Segment Reporting

We have two strategic business units that we manage separately—Mortgage Insurance and, effective with the June 30, 2014 acquisition of Clayton, our Services segment. 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. See Note 18 for information related to discontinued operations.

In the fourth quarter of 2016, we completed an organizational change that resulted in a change to our segment financial reporting structure. Previously, contract underwriting activities on behalf of third parties were reported in either the Mortgage Insurance segment or the Services segment, based on the customer relationship. Management responsibility for this contract underwriting business was moved entirely to the Services segment. This organizational change resulted in the transfer to the Services segment of revenue and expenses for all contract underwriting performed on behalf of third parties. Mortgage Insurance underwriting continues to be reported as an expense in the Mortgage Insurance segment. This change aligns with recent changes in personnel reporting lines and management oversight, and is consistent with the way the chief operating decision maker began assessing the performance of the reportable segments in the fourth quarter of 2016. As a result, on a segment basis, Services revenue, cost of services and other operating expenses have increased, with offsetting reductions in Mortgage Insurance other income and other operating expenses. This change has been reflected in our segment operating results for all periods presented.

We include underwriting-related expenses for mortgage insurance, based on a pro-rata volume of mortgage applications excluding third-party contract underwriting services, in our Mortgage Insurance segment’s other operating expenses before corporate allocations. We include underwriting-related expenses for third-party contract underwriting services, based on a pro-rata volume of mortgage applications, in our Services segment’s cost of services and other operating expenses before corporate allocations, as applicable.

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 material 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: (i) not viewed as part of the operating performance of our primary activities or (ii) not expected to result in an economic impact equal to the amount reflected in consolidated 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 securities. 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:



	December 31, 2016 (1)
(In thousands)	Mortgage Insurance		Services			Total
Net premiums written—insurance (2)	$	733,834	$	—		$	733,834
Decrease (increase) in unearned premiums	187,935		—			187,935
Net premiums earned—insurance	921,769		—			921,769
Services revenue	—		177,249			177,249
Net investment income	113,466		—			113,466
Other income	3,572		—			3,572
Total (3) (4)	1,038,807		177,249			1,216,056

Provision for losses	204,175		—			204,175
Policy acquisition costs	23,480		—			23,480
Cost of services	—		115,369			115,369
Other operating expenses before corporate allocations	140,624		55,815			196,439
Total (4)	368,279		171,184			539,463
Adjusted pretax operating income (loss) before corporate allocations	670,528		6,065			676,593
Allocation of corporate operating expenses	45,178		8,533			53,711
Allocation of interest expense	63,439		17,693			81,132
Adjusted pretax operating income (loss)	$	561,911	$	(20,161	)	$	541,750

Total assets	$	5,506,338	$	356,836		$	5,863,174

NIW (in millions)	$	50,530

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(1)

Reflects changes to align our segment reporting structure with recent changes in personnel reporting lines and management oversight related to contract underwriting performed on behalf of third parties. Revenue and expenses for this business are now reflected in the Services segment. As a result, for all periods presented, Services revenue, cost of services and other operating expenses have increased, with offsetting reductions in Mortgage Insurance other income and other operating expenses.


(2)	Net of ceded premiums written under the QSR Transactions and the Single Premium QSR Transaction. See Note 8 for additional information.


(3)	Excludes net gains on investments and other financial instruments of $30.8 million, not included in adjusted pretax operating income.


(4)	Includes inter-segment revenues and expenses as follows:



	December 31, 2016
(In thousands)	Mortgage Insurance		Services
Inter-segment revenues included in Services segment	$	—	$	8,355
Inter-segment expenses included in Mortgage Insurance segment	8,355		—



	December 31, 2015 (1)
(In thousands)	Mortgage Insurance			Services			Total
Net premiums written—insurance (2)	$	968,505		$	—		$	968,505
Decrease (increase) in unearned premiums	(52,597		)	—			(52,597		)
Net premiums earned—insurance	915,908			—			915,908
Services revenue	—			163,140			163,140
Net investment income	81,537			—			81,537
Other income	2,899			—			2,899
Total (3) (4)	1,000,344			163,140			1,163,484

Provision for losses	198,433			—			198,433
Policy acquisition costs	22,424			—			22,424
Cost of services	—			97,256			97,256
Other operating expenses before corporate allocations	148,619			43,515			192,134
Total (4)	369,476			140,771			510,247
Adjusted pretax operating income (loss) before corporate allocations	630,868			22,369			653,237
Allocation of corporate operating expenses	46,418			4,823			51,241
Allocation of interest expense	73,402			17,700			91,102
Adjusted pretax operating income (loss)	$	511,048		$	(154	)	$	510,894

Total assets	$	5,290,422		$	351,678		$	5,642,100

NIW (in millions)	$	41,411

______________________

(1)


(2)	Net of ceded premiums written under the QSR Transactions. See Note 8 for additional information.


(3)	Excludes net gains on investments and other financial instruments of $35.7 million, not included in adjusted pretax operating income.


(4)	Includes inter-segment revenues and expenses as follows:



	December 31, 2015
(In thousands)	Mortgage Insurance		Services
Inter-segment revenues included in Services segment	$	—	$	5,924
Inter-segment expenses included in Mortgage Insurance segment	5,924		—



	December 31, 2014 (1)
	Mortgage Insurance			Services (2)			Total
(In thousands)
Net premiums written—insurance (3)	$	925,181		$	—		$	925,181
Decrease (increase) in unearned premiums	(80,653		)	—			(80,653		)
Net premiums earned—insurance	844,528			—			844,528
Services revenue	—			78,908			78,908
Net investment income	65,655			—			65,655
Other income	4,063			1,265			5,328
Total (4) (5)	914,246			80,173			994,419

Provision for losses	246,865			—			246,865
Change in expected economic loss or recovery for consolidated VIEs	113			—			113
Policy acquisition costs	24,446			—			24,446
Cost of services	—			44,679			44,679
Other operating expenses before corporate allocations	158,228			30,944			189,172
Total (5)	429,652			75,623			505,275
Adjusted pretax operating income (loss) before corporate allocations	484,594			4,550			489,144
Allocation of corporate operating expenses	55,154			1,144			56,298
Allocation of interest expense	81,600			8,864			90,464
Adjusted pretax operating income (loss)	$	347,840		$	(5,458	)	$	342,382

Assets held for sale (6)	$	—		$	—		$	1,736,444
Total assets	4,779,917			325,975			6,842,336

NIW (in millions)	$	37,349

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(1)


(2)	Includes the acquisition of Clayton, effective June 30, 2014.


(3)	Net of ceded premiums written under the QSR Transactions. See Note 8 for additional information.


(4)	Excludes net gains on investments and other financial instruments of $80.1 million, not included in adjusted pretax operating income.


(5)	Includes inter-segment revenues and expenses as follows:



	December 31, 2014
(In thousands)	Mortgage Insurance		Services
Inter-segment revenues included in Services segment	$	—	$	1,723
Inter-segment expenses included in Mortgage Insurance segment	1,723		—


(6)	Assets held for sale are not part of the Mortgage Insurance or Services segments.

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



	December 31,
(In thousands)	2016			2015			2014
Adjusted pretax operating income (loss):
Mortgage insurance (1)	$	561,911		$	511,048		$	347,840
Services (1)	(20,161		)	(154		)	(5,458		)
Total adjusted pretax operating income	$	541,750		$	510,894		$	342,382

Net gains (losses) on investments and other financial instruments (2)	30,751			35,693			80,102
Loss on induced conversion and debt extinguishment	(75,075		)	(94,207		)	—
Acquisition-related expenses (3)	(519		)	(1,565		)	(6,680		)
Amortization and impairment of intangible assets	(13,221		)	(12,986		)	(8,648		)
Consolidated pretax income from continuing operations	$	483,686		$	437,829		$	407,156

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

(2)

The change in expected economic loss or recovery associated with our previously owned VIEs is included in adjusted pretax operating income above, although it represents amounts that are not included in net income. Therefore, for purposes of this reconciliation, net gains (losses) on investments and other financial instruments has been adjusted by income of $0.1 million for the year ended December 31, 2014 to reverse this item.


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

Concentration of Risk

As of December 31, 2016, California is the only state that accounted for more than 10% of our mortgage insurance business measured by primary RIF. California accounted for 12.4% of our Mortgage Insurance segment’s primary RIF at December 31, 2016, compared to 12.8% at December 31, 2015. California accounted for 14.8% of our Mortgage Insurance segment’s direct primary NIW for the year ended December 31, 2016, compared to 15.2% and 17.2% for the years ended December 31, 2015 and 2014, respectively.

The largest single mortgage insurance customer (including branches and affiliates), measured by primary NIW, accounted for 5.7% of NIW during 2016, compared to 4.6% and 4.0% from the largest single customer in 2015 and 2014, respectively. Earned premiums from one mortgage insurance customer represented 15%, 16% and 19% of our consolidated revenues (excluding net gains (losses) on investments and other financial instruments) in 2016, 2015 and 2014, respectively.

Net premiums earned attributable to foreign countries and long-lived assets located in foreign countries were immaterial for the periods presented.