Segment Reporting

Our mortgage insurance and financial guaranty segments are strategic business units that are managed separately. We allocate corporate income and expenses to our mortgage insurance and financial guaranty segments based on either an allocated percentage of time spent on each segment or internally allocated capital, which is based on the relative GAAP equity of each segment. We allocate corporate cash and investments to our segments based on internally allocated capital. The results for each segment for each reporting period can cause significant volatility in internally allocated capital based on relative GAAP equity, which can impact the allocations of income and expenses to our segments.

Adjusted Pretax Operating Income (Loss)

Our senior management, including our Chief Executive Officer (our chief operating decision maker), uses adjusted pretax operating income (loss) as our primary measure to facilitate evaluation of the fundamental financial performance of the Company’s business segments and to allocate resources to the segments. Adjusted pretax operating income (loss) is defined as pretax income (loss) excluding the effects of net gains (losses) on investments and other financial instruments and net impairment losses recognized in earnings. It also excludes gains and losses related to changes in fair value estimates on insured credit derivatives and includes the impact of changes in the present value of insurance claims and recoveries on insured credit derivatives, based on our ongoing insurance loss monitoring, as well as premiums earned on insured credit derivatives. Management’s use of this measure as its primary measure to evaluate segment performance began with the quarter ended March 31, 2014. Accordingly, for comparison purposes, we also present the applicable measures from the corresponding period of 2013 on a basis consistent with the current year presentation.

Although adjusted pretax operating income (loss) excludes certain items that have occurred in the past and are expected to occur in the future, the excluded items represent those that are: (1) not viewed as part of the operating performance of our primary activities; or (2) not expected to result in an economic impact equal to the amount reflected in pretax income (loss). These adjustments, along with the reasons for their treatment, are described below.

(1)

Change in fair value of derivative instruments. Gains and losses related to changes in the fair value of insured credit derivatives are subject to significant fluctuation based on changes in interest rates, credit spreads (of both the underlying collateral as well as our credit spread), credit ratings and other market, asset-class and transaction-specific conditions and factors that may be unrelated or only indirectly related to our obligation to pay future claims. With the exception of the estimated present value of net credit (losses) recoveries incurred and net premiums earned on derivatives, discussed in items 2 and 3 below, we believe these gains and losses will reverse over time and consequently these changes are not expected to result in economic gains or losses. Therefore, these gains and losses are excluded from our calculation of adjusted pretax operating income (loss).

(2)

Estimated present value of net credit (losses) recoveries incurred. The change in present value of insurance claims we expect to pay or recover on insured credit derivatives represents the amount of the change in credit derivatives from item 1 above, that we expect to result in an economic loss or recovery based on our ongoing loss monitoring analytics. Therefore, this item is expected to have an economic impact and is included in our calculation of adjusted pretax operating income (loss). Also included in this item is the expected recovery of miscellaneous operating expenses associated with our consolidated VIEs.


(3)	Net premiums earned on derivatives. The net premiums earned on insured credit derivatives are classified as part of the change in fair value of derivative instruments discussed in item 1 above. However, since net premiums earned on derivatives are considered part of our fundamental operating activities, these premiums are included in our calculation of adjusted pretax operating income (loss).

(4)

Net gains (losses) on investments and other financial instruments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on the timing of individual securities sales due to such factors as market opportunities, our tax and capital profile and overall market cycles. Unrealized investment gains and losses arise primarily from changes in the market value of our investments that are classified as trading. These valuation adjustments may not necessarily result in economic gains or losses. We do not view them to be indicative of our fundamental operating activities. Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized and unrealized gains or losses. Therefore, these items are excluded from our calculation of adjusted pretax operating income (loss).


(5)	Net impairment losses recognized in earnings. The recognition of net impairment losses on investments can vary significantly in both size and timing, depending on market credit cycles. We do not view them to be indicative of our fundamental operating activities. Therefore, these losses are excluded from our calculation of adjusted pretax operating income (loss).

Summarized financial information concerning our operating segments as of and for the periods indicated, is as follows:



	Three Months Ended March 31, 2014
	Mortgage		Financial
(In thousands)	Insurance		Guaranty			Total
Net premiums written—insurance	$	212,953	$	753		$	213,706
Net premiums earned—insurance	$	198,762	$	6,903		$	205,665
Net premiums earned on derivatives	—		3,445			3,445
Net investment income	14,021		10,208			24,229
Other income	1,057		70			1,127
Total revenues	213,840		20,626			234,466

Provision for losses	49,159		5,650			54,809
Estimated present value of net credit losses (recoveries) incurred	139		(501		)	(362		)
Change in PDR	466		—			466
Policy acquisition costs	7,017		1,597			8,614
Other operating expenses	50,358		9,551			59,909
Interest expense	5,372		14,555			19,927
Total expenses	112,511		30,852			143,363

Equity in net loss of affiliates	—		(13		)	(13		)

Adjusted pretax operating income (loss)	$	101,329	$	(10,239	)	$	91,090

Cash and investments	$	2,735,809	$	2,166,099		$	4,901,908
Deferred policy acquisition costs	27,870		35,838			63,708
Total assets	3,136,537		2,392,448			5,528,985
Unearned premiums	580,453		194,335			774,788
Reserve for losses and LAE	1,893,960		29,751			1,923,711
VIE debt	3,144		92,436			95,580
Derivative liabilities	—		257,717			257,717

New Insurance Written (“NIW”) (in millions)	$	6,808



	Three Months Ended March 31, 2013
	Mortgage			Financial
(In thousands)	Insurance			Guaranty			Total
Net premiums written—insurance	$	217,286		$	(10,101	)	$	207,185
Net premiums earned—insurance	$	182,992		$	9,596		$	192,588
Net premiums earned on derivatives	—			4,992			4,992
Net investment income	15,102			11,771			26,873
Other income	1,712			59			1,771
Total revenues	199,806			26,418			226,224

Provision for losses	131,956			103			132,059
Estimated present value of net credit recoveries incurred	(299		)	(2,845		)	(3,144		)
Change in PDR	(629		)	—			(629		)
Policy acquisition costs	11,732			5,463			17,195
Other operating expenses	65,780			14,320			80,100
Interest expense	2,669			13,212			15,881
Total expenses	211,209			30,253			241,462

Equity in net income of affiliates	—			1			1

Adjusted pretax operating loss	$	(11,403	)	$	(3,834	)	$	(15,237	)

Cash and investments	$	3,186,871		$	2,486,017		$	5,672,888
Deferred policy acquisition costs	29,920			44,681			74,601
Total assets	3,663,552			2,707,397			6,370,949
Unearned premiums	428,574			245,275			673,849
Reserve for losses and LAE	2,894,500			24,573			2,919,073
VIE debt	11,062			96,339			107,401
Derivative liabilities	—			430,898			430,898

NIW (in millions)	$	10,906

The reconciliation of adjusted pretax operating income (loss) to consolidated pretax income (loss) and consolidated net income (loss) is as follows:



	Three Months Ended March 31,
	2014			2013
Adjusted pretax operating income (loss):
Mortgage insurance	$	101,329		$	(11,403	)
Financial guaranty	(10,239		)	(3,834		)
Total adjusted pretax operating income (loss)	$	91,090		$	(15,237	)

Change in fair value of derivative instruments	50,086			(167,670		)
Less: Estimated present value of net credit recoveries incurred	362			3,144
Less: Net premiums earned on derivatives	3,445			4,992
Change in fair value of derivative instruments expected to reverse over time	46,279			(175,806		)

Net gains (losses) on investments	64,451			(5,505		)
Net gains (losses) on other financial instruments	698			(5,675		)
Consolidated pretax income (loss)	202,518			(202,223		)
Income tax benefit	(241		)	(14,723		)
Consolidated net income (loss)	$	202,759		$	(187,500	)

On a consolidated basis, “adjusted pretax operating income (loss)” is a measure not determined in accordance with GAAP. Total adjusted pretax operating income (loss) is not a measure of total profitability, and therefore should not be viewed as a substitute for GAAP pretax income (loss). Our definition of adjusted pretax operating income (loss) may not be comparable to similarly-named measures reported by other companies.