Segment Reporting

We have two strategic business units that we manage separately—Mortgage Insurance and Services. Adjusted pretax operating income (loss) for each segment represents segment results on a standalone basis; therefore, inter-segment eliminations and reclassifications required for consolidated GAAP presentation have not been reflected.

We allocate to our Mortgage Insurance segment: (i) corporate expenses based on an allocated percentage of time spent on the Mortgage Insurance segment; (ii) all interest expense except for interest expense related to the Senior Notes due 2019 that were issued to fund our purchase of Clayton; and (iii) all corporate cash and investments.

We allocate to our Services segment: (i) corporate expenses based on an allocated percentage of time spent on the Services segment; and (ii) as noted above, all interest expense related to the Senior Notes due 2019. No corporate cash or investments are allocated to the Services segment. Inter-segment activities are recorded at market rates for segment reporting and eliminated in consolidation.

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 evaluate the fundamental financial performance of each of Radian’s business segments and to allocate resources to the segments. Adjusted pretax operating income (loss) is defined as pretax income (loss) from continuing operations excluding the effects of net gains (losses) on investments and other financial instruments, loss on induced conversion and debt extinguishment, acquisition-related expenses, amortization and impairment of intangible assets, and net impairment losses recognized in earnings.

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) from continuing operations. These adjustments, along with the reasons for their treatment, are described below.

(1)

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.

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. We do not view them to be indicative of our fundamental operating activities. Therefore, these items are excluded from our calculation of adjusted pretax operating income (loss). However, we include the change in expected economic loss or recovery associated with our consolidated VIEs, if any, in the calculation of adjusted pretax operating income (loss).

(2)

Loss on induced conversion and debt extinguishment. Gains or losses on early extinguishment of debt and losses incurred to purchase our convertible debt prior to maturity are discretionary activities that are undertaken in order to take advantage of market opportunities to strengthen our financial and capital positions; therefore, we do not view these activities as part of our operating performance. Such transactions do not reflect expected future operations and do not provide meaningful insight regarding our current or past operating trends. Therefore, these items are excluded from our calculation of adjusted pretax operating income (loss).

(3)

Acquisition-related expenses. Acquisition-related expenses represent the costs incurred to effect an acquisition of a business (i.e., a business combination). Because we pursue acquisitions on a strategic and selective basis and not in the ordinary course of our business, we do not view acquisition-related expenses as a consequence of a primary business activity. Therefore, we do not consider these expenses to be part of our operating performance and they are excluded from our calculation of adjusted pretax operating income (loss).

(4)

Amortization and impairment of intangible assets. Amortization of intangible assets represents the periodic expense required to amortize the cost of intangible assets over their estimated useful lives. Intangible assets with an indefinite useful life are also periodically reviewed for potential impairment, and impairment adjustments are made whenever appropriate. These charges are not viewed as part of the operating performance of our primary activities and therefore 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 these impairment losses to be indicative of our fundamental operating activities. Therefore, whenever these losses occur, we exclude them from our calculation of adjusted pretax operating income (loss).

Summarized operating results for our segments as of and for the periods indicated, are as follows:



	Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)	2016			2015			2016		2015
Mortgage Insurance
Net premiums written—insurance (1)	$	240,999		$	242,168		$	499,662	$	735,158
Decrease (increase) in unearned premiums	(2,850		)	(14,735		)	188,522		(45,693		)
Net premiums earned—insurance	238,149			227,433			688,184		689,465
Net investment income	28,430			22,091			84,470		58,704
Other income	3,511			1,711			8,850		4,785
Total (2)	270,090			251,235			781,504		752,954

Provision for losses	56,151			64,128			149,500		141,616
Policy acquisition costs	6,119			2,880			17,901		17,593
Other operating expenses before corporate allocations	38,081			36,632			108,036		112,535
Total (3)	100,351			103,640			275,437		271,744
Adjusted pretax operating income before corporate allocations	169,739			147,595			506,067		481,210
Allocation of corporate operating expenses	11,911			14,893			35,526		37,167
Allocation of interest expense	15,360			16,797			50,596		56,820
Adjusted pretax operating income	$	142,468		$	115,905		$	419,945	$	387,223

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(1)	Net of ceded premiums written under the QSR Transactions and the Single Premium QSR Transaction. See Note 7 for additional information.


(2)	Excludes net gains on investments and other financial instruments of $7.7 million and $69.5 million, respectively, for the three and nine months ended September 30, 2016, and $3.9 million and $49.1 million, respectively, for the three and nine months ended September 30, 2015, not included in adjusted pretax operating income.


(3)	Includes inter-segment expenses as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands)	2016		2015		2016		2015
Inter-segment expenses	$	718	$	925	$	2,023	$	2,919



	Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)	2016			2015			2016			2015
Services
Services revenue (1)	$	43,800		$	43,114		$	114,998		$	119,241

Direct cost of services	26,911			25,870			74,188			70,624
Other operating expenses before corporate allocations	12,740			11,533			39,160			31,912
Total	39,651			37,403			113,348			102,536
Adjusted pretax operating income before corporate allocations	4,149			5,711			1,650			16,705
Allocation of corporate operating expenses	2,265			1,567			6,795			3,855
Allocation of interest expense	4,423			4,423			13,267			13,286
Adjusted pretax operating income (loss)	$	(2,539	)	$	(279	)	$	(18,412	)	$	(436	)

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(1)	Includes inter-segment revenues as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands)	2016		2015		2016		2015
Inter-segment revenues	$	718	$	925	$	2,023	$	2,919

Selected balance sheet information for our segments as of the periods indicated, is as follows:



	At September 30, 2016
(In thousands)	Mortgage Insurance		Services		Total
Total assets	$	5,686,726	$	363,101	$	6,049,827



	At December 31, 2015
(In thousands)	Mortgage Insurance		Services		Total
Total assets	$	5,281,597	$	360,503	$	5,642,100

The reconciliation of adjusted pretax operating income to consolidated pretax income from continuing operations is as follows:



	Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)	2016			2015			2016			2015
Adjusted pretax operating income (loss):
Mortgage Insurance (1)	$	142,468		$	115,905		$	419,945		$	387,223
Services (1)	(2,539		)	(279		)	(18,412		)	(436		)
Total adjusted pretax operating income	139,929			115,626			401,533			386,787

Net gains (losses) on investments and other financial instruments	7,711			3,868			69,524			49,095
Loss on induced conversion and debt extinguishment	(17,397		)	(11		)	(75,075		)	(91,887		)
Acquisition-related (expenses) benefits (2)	(10		)	(525		)	(161		)	(1,299		)
Amortization and impairment of intangible assets	(3,292		)	(3,273		)	(9,931		)	(9,577		)
Consolidated pretax income from continuing operations	$	126,941		$	115,685		$	385,890		$	333,119

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(1)	Includes inter-segment expenses and revenues as listed in the notes to the preceding tables.


(2)	Acquisition-related (expenses) benefits represent expenses incurred to effect the acquisition of a business, net of adjustments to accruals previously recorded for acquisition expenses.

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) from continuing operations. Our definition of adjusted pretax operating income (loss) may not be comparable to similarly-named measures reported by other companies.