Losses and LAE

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



(In thousands)	March 31, 2013		December 31, 2012
Mortgage insurance reserves	$	2,894,500	$	3,083,608
Financial guaranty reserves	24,573		66,328
Total reserve for losses and LAE	$	2,919,073	$	3,149,936

The following table presents information relating to our mortgage insurance reserves for losses, including our estimate of defaults incurred but not reported (“IBNR”), and LAE as of the dates indicated:



	Three Months Ended March 31,
(In thousands)	2013			2012
Mortgage Insurance
Balance at beginning of period	$	3,083,608		$	3,247,900
Less reinsurance recoverables (1)	83,238			151,569
Balance at beginning of period, net of reinsurance recoverables	3,000,370			3,096,331
Add losses and LAE incurred in respect of default notices reported and unreported in:
Current year (2)	182,534			218,345
Prior years	(50,578		)	16,384
Total incurred	131,956			234,729
Deduct paid claims and LAE related to:
Current year (2)	—			—
Prior years	309,927			218,193
Total paid	309,927			218,193
Balance at end of period, net of reinsurance recoverables	2,822,399			3,112,867
Add reinsurance recoverables (1)	72,101			118,071
Balance at end of period	$	2,894,500		$	3,230,938

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(1)	Related to ceded losses on captive reinsurance transactions, capital markets 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.

The ultimate amount and timing of future losses will depend, in part, on general economic conditions and other factors, including the status of credit markets, home prices and unemployment rates, all of which are difficult to predict and beyond our control. Our mortgage insurance incurred losses are driven primarily by new mortgage insurance defaults and any changes in the assumptions used to determine our loss reserves.

Our mortgage insurance loss reserves declined in the first quarter of 2013, primarily as a result of a decrease in our total inventory of defaults, as the volume of paid claims, defaulted loans that cure (“cures”), and insurance rescissions and claim denials outpaced new default notices received during the quarter. Additionally, we experienced favorable reserve development on prior year defaults, as discussed below. Total paid claims increased for the three months ended March 31, 2013 from the comparable period in 2012, mainly as a result of our recent effort to improve the efficiency of our claim review process. In prior periods, our process for reviewing claims received for non-compliance with our insurance policies lengthened the claim resolution period. Delays created by foreclosure slowdowns, servicer issues, and loan modification programs also had lengthened the claim resolution period. We cannot be certain of the ultimate impact of these factors on our business or results of operations, or the timing of this impact.

For the three months ended March 31, 2013, reserves established for new default notices reported in the current quarter were the primary driver of our total incurred losses. Favorable reserve development on default notices reported in prior years partially mitigated the impact from new defaults, as the benefit to prior year defaults from higher cures and claim curtailments was more than previously estimated.

For the three months ended March 31, 2012, reserves established for new default notices were the primary driver of total incurred losses. In addition, our results for the three months ended March 31, 2012, were negatively affected by a $27.0 million decrease in our estimated reinsurance recoverable from our Smart Home transactions. This decrease was a result of trends in lower claims paid and higher insurance rescissions and claim denials than were previously estimated to occur by the scheduled maturity dates of our Smart Home transactions.

In recent years, our default inventory has experienced an increase in its weighted average age, as measured by the number of monthly payments missed, and because we apply higher estimated “default to claim rates” (rate at which defaulted loans are expected to result in claim) 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, which is net of estimated denials, rescissions and reinstatements, used in estimating our reserve for losses was 49% at March 31, 2013, compared to 47% at December 31, 2012. As of March 31, 2013, our aggregate weighted average default to claim rate estimate, excluding pending claims, was 40%, and ranged from 20% for insured loans that had missed two to three monthly payments to 46% for such loans that had missed 12 or more monthly payments.

Our reserve for losses also 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 net future rescissions and denials reduced our loss reserves as of March 31, 2013 and December 31, 2012 by approximately $392 million and $455 million, respectively. Conversely, the impact of our estimate of future reinstatements of previously rescinded policies and denied claims increased our loss reserves as of March 31, 2013 and December 31, 2012 by approximately $259 million and $303 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. Although we expect the amount of estimated rescissions and denials embedded within our reserve for losses to remain elevated as compared to levels before 2009, we expect them to decrease over time, as the defaults related to our legacy portfolio 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 challenge by our lender customers. Recently, we have seen an increase in claim denials compared to rescissions, resulting primarily from the failure of our lender customers to provide the documentation required to perfect a claim submission. 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 increases in claim denials during 2012, we expect that a portion of previously denied claims will be resubmitted with the required documentation and ultimately paid, and we have considered this expectation in developing our IBNR reserve estimate. This IBNR reserve estimate was $275.8 million and $323.0 million at March 31, 2013 and December 31, 2012, respectively. For 2013, our IBNR reserve estimate of $275.8 million includes our estimate of future reinstatements of previously denied claims and rescinded policies of $166.3 million and $92.5 million, respectively. These reserves relate to $465.3 million of claims that were denied within the preceding 12 months and $767.9 million of policies that were rescinded within the preceding 24 months.

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



	Three Months Ended March 31,
(In millions)	2013		2012
Rescissions	$	15.3	$	33.3
Denials	27.2		212.4
Total first-lien claims submitted for payment that were rescinded or denied (1)	$	42.5	$	245.7

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

We estimate our claim liability related to the potential future reinstatement of these previously rescinded policies and denied claims by estimating an initial gross reinstatement rate at the time of denial or rescission, which then declines over a 12 or 24 month timeframe as certain denials and rescissions are reinstated. As of March 31, 2013, for previously denied claims, this initial gross reinstatement assumption begins at approximately 60% and declines to 0% after 12 months, while for previously rescinded policies, the initial assumed reinstatement rate begins at approximately 20% and declines to 0% after 24 months. Our IBNR reserve estimate also includes projected impacts from future estimated rescissions (with respect to reinstated denials) and future claim curtailments (with respect to both reinstated denials and rescissions). Therefore, at any particular point in time, our IBNR reserve estimate with respect to previously rescinded policies or denied claims is affected not only by our initial reinstatement assumption, but also by the length of time since the denial or rescission, our estimated likelihood of such reinstatements resulting in a paid claim, expected claim curtailments on such paid claims, as well as potential settlement discussions with our lender customers.

The cumulative amount of first-lien claims submitted to us for payment that have been rescinded in the last two years for primary loans and in the last three years for pool loans, and then subsequently were challenged (“rebutted”) by the lenders and policyholders, but have not been reinstated, was $842.5 million for the applicable period through March 31, 2013.

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 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 $47.5 million and $48.0 million as of March 31, 2013 and December 31, 2012, 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 violations of our insurance policies. The following table shows the cumulative rescission/denial rates in our total first-lien portfolio, net of both actual and expected reinstatements, as of March 31, 2013, with respect to claims received in each quarter indicated below:



Claim Received Quarter	Cumulative Rescission/Denial Rate for Each Quarter (1)	Percentage of Total Claims Resolved (2)
Q3 2010	16.1%	100%
Q4 2010	17.5%	100%
Q1 2011	20.9%	99%
Q2 2011	25.8%	99%
Q3 2011	31.2%	99%
Q4 2011	27.6%	97%
Q1 2012	22.8%	91%
Q2 2012	19.2%	73%
Q3 2012	15.3%	55%

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(1)

The 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 March 31, 2013. As discussed in footnote (2) below, these rates remain subject to change based on differences between estimated and actual reinstatements of previously rescinded policies or denied claims. Until all of the claims received during the periods shown have been internally resolved, the rescission/denial rates for each quarter are projections and remain subject to change.

(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. For the fourth quarter of 2012 and first quarter of 2013, 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.

We considered the sensitivity of first-lien loss reserve estimates at March 31, 2013 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 March 31, 2013), we estimated that our loss reserves would change by approximately $83 million at March 31, 2013. For every one percentage point change in pool claim severity (which we estimate to be 45% of unpaid principal balance at March 31, 2013), we estimated that our loss reserves would change by approximately $4 million at March 31, 2013. For every one percentage point change in our overall default to claim rate (which we estimate to be 49% at March 31, 2013), we estimated a $50 million change in our loss reserves at March 31, 2013.

Estimating the loss reserves in both our mortgage insurance and financial guaranty business segments involves significant reliance upon assumptions and estimates with regard to the likelihood, magnitude and timing of each potential loss. The models, assumptions and estimates 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, as has existed for the last several years. Our reserves could be impacted in the future by the continued delay of the U.S. economy to fully recover from the most recent recession and prolonged economic downturn, including high unemployment, uncertainty in the housing, municipal, foreign sovereign and related credit markets, which could increase our mortgage insurance or financial guaranty losses beyond our existing expectations. As such, we cannot be certain that our reserve estimate will be adequate to cover ultimate losses on incurred defaults.

See Note 9 for information regarding our financial guaranty net claim liabilities.