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Note 3 - Segment Reporting

3 Months Ended

Mar. 31, 2019

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 the segment’s forecasted annual percentage of total revenue, which approximates the estimated percentage of time spent on the segment; (ii) except as described below, all interest expense; and (iii) all corporate cash and investments. Prior to January 1, 2019, interest expense related to the Clayton Intercompany Note was allocated to our Services segment. Effective January 1, 2019, Radian Group recapitalized the Services segment with a capital contribution that enabled the Services segment to repay the intercompany note and its accumulated allocated interest expense associated with the note, and effective as of the same date, all interest expense is allocated to our Mortgage Insurance segment.

We allocate to our Services segment: (i) corporate expenses based on the segment’s forecasted annual percentage of total revenue, which approximates the estimated percentage of time spent on the segment and (ii) until January 1, 2019, the allocated interest expense related to the intercompany note as described above. 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.

Contract underwriting activities are reported within our Services segment. 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.

With the exception of goodwill and other acquired intangible assets that relate to our Services segment, which are reviewed as part of our annual goodwill impairment assessment, we do not manage assets by segment.

Adjusted Pretax Operating Income (Loss)

Our senior management, including our Chief Executive Officer (Radian’s 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 or impairment of goodwill and other acquired intangible assets, and net impairment losses recognized in earnings and infrequent or unusual non-operating items.

Although adjusted pretax operating income 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 pretax income. 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 gains and losses arise primarily from changes in the market value of our investments that are classified as trading or equity securities. These valuation adjustments may not necessarily result in realized 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 and changes in fair value of other financial instruments. 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).

(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, we do not view acquisition-related expenses as 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 or impairment of goodwill and other acquired intangible assets. Amortization of acquired intangible assets represents the periodic expense required to amortize the cost of acquired intangible assets over their estimated useful lives. Acquired 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 and infrequent or unusual non-operating items. The recognition of net impairment losses on investments and the impairment of other long-lived assets can vary significantly in both amount and frequency, depending on market credit cycles and other factors. Infrequent and unusual non-operating items reflect activities that we do not view to be indicative of our fundamental operating activities. Therefore, whenever such income or loss items occur, we exclude them from our calculation of adjusted pretax operating income (loss).

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



	Three Months Ended March 31,
(In thousands)	2019		2018
Mortgage Insurance
Net premiums written—insurance (1)	$	251,586	$	237,980
(Increase) decrease in unearned premiums	10,192		4,570
Net premiums earned—insurance	261,778		242,550
Net investment income	43,665		33,956
Other income	1,196		807
Total (2)	306,639		277,313

Provision for losses	20,844		37,391
Policy acquisition costs	5,893		7,117
Other operating expenses before corporate allocations	30,410		31,888
Total (3)	57,147		76,396
Adjusted pretax operating income before corporate allocations	249,492		200,917
Allocation of corporate operating expenses	25,625		18,577
Allocation of interest expense	15,697		10,629
Adjusted pretax operating income	$	208,170	$	171,711

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(1)	Net of ceded premiums written under our reinsurance programs. See Note 7 for additional information.


(2)	Excludes net gains on investments and other financial instruments of $21.9 million for the three months ended March 31, 2019, and net losses on investments and other financial instruments of $18.9 million for the three months ended March 31, 2018, not included in adjusted pretax operating income.

(3)Includes inter-segment expenses as follows:



	Three Months Ended March 31,
(In thousands)	2019		2018
Inter-segment expenses	$	970	$	1,002



	Three Months Ended March 31,
(In thousands)	2019				2018
Services
Net premiums earned—insurance (1)	$	1,734			$	—
Services revenue (2)	33,723				34,166
Net investment income (1)	182				—
Other income (1)	408				—
Total (2)	36,047				34,166

Provision for losses (1)	(18		)		—
Cost of services	24,559				23,270
Other operating expenses before corporate allocations	13,435				10,744
Restructuring and other exit costs	—				525
Total	37,976				34,539
Adjusted pretax operating income (loss) before corporate allocations	(1,929		)		(373		)
Allocation of corporate operating expenses	4,171				2,784
Allocation of interest expense	—			(3)	4,451
Adjusted pretax operating income (loss)	$	(6,100	)		$	(7,608	)

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(1)	Results from inclusion of the operations of EnTitle Direct, a national title insurance and settlement services company, acquired in March 2018.

(2)Includes inter-segment revenues as follows:



	Three Months Ended March 31,
(In thousands)	2019		2018
Inter-segment revenues	$	970	$	1,002


(3)	Effective January 1, 2019, the Clayton Intercompany Note was repaid using proceeds from an additional capital contribution from Radian Group. As a result of the intercompany note repayment, the Services segment no longer incurs interest expense on the intercompany note.

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



	Three Months Ended March 31,
(In thousands)	2019			2018
Adjusted pretax operating income (loss):
Mortgage Insurance (1)	$	208,170		$	171,711
Services (1)	(6,100		)	(7,608		)
Total adjusted pretax operating income	202,070			164,103

Net gains (losses) on investments and other financial instruments	21,913			(18,887		)
Acquisition-related expenses (2)	(233		)	—
Amortization and impairment of other acquired intangible assets	(2,187		)	(2,748		)
Impairment of other long-lived assets and infrequent or unusual non-operating items (3)	(5,427		)	(26		)
Consolidated pretax income	$	216,136		$	142,442

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


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


(3)	The amount for the three months ended March 31, 2019 is included in other operating expenses on the condensed consolidated statement of operations and primarily relates to impairments of other long-lived assets. The amount for the three months ended March 31, 2018 is included within restructuring and other exit costs on the condensed consolidated statement of operations.

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 considered in isolation or 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.

Revenue Recognition—Services

The accounting standard on revenue from contracts with customers is primarily applicable to revenues from our Services segment and is not applicable to our investments and insurance products, which represent the majority of our revenue. See Notes 1 and 2 of Notes to Consolidated Financial Statements in our 2018 Form 10-K for additional information regarding our accounting policies and the services we offer.

The table below represents the disaggregation of Services revenues by revenue type:



	Three Months Ended March 31,
(In thousands)	2019		2018
Services segment revenue
Mortgage Services	$	16,063	$	17,498
Real Estate Services	15,836		14,394
Title Services	2,232		2,274
Total (1)	$	34,131	$	34,166

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(1)	Includes inter-segment revenues of $1.0 million for each of the three months ended March 31, 2019 and 2018, respectively. For the three months ended March 31, 2019, amounts exclude a total of $1.9 million, comprised of Services segment net premiums earned—insurance and net investment income, as both are excluded from the scope of the revenue recognition standard.

Our Services segment revenues, other than net premiums earned—insurance and net investment income, are recognized over time and measured each period based on the progress to date as services are performed and made available to customers.

Our contracts with customers, including payment terms, are generally short-term in nature; therefore, any impact related to timing is immaterial. Revenue recognized related to services made available to customers and billed is reflected in accounts and notes receivable. Revenue recognized related to services performed and not yet billed is recorded in unbilled receivables and reflected in other assets. Deferred revenue represents advance payments received from customers in advance of revenue recognition. We have no material bad-debt expense. The following represents balances related to Services contracts as of the dates indicated:



(In thousands)	March 31, 2019		December 31, 2018
Accounts Receivable - Services Contracts	$	13,241	$	15,461
Unbilled Receivables - Services Contracts	22,967		19,917
Deferred Revenues - Services Contracts	3,044		3,204

Revenue expected to be recognized in any future period related to remaining performance obligations, such as contracts where revenue is recognized as invoiced and contracts with variable consideration related to undelivered performance obligations, is not material.