RDN » Topics » A prolonged period of losses could increase our subsidiaries risk-to-capital or leverage ratios, preventing them from writing new insurance.

These excerpts taken from the RDN 10-K filed Mar 14, 2008.

A prolonged period of losses could increase our subsidiaries’ risk-to-capital or leverage ratios, preventing them from writing new insurance.

Rating agencies and state insurance regulators impose capital requirements on our subsidiaries. These capital requirements include risk-to-capital ratios, leverage ratios and surplus requirements that limit the amount of insurance that these subsidiaries may write. Most of the individual states limit a mortgage insurer’s risk to capital ratio to 25-to-1. At December 31, 2006, the risk-to-capital ratio of our mortgage insurance subsidiaries was 10.4-to-1. As a result of their net losses during 2007, the risk-to-capital ratio grew to 14.4-to-1 at December 31, 2007. A material reduction in the statutory capital and surplus of any of our insurance subsidiaries, whether resulting from additional underwriting or investment losses or otherwise, or a disproportionate increase in risk in force, could increase that subsidiary’s risk-to-capital ratio or leverage ratio. This in turn could limit that subsidiary’s ability to write new business or require that subsidiary to lower its ratio by obtaining capital contributions from us or another of our insurance subsidiaries or by reinsuring existing business, which may not be available to us on attractive terms or at all. If we are required to contribute capital to a subsidiary, it would adversely affect our liquidity.

A prolonged period of losses could increase our subsidiaries’ risk-to-capital or leverage ratios, preventing them from writing new insurance.

Rating agencies and state insurance regulators impose capital requirements on our subsidiaries. These capital requirements include
risk-to-capital ratios, leverage ratios and surplus requirements that limit the amount of insurance that these subsidiaries may write. Most of the individual states limit a mortgage insurer’s risk to capital ratio to 25-to-1. At
December 31, 2006, the risk-to-capital ratio of our mortgage insurance subsidiaries was 10.4-to-1. As a result of their net losses during 2007, the risk-to-capital ratio grew to 14.4-to-1 at December 31, 2007. A material reduction in the
statutory capital and surplus of any of our insurance subsidiaries, whether resulting from additional underwriting or investment losses or otherwise, or a disproportionate increase in risk in force, could increase that subsidiary’s
risk-to-capital ratio or leverage ratio. This in turn could limit that subsidiary’s ability to write new business or require that subsidiary to lower its ratio by obtaining capital contributions from us or another of our insurance subsidiaries
or by reinsuring existing business, which may not be available to us on attractive terms or at all. If we are required to contribute capital to a subsidiary, it would adversely affect our liquidity.

STYLE="margin-top:18px;margin-bottom:0px">If the estimates we use in establishing loss reserves for our mortgage insurance or financial guaranty business are incorrect, we may be required to take
unexpected charges to income and our ratings may be downgraded.

We establish loss reserves in both our mortgage insurance and
financial guaranty businesses to provide for the estimated cost of claims. However, because our reserves represent an estimate, these reserves may be inadequate to protect us from the full amount of claims we ultimately may have to pay. Setting our
loss reserves involves significant reliance on estimates of the likelihood, magnitude and timing of anticipated losses. The models and estimates we use to establish loss reserves may prove to be inaccurate, especially during an extended economic
downturn or in a period of extreme credit market volatility as has existed for most of 2007. If our estimates are inadequate, we may be required to increase our reserves, including by raising additional capital, which we may not be able to access on
acceptable terms, if at all. Failure to establish adequate reserves or a requirement that we increase our reserves, including through a downgrade or warning of potential downgrade of our credit and financial strength ratings, would have a material
adverse effect on our financial condition, including our capital position, operating results and business prospects.

In our mortgage
insurance business, in accordance with GAAP, we generally do not establish reserves until we are notified that a borrower has failed to make at least two consecutive payments when due. Upon notification that two payments have been missed, we
establish a loss reserve by using historical models based on a variety of loan characteristics, including the type of loan, the status of the loan as reported by the servicer of the loan, and

 


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the area where the loan is located. We are required under GAAP to establish a premium deficiency reserve for our second-lien business, equal to the amount by
which the net present value of expected future losses and expenses for this business exceeds expected future premiums and existing reserves. All of our mortgage insurance reserves are therefore based on a number of assumptions and estimates that may
prove to be inaccurate.

It also is difficult to estimate appropriate loss reserves for our financial guaranty business because of the
nature of potential losses in that business, which are largely influenced by the particular circumstances surrounding each troubled credit, including the availability of loss mitigation, and therefore, are less capable of being evaluated based on
historical assumptions or precedent. In addition, in our reinsurance business, we generally rely on information provided by the primary insurer in order to establish results. If this information is incomplete or untimely, our loss reserves may be
inaccurate and could require adjustment in future periods as new or corrected information becomes available.

On April 18, 2007, the
Financial Accounting Standards Board (“FASB”) issued an exposure draft, “Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60” (“Exposure Draft”). The Exposure Draft
clarifies how Statement of Financial Accounting Standards (“SFAS”) No. 60, “Accounting and Reporting by Insurance Enterprises” applies to financial guaranty insurance contracts and provides guidance with respect to the
timing of claim liability recognition, premium recognition and the related amortization of deferred policy acquisition costs, specifically for financial guaranty contracts issued by insurance companies that are not accounted for as derivative
contracts under SFAS No. 133. The goal of the proposed statement is to reduce diversity in accounting by financial guaranty insurers, thereby enabling users to better understand and more readily compare insurers’ financial statements.
Final guidance from the FASB regarding accounting for financial guaranty insurance is expected to be issued in 2008. If the Exposure Draft is issued as proposed, the effect on our consolidated financial statements, particularly with respect to
revenue recognition and claims liability, could be material.

EXCERPTS ON THIS PAGE:

10-K (2 sections)
Mar 14, 2008
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