increase) in discount
84,646

 
7,506

 
(1,939
)
Decrease/(increase) in unearned premiums
95

 
4,668

 
(1,085
)
Incurred losses and LAE
37,176

 
4,151

 
9,044

Paid losses and LAE:
 
 
 
 
 
Current year
(4
)
 

 
(1,636
)
Prior years
(33,431
)
 
(11,048
)
 
(61,794
)
Paid losses and LAE
(33,435
)
 
(11,048
)
 
(63,430
)
Claim liability at December 31
$
64,291

 
$
60,550

 
$
67,447

Components of incurred losses and LAE:

 
 
 
 
Claim liability established in current period
$
9,063

 
$
2,254

 
$
1,714

Changes in existing claim liabilities
28,113

 
1,897

 
7,330

Total incurred losses and LAE
$
37,176

 
$
4,151

 
$
9,044

Components of decrease/(increase) in discount:
 
 
 
 
 
Decrease/(increase) in discount related to claim liabilities established in current period
$
81,061

 
$
177

 
$
(6,377
)
Decrease in discount related to existing claim liabilities
3,585

 
7,329

 
4,438

Total decrease/(increase) in discount
$
84,646

 
$
7,506

 
$
(1,939
)

In 2012, we significantly increased our estimated gross claim liability associated with a project finance credit within our public finance insured portfolio, with net par outstanding of $69.9 million at December 31, 2012, based primarily on refinancing risk upon the maturity or scheduled principal amortization of the insured obligations beginning in 2017. Revenues for the project, however, serve as collateral for our insured risk and we have also projected a full recovery of the gross claim over time, which has resulted in an increase in our potential recovery and a decrease in our discount amount for 2012. We paid $23.5 million to settle our obligations related to our exposure to insured sovereign indebtedness of Greece in the third quarter of 2012, which was the reason for the increase in paid claims related to prior years and change in existing claim liabilities in 2012.
As of December 31, 2012, we have $2.9 billion of net par outstanding related to international public finance obligations, including $171.8 million of sovereign risk. Our sovereign risk to the six countries whose sovereign obligations have been under stress due to economic uncertainty, potential restructuring and additional ratings downgrades was as follows: Spain $47.5 million, Hungary $22.5 million, Italy $20.5 million and Portugal $0.9 million. We had no exposure to Ireland or Greece at December 31, 2012.
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.
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, 2012
2.00
%
December 31, 2011
2.80
%
December 31, 2010
3.69
%
December 31, 2009
3.81
%