SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 2002
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from ___________ to ___________ Commission
file number 0-22342
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TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1838519
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 SOUTH STRATFORD ROAD
WINSTON-SALEM, NORTH CAROLINA 27104
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (336) 723-1282
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Securities registered pursuant to Section 12(b) of
the Act:
None
Securities registered pursuant to Section 12(g) of
the Act:
Title of each class
Common Stock, par value $.01 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of RegulationS-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes /X/ No / /.
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant, computed by reference to the price at which
the common equity was last sold, or the average bid and asked price of such
common equity, as of the last business day of the registrant's most recently
completed second fiscal quarter: $353,805,876 as of June 28, 2002, which amount
excludes the value of all shares beneficially owned (as defined in Rule 13d-3
under the Securities Exchange Act of 1934) by officers and directors of the
registrant (however this does not constitute a representation or acknowledgment
that any such individual is an affiliate of the registrant).
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of February 15, 2003, was 14,218,674.
Portions of the following documents are Part of this Form 10-K
incorporated by reference into this into which the document is
Form 10-K: incorporated by reference
Triad Guaranty Inc. Part III
Proxy Statement for 2003 Annual Meeting
of Stockholders
PART I
ITEM 1. BUSINESS.
Triad Guaranty Inc. is a holding company which, through its wholly-owned
subsidiary, Triad Guaranty Insurance Corporation ("Triad"), provides private
mortgage insurance ("MI") coverage in the United States to residential mortgage
lenders and investors. Triad Guaranty Inc. and its subsidiaries are collectively
referred to as the "Company". The "Company" when used within this document
refers to the holding company and/or one or more of its subsidiaries, as
appropriate.
Private mortgage insurance, also known as mortgage guaranty insurance, is
issued in most home purchases and refinancings involving conventional
residential first mortgage loans to borrowers with equity of less than 20%. If
the homeowner defaults, private mortgage insurance reduces, and in some
instances eliminates, the loss to the insured lender. Private mortgage insurance
also facilitates the sale of low down payment mortgage loans in the secondary
mortgage market, principally to the Federal National Mortgage Association
("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac").
Under risk-based capital regulations applicable to most financial institutions,
private mortgage insurance also reduces the capital requirement for such lenders
on residential mortgage loans with equity of less than 20%. In addition,
mortgage insurance is purchased by investors and lenders who seek additional
default protection or capital relief on loans with equity of greater than 20%.
Private mortgage insurance has traditionally involved underwriting and
insuring an individual loan. This type of mortgage insurance is known as
"traditional flow" mortgage insurance and will be referred to as such throughout
this document. In 2001, the Company began participating in structured bulk
transactions which involve underwriting and insuring a group of loans. This type
of mortgage insurance is known as "structured bulk" mortgage insurance and will
be referred to as such throughout this document.
Triad was formed in 1987 as a wholly-owned subsidiary of Primerica
Corporation and began writing private mortgage insurance in 1988. In September
1989, Triad was acquired by Collateral Mortgage, Ltd. ("CML"), a mortgage
banking and real estate lending firm located in Birmingham, Alabama. In 1990,
CML contributed the outstanding stock of Triad to its affiliate, Collateral
Investment Corp. ("CIC"), an insurance holding company.
The Company was incorporated by CIC in Delaware in August 1993, for the
purpose of holding all the outstanding stock of Triad and to undertake the
initial public offering of the Company's Common Stock, which was completed in
November 1993. CIC currently owns 18.9% and CML owns 18.2% of the outstanding
Common Stock of the Company.
The principal executive offices of the Company are located at 101 South
Stratford Road, Winston-Salem, North Carolina 27104. Its telephone number is
(336) 723-1282.
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TYPES OF MORTGAGE INSURANCE PRODUCTS
PRIMARY INSURANCE
Primary insurance provides mortgage default protection on individual loans
and covers unpaid loan principal, delinquent interest, and certain expenses
associated with the default and subsequent foreclosure (collectively, the "claim
amount"). The claim amount, to which the appropriate coverage percentage is
applied, generally ranges from 110% to 115% of the unpaid principal balance of
the loan. The Company's obligation to an insured lender with respect to a claim
is determined by applying the appropriate coverage percentage to the claim
amount. Under its master policy, the Company has the option of paying the entire
claim amount and taking title to the mortgaged property or paying the coverage
percentage in full satisfaction of its obligations under the insurance written.
Primary insurance can be placed on many types of loan instruments and generally
applies to loans secured by mortgages on owner occupied homes.
The Company offers primary coverage generally from 6% to 45% of the claim
amount, with most coverage from 12% to 40% as of December 31, 2002. The coverage
percentage provided by the Company is selected by the insured lender, subject to
the Company's underwriting approval, usually in order to comply with investor
requirements to reduce investor loss exposure on loans they purchase.
Fannie Mae and Freddie Mac are the ultimate purchasers of a large
percentage of the loans insured by the Company. Generally they require a
coverage percentage that will reduce their loss exposure on loans they purchase
to 75% or less of the property's value at the time the loan is originated. Since
1999, Fannie Mae and Freddie Mac have accepted lower coverage percentages for
certain categories of mortgages when the loan is approved by their automated
underwriting services. The reduced coverage percentages limit loss exposure to
80% or less of the property's value at the time the loan is originated.
The Company's premium rates vary depending upon the loan-to-value (LTV)
ratio, loan type, mortgage term, coverage amount, documentation required, and
use of property, which all affect the perceived risk of a claim on the insured
mortgage loan. Generally, premium rates cannot be changed after issuance of
coverage. The Company, consistent with industry practice, generally utilizes a
nationally based, rather than a regional or local, premium rate structure,
although special risk rates are utilized as well.
With respect to its traditional flow mortgage insurance, the premiums are
paid by either the borrower (borrower-paid) or the lender (lender-paid). Under
the Company's borrower-paid plan, mortgage insurance premiums are charged to the
mortgage lender or servicer which collects the premium from the borrower and, in
turn, remits the premiums to the Company. Under the Company's lender-paid plan,
mortgage insurance premiums are charged to the mortgage lender or loan servicer,
which pays the premium to the Company. The lender typically builds the mortgage
insurance premium into the borrower's interest rate. Approximately 72% and 82%
of the Company's traditional flow insurance was written under its borrower-paid
plan during 2002 and 2001, respectively. The remainder was written under its
lender-paid plan (28% and 18% of traditional flow insurance during 2002 and
2001, respectively). The Company's lender-paid volume is concentrated among
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larger mortgage lender customers. The premium rate structures associated with
the lender-paid plan are lower than standard borrower-paid rates. The Company is
able to have lower premium rate structures with lender-paid plans due to lower
acquisition costs, higher expected persistency, and expected favorable loss
development associated with lender-paid plans.
Premiums may be remitted to the Company monthly, annually, or in one single
payment. The monthly premium payment plan involves the payment of one or two
months' premium at the mortgage loan closing. Thereafter, level monthly premiums
are collected by the loan servicer for monthly remittance to the Company. The
Company also offers a plan under which the first monthly mortgage insurance
payment is deferred until the first loan payment is remitted to the Company.
This deferred monthly premium product decreases the amount of cash required from
the borrower at closing, therefore making home ownership more affordable.
Monthly premium plans represented approximately 80% and 88% of traditional flow
insurance written in 2002 and 2001, respectively.
The annual premium payment plan requires a first-year premium paid at
mortgage loan closing with annual renewal payments. With respect to the
Company's borrower-paid plan, renewal payments are collected monthly from the
borrower and held in escrow by the mortgage lender or servicer for annual
remittance to the Company in advance of each renewal year. Annual premium plans
represented approximately 20% and 11% of traditional flow insurance written in
2002 and 2001, respectively. The increase in the percentage of traditional flow
insurance written under the Company's annual premium plan is primarily the
result of a large mortgage lender customer choosing the Company's annual premium
plan for its lender-paid volume in 2002.
The single premium payment plan requires a single payment paid at loan
closing. The single premium payment can be financed by the borrower by adding it
to the principal amount of the mortgage or can be paid in cash at closing by the
borrower. Single premium plans represented less than 1% of traditional flow
insurance written in 2002 and 2001.
POOL INSURANCE
Pool insurance generally has been offered by private mortgage insurers to
lenders as an additional credit enhancement for certain mortgage-backed
securities and provides coverage for the full amount of the net loss on each
individual loan included in the pool, subject to a provision limiting aggregate
losses to a specified percentage of the total original balances of all loans in
the pool. The Company does not offer this traditional form of pool insurance.
In the second quarter of 2000, the Company began to participate in modified
pool insurance programs on loans purchased by Freddie Mac. Modified pool
insurance provides coverage for a specified percentage of the claim amount for
each loan insured, subject to an overall stop-loss provision applicable to the
entire pool of loans insured. At December 31, 2002, Freddie Mac modified pool
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insurance programs represented less than 1% of the Company's insurance in force.
The Company ceased participation in the Freddie Mac modified pool insurance
programs in September of 2002 and has not entered into any new Freddie Mac
programs subsequent to that date.
STRUCTURED BULK TRANSACTIONS
The Company participates in structured bulk transactions. Structured bulk
transactions involve insuring a group of loans where the insured loans have
individual loan level coverage. These transactions frequently include an
aggregate stop-loss limit applied to the entire group of insured loans.
Insurance issued in structured bulk transactions is generally either primary,
supplemental if the policy already has primary coverage, or a combination of
both. Individual loan level coverage is determined in order to reduce the
insured's exposure on a given loan down to a percentage of the loan's balance
("down to" coverage). Through December 31, 2002, insurance written through the
structured bulk channel has not been subject to captive mortgage reinsurance or
other risk-sharing arrangements.
Structured bulk transactions are generally initiated by secondary mortgage
market participants, including underwriters of mortgage-backed securities,
mortgage lenders, and mortgage investors such as Fannie Mae and Freddie Mac,
where mortgage insurance is used as a credit enhancement. The Company is
provided loan-level information on the group of loans and, based on the risk
characteristics of the entire group of loans and the requirements of the
secondary mortgage market participant, the Company will submit a price for
insuring the entire group of loans. The Company competes against other mortgage
insurers as well as other forms of credit enhancements provided by capital
markets for these transactions.
The structured bulk market can be divided into three broad segments: the
Prime segment (predominantly fully underwritten loans, high credit scores, high
percentage of low LTV's), the Alternative - A segment (generally high credit
score, low to moderate LTV loans that have been underwritten with reduced
documentation), and the Sub-prime segment (generally fully underwritten loans
with credit impaired borrowers). Although the Company has evaluated transactions
in all segments of the structured bulk market, all of the Company's insurance in
force from structured bulk transactions at December 31, 2002 was in the Prime
segment and the Alternative - A segment. During 2002, all of the Company's
structured bulk insurance written was in the Alternative - A segment of the
structured bulk market. During 2001, approximately 80% of the Company's
structured bulk insurance written was in the Prime segment of the structured
bulk market and approximately 20% was in the Alternative - A segment. The
Company anticipates bidding on and insuring loans across all market segments in
2003.
During 2002, structured bulk transactions represented approximately 9% of
the Company's insurance written for the year. Insurance written during 2001
attributed to structured bulk transactions represented approximately 36% of the
Company's total insurance written. The Company expects to continue to be
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competitive in the structured bulk transaction market. However, it is difficult
to predict the Company's volume of business during 2003 due to the relatively
small number of transactions that encompass this market (as opposed to the
traditional flow market), competitiveness with other mortgage insurers, the
attractiveness in the marketplace of mortgage insurance versus other forms of
credit enhancements, and the changing loan composition of the market.
RISK-SHARING PRODUCTS
The Company offers mortgage insurance programs designed to allow lenders to
share in the risks of mortgage insurance in exchange for a portion of the
insurance premium. One such program is the captive reinsurance program. Under
the captive reinsurance program, a reinsurance company, generally an affiliate
of the lender, assumes a portion of the risk associated with the lender's
insured book of business in exchange for a percentage of the premium. Typically,
the reinsurance program is an excess of loss arrangement with defined entry and
exit points and a maximum exposure limit for the captive reinsurance company.
These captive reinsurance programs may also be in the form of a quota share
arrangement, although the Company had no quota share arrangements in force as of
December 31, 2002. Under excess-of-loss programs, with respect to a given book
year of business, Triad retains a first loss position on a defined aggregate
layer of risk and reinsures a second defined aggregate layer with the reinsurer.
Triad generally retains the remaining risk above the layer reinsured. Because
claims incidence is generally highest in the third through six years after loan
origination, Triad is likely to retain all losses in the earlier years,
particularly in the first two years after loans for a given book year are
originated, and the reinsurer will assume the losses in subsequent years subject
to the defined layer of risk and up to their aggregate limit. The ultimate
impact on the Company's financial performance of an excess-of-loss captive
structure is dependent on the operating environment, primarily the total level
of losses and the persistency rates, during the life of a given book year of
business. The Company believes that its excess-of-loss captive reinsurance
programs provide valuable reinsurance protection by limiting the aggregate level
of losses, and under normal operating environments potentially reduces the
degree of volatility in the Company's earnings from the development of such
losses over a period of years.
The Company believes that its excess-of-loss captive reinsurance programs
provide valuable reinsurance protection and potentially reduce the risk of
volatility in the Company's earnings.
In addition to captive reinsurance programs, the Company has insurance in
force under programs, which are in run-off, that increase a lender's share of
the risk of loss on an insured book of business and provide a fee to the lender
for the increased risk. Approximately 46% and 35% of the Company's insurance in
force at December 31, 2002 and December 31, 2001, respectively, was subject to
risk-sharing programs. This increase in insurance in force subject to
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risk-sharing arrangements is due primarily to the increased market penetration
of the Company's risk-sharing arrangements and the high level of refinance
activity during the past twelve months, as policies that were previously not
subject to risk-sharing arrangements refinanced and new policies issued were
subject to risk-sharing arrangements. One of the Company's competitors has
announced that as of March 31, 2003 it will not participate in excess of loss
risk-sharing arrangements where the net premium cede rate is greater than 25%
("deep ceded"). The Company currently participates in excess of loss
risk-sharing arrangements where the net premium cede rate is greater than 25%.
As of December 31, 2002, the Company had "deep ceded" captive arrangements with
15% of the lenders participating in risk-sharing programs. Insurance in force
subject to risk-sharing arrangements from these lenders represented
approximately 69% of the Company's total insurance in force subject to
risk-sharing arrangements at December 31, 2002. The Company believes that, based
upon historical data and actuarial studies, its deep ceded captive arrangements
will produce acceptable returns on capital. It is uncertain at this time what
impact, if any, the competitor's decision to exit this business will have on the
Company.
Regulatory issues exist regarding the future of risk-sharing programs
currently being marketed within the mortgage insurance industry. Management is
unable to predict the impact of the regulatory issues on these products.
CANCELLATION OF INSURANCE
Mortgage insurance coverage cannot be canceled by the Company except for
nonpayment of premium or certain material violations of the master policy, and
remains renewable at the option of the insured lender. Generally, mortgage
insurance is renewable at a rate fixed when the insurance on the loan was
initially issued.
Insured lenders may cancel insurance at any time at their option. Pursuant
to the Homeowners Protection Act, most loans with borrower-paid mortgage
insurance made on or after July 29, 1999 are required to have their private
mortgage insurance canceled automatically by lenders when the outstanding loan
amount is 78% or less of the property's original purchase price and certain
other conditions are met. A borrower may request that a loan servicer cancel
borrower-paid mortgage insurance on a mortgage loan when the loan balance is
less than 80% of the property's current value, but loan servicers are generally
restricted in their ability to grant such requests by secondary market
requirements and by certain other regulatory restrictions.
Mortgage insurance coverage can also be cancelled when an insured loan is
refinanced. If the Company provides insurance on the refinanced mortgage, the
policy on the refinanced home loan is considered new insurance written.
Therefore, continuation of the Company's coverage from a refinanced loan to a
new loan results in both a cancellation of insurance and new insurance written.
The percentage of insurance written from refinanced loans was 40.1%, 35.8%, and
13.2% in 2002, 2001, and 2000, respectively.
To the extent canceled insurance coverage in areas experiencing economic
growth is not replaced by new insurance in such areas, the percentage of the
Company's book of business in economically weaker areas may increase. This
development may occur during periods of heavy mortgage refinancing. Refinanced
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loans in regions experiencing economic growth are less likely to require private
mortgage insurance, while borrowers in economically distressed areas are less
likely to qualify for refinancing because of depreciated real estate values. The
percentage of the Company's insurance in force at the end of the previous year
that was canceled during 2002, 2001, and 2000 was 39.1%, 32.4%, and 17.4%,
respectively. The high cancellation levels in 2002 were due to significant
refinance activity as mortgage rates remained low throughout the year. The
cancellations have not had a material impact on the geographic dispersion of the
Company's risk in force.
CUSTOMERS
Residential mortgage lenders such as mortgage bankers, mortgage brokers,
commercial banks and savings institutions are the principal customers of
traditional flow insurance written by the Company. At December 31, 2002,
approximately 73% of the Company's traditional flow risk in force came from
mortgage bankers, 15% from commercial banks, 9% from mortgage brokers, and the
remainder from savings institutions and credit unions. At December 31, 2001,
approximately 67% of the Company's traditional flow risk in force came from
mortgage bankers, 16% from commercial banks, 13% from mortgage brokers, and the
remainder from savings institutions and credit unions.
To obtain primary insurance from the Company written on a traditional flow
basis, a mortgage lender must first apply for and receive a master policy from
the Company. The Company's approval of a lender as a master policyholder is
based, among other factors, upon evaluation of the lender's financial position
and demonstrated adherence to sound loan origination practices.
The master policy sets forth the terms and conditions of the Company's
mortgage insurance policy. The master policy does not obligate the lender to
obtain insurance from the Company, nor does it obligate the Company to issue
insurance on a particular loan. The master policy provides that the lender must
submit individual loans for insurance to the Company and the loan, subject to
certain underwriting criteria, must be approved by the Company to effect
coverage (except in the case of delegated underwriting and when the originator
has the authority to approve coverage within certain guidelines). The Company
had 7,809 master policyholders at December 31, 2002, compared to 7,337 at
December 31, 2001.
The Company's ten largest customers generated 73.0%, 64.3%, and 47.1% of
traditional flow insurance written during 2002, 2001, and 2000, respectively.
The Company's two largest customers generated 53.4%, 42.0%, and 24.8% of
traditional flow insurance written during 2002, 2001, and 2000, respectively.
The Company's ten largest customers were responsible for 58.9%, 42.3%, and
30.0% of traditional flow risk in force at December 31, 2002, 2001, and 2000,
respectively. The two largest customers of the Company accounted for 39.7%,
24.8%, and 11.5% of traditional flow risk in force at December 31, 2002, 2001,
and 2000, respectively.
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Premium revenue for the Company is comprised of premium from current year
originated business plus renewal premiums from insurance originated in prior
years. There was no single customer whose revenue from current year originated
business accounted for 10% or more of the Company's consolidated revenue in
2002, 2001, or 2000. However, approximately 11% of the Company's consolidated
revenue in 2002 was from current year and prior years originated business from
Countrywide Credit Industries, Inc. There was no single customer whose revenue
from current and prior years originated business accounted for 10% or more of
the Company's consolidated revenue in 2001 or 2000.
The mortgage lending industry continues to experience consolidation and a
greater percentage of origination volume is being generated by the large
lenders. The top 30 lenders in the United States, as ranked by mortgage
origination volume, accounted for approximately 82% of originated mortgage
volume in 2002 compared to 73% in 2001. As a result of this continued
consolidation, the number of lenders making decisions as to which insurer to
select for mortgage insurance is being reduced. The Company could be adversely
affected if one of its large customers is consolidated with a lender with which
the Company is not approved to do business or if one of its large lenders
terminates its relationship with the Company for any reason. Currently the
Company is approved to do business with 21 of the top 30 lenders and production
from these lenders accounted for approximately 60% of the Company's traditional
flow insurance written in 2002 compared to 51% in 2001.
Structured bulk transactions are generally initiated by secondary mortgage
market participants such as underwriters of mortgage-backed securities.
SALES AND MARKETING
The Company currently markets its insurance products through a dedicated
sales force, including sales management, of approximately 41 professionals and
an exclusive commissioned general agency serving a specific geographic market.
The Company is licensed to do business in 46 states and the District of Columbia
and has license applications pending in four states. The Company will continue
to evaluate geographic expansion opportunities as well as the need for
additional sales representation.
The Company's field sales force is divided into two sales divisions, each
with its own manager, regional account representatives, and national account
executives. The division managers report to a senior executive who oversees all
sales and marketing activities for the Company. The national account executives
are primarily responsible for managing the Company's sales efforts toward the
larger national mortgage originators. The division managers and the regional
account executives serve key regional accounts and provide support for national
account sales efforts. This reporting structure allows the senior executive in
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charge of all sales activities to focus time on large, national accounts while
maintaining responsibility of all other sales activities. This senior executive
reports directly to the President of the Company.
The success of the Company is dependent upon the services of its sales
force and its general agency. For 2002, the Company's commissioned general
agency produced approximately 4% of the Company's traditional flow insurance
written while the salaried account executives and the national account
representatives produced the remainder.
The marketing department's mission is to develop and implement programs in
support of the Company's sales objectives and to promote the Company's image. A
variety of tools are used to achieve these goals including public relations,
marketing materials, internal/external publications, convention trade shows, and
the Internet. A national advertising and public relations campaign designed to
raise corporate visibility to lenders and investors is also part of the
Company's integrated marketing approach.
CONTRACT UNDERWRITING
The Company provides fee-based contract underwriting services that enable
customers to improve the efficiency of their operations by outsourcing all or
part of their mortgage loan underwriting. Contract underwriting involves
examining a prospective borrower's information contained in a lender's mortgage
application file and making a determination whether the borrower is approved for
a mortgage loan subject to the lender's underwriting guidelines. This service is
provided for loans that require mortgage insurance as well as loans that do not
require mortgage insurance. In the event that Triad fails to properly underwrite
a loan subject to the lender's underwriting guidelines, Triad may be required to
provide monetary or other remedies to the lender customer.
Contract underwriting services have become increasingly important to
lenders as they seek to reduce fixed costs. Accordingly, contract underwriting
significantly contributes to the Company's mortgage insurance production. The
Company provides contract underwriting services through its own employees as
well as independent contractors. If the Company becomes unable to maintain and
provide a sufficient number of qualified underwriters, the Company's operations
could be materially adversely affected.
COMPETITION AND MARKET SHARE
The Company and other private mortgage insurers compete directly with
federal and state governmental and quasi-governmental agencies, principally the
Federal Housing Administration ("FHA"). These agencies sponsor government-backed
mortgage insurance programs which accounted for approximately 36% of high LTV
loans in 2002 and 37% in 2001. In addition to competition from federal agencies,
the Company and other private mortgage insurers face competition from
state-supported mortgage insurance funds, some of which are either independent
agencies or affiliated with state housing agencies. Indirectly, the Company also
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competes with certain mortgage lenders which forego private mortgage insurance
and self-insure against the risk of loss from defaults on all or a portion of
their low down payment mortgage loans.
Fannie Mae and Freddie Mac have the ability to modify the required level of
mortgage insurance coverage which should be maintained by lenders on loans for
resale to the secondary market. Both Fannie Mae and Freddie Mac have programs
that reduce the amount of private mortgage insurance they require in exchange
for the lender providing an upfront delivery fee. The Company's financial
condition and results of operations could be adversely affected as a result of
these programs or if Fannie Mae and/or Freddie Mac adopt private mortgage
insurance substitutes.
Various proposals are periodically discussed by Congress and certain
federal agencies to reform or modify the FHA. Management is unable to predict
the scope and content of such proposals, or whether any such proposals will be
enacted into law, and if enacted, the effect on the Company.
The private mortgage insurance industry consists of eight active mortgage
insurance companies including Triad, Mortgage Guaranty Insurance Corporation,
PMI Mortgage Insurance Co., United Guaranty Residential Insurance Company,
Radian Guaranty Inc, General Electric Mortgage Insurance Corporation, Republic
Mortgage Insurance Company, and CMG Mortgage Insurance Co. Triad is the seventh
largest private mortgage insurer based on 2002 market share and, according to
industry data, had a 3.7% share of net new primary insurance written in 2002
compared to 3.6% in 2001. Net new primary insurance written includes insurance
written on a traditional flow basis as well as that attributed to structured
bulk transactions. Triad's national market share of net new primary insurance
written on a traditional flow basis was 4.3% for 2002 compared to 3.4% for 2001.
Management believes the Company competes with other private mortgage
insurers principally on the basis of personalized and professional service, a
strong management and sales team, responsive and versatile technology, and
innovative products.
Underwriting Practices
The Company considers effective risk management to be critical to its
long-term financial stability. Market analysis, prudent underwriting, the use of
automated risk evaluation models, auditing, and customer service are all
important elements of the Company's risk management process.
UNDERWRITING PERSONNEL
The Company's Senior Vice President of Audit and Senior Vice President of
Underwriting have been in their positions since shortly after the Company was
formed. The Company's Senior Vice President of Risk Management has been with the
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Company since 2001 and has more than 20 years of industry experience. In
addition to a centralized underwriting department in the home office, the Senior
Vice President of Underwriting is responsible for the Company's regional offices
in Arizona, California, Colorado, Georgia, Illinois, Ohio, Pennsylvania, Texas,
and Washington. The Senior Vice President of Audit is responsible for the
quality control function. The Senior Vice President of Risk Management is
responsible for assessing the risk factors used by the Company in its
underwriting procedures
The Company employed an underwriting staff of 46 at December 31, 2002. The
Company's field underwriters and underwriting managers are limited in their
authority to approve programs for certain mortgage loans. The authority levels
are tied to underwriting position, knowledge, and experience and relate
primarily to loan amounts and property type. All loans insured by the Company
are subject to quality control reviews.
The Company also utilizes various non-employee underwriters to perform
contract underwriting services. The number can vary substantially depending on
the need for this service.
RISK MANAGEMENT APPROACH
The Company evaluates risk based on historical performance of risk factors
and utilizes automated underwriting systems in the risk selection process to
assist the underwriter with decision making. This process evaluates the
following categories of risk:
o MORTGAGE LENDER. The Company reviews each lender's financial
statements and management experience before issuing a master policy.
The Company also tracks the historical risk performance, including
loan level risk characteristics, of all customers that hold a master
policy. This information is factored into determining the loan
programs the Company approves for various lenders. The Company assigns
delegated underwriting authority only to lenders with substantial
financial resources and established records of originating good
quality loans.
o PURPOSE AND TYPE OF LOAN. The Company analyzes five general
characteristics of a loan to evaluate its level of risk: (i) LTV
ratio; (ii) purpose of the loan; (iii) type of loan instrument; (iv)
level of documentation; and, (v) type of property. Generally, the
Company seeks loan types with proven track records for which an
assessment of risk can be readily made and the premium received
sufficiently offsets that risk. Loan types that do not have a proven
track record are charged a higher premium, as are other loans which
have been shown to carry higher risks, such as adjustable rate
mortgages ("ARMs") and loans having higher LTV ratios. Certain
categories of loans are not actively pursued by the Company because
such loans have a disproportionate amount of risk, including scheduled
negatively amortizing ARMs and investment properties.
o INDIVIDUAL LOAN AND BORROWER. Except to the extent that the Company's
delegated underwriting program and Freddie Mac's and Fannie Mae's
automated underwriting services are being utilized, the Company
evaluates insurance applications based on analysis of the borrower's
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ability and willingness to repay the mortgage loan and the
characteristics and value of the mortgaged property. The analysis of
the borrower includes reviewing the borrower's housing and total debt
ratios as well as the borrower's Fair, Isaac and Co., Inc. ("FICO")
credit score, as reported by credit rating agencies. Loans may be
submitted under the Stick With Triad program provided the loans meet
the program requirements. Within this program, the degree to which the
borrower must meet certain underwriting standards, as well as the
amount of documentation required, is a function of the credit score.
(For a further description of the Stick With Triad program, see
Underwriting Process below.) In the case of delegated underwriting,
compliance with program parameters is monitored by periodic audits of
delegated business. With the automated underwriting services provided
by Fannie Mae and Freddie Mac, lenders are able to obtain approval for
mortgage guaranty insurance with any participating mortgage insurer.
Triad works with both agencies in offering insurance services through
their systems, while monitoring the risk quality of loans insured
through such systems.
o GEOGRAPHIC SELECTION OF RISK. The Company places significant emphasis
on the condition of the regional housing markets in determining
marketing and underwriting policies. Using both internal and external
data, the Company's risk management department continually monitors
the economic conditions in the Company's active and potential markets.
UNDERWRITING PROCESS FOR TRADITIONAL FLOW BUSINESS
The Company accepts applications for insurance under three basic programs:
a traditional fully-documented program, a credit-score driven reduced
documentation program, and a delegated underwriting program which allows a
lender's underwriters to commit insurance to a loan based on strict, agreed upon
underwriting guidelines. The Company also accepts loans approved through Feddie
Mac's or Fannie Mae's automated underwriting systems.
The Company generally utilizes nationwide underwriting guidelines to
evaluate the potential risk of default on mortgage loans submitted for insurance
coverage. These guidelines have evolved over time and take into account the loss
experience of the entire private mortgage insurance industry. They also are
largely influenced by Fannie Mae and Freddie Mac underwriting guidelines. The
Company believes its guidelines generally are consistent with those used by
other private mortgage insurers with respect to the types of loans that the
Company will insure. Specific underwriting guidelines applicable to a given
local, state, or regional market are modified to address concerns resulting from
the Company's review of regional economies and housing patterns.
Subject to the Company's underwriting guidelines and exception approval
procedures, the Company expects its internal underwriters and contract
underwriters to utilize their experience and business judgment in evaluating
each loan on its own merits. Accordingly, the Company's underwriting staff has
discretionary authority to insure loans which deviate in certain minor respects
from the Company's underwriting guidelines. More significant exceptions are
subject to management approval. In all such cases, compensating factors must be
identified. The predominant reason for such deviations involves instances where
the borrower's debt-to-income ratio exceeds the Company's guidelines. To
compensate for exceptions, the Company's underwriters give favorable
consideration to such factors as excellent borrower credit history, the
availability of satisfactory cash reserves after closing, and employment
stability.
13
In addition to the borrower's willingness and ability to repay the loan,
the Company believes that mortgage default risk is affected by a variety of
other factors, including the borrower's employment status. Insured mortgage
loans made to self-employed borrowers are perceived by the Company to have
higher risk of claim, all other factors being equal, than loans to borrowers
employed by third parties. The Company's percentage of risk in force involving
self-employed borrowers was 2.6% at December 31, 2002 and 1.8% at December 31,
2001.
The Company's Stick With Triad program featuring the Slam Dunk Loan SM
approval process allows lenders to submit insurance applications with reduced
documentation. Under this program, Triad issues a certificate of insurance based
on the borrower's FICO credit score or the approval of the loan through Fannie
Mae's or Freddie Mac's automated underwriting system. The Company issues a
certificate of insurance without the standard underwriting process if certain
program parameters are met and the borrower has a credit score above established
thresholds. Documentation submission requirements for non-automated underwritten
loans vary depending on the borrower's credit score. The Stick With Triad
program represented approximately 33% of the Company's traditional flow
applications in 2002 and 36% in 2001. The Company randomly and through adverse
selection audits lenders' files on loans submitted under the Stick With Triad
program.
The Company's delegated underwriting program, in addition to the Company's
risk management strategies, utilizes extensive quality control practices
including reunderwriting, reappraisal, and similar procedures following issuance
of the policy. Standards for type of loan, property type, and credit history of
the borrower are established consistent with the Company's risk strategy. The
program has allowed the Company to serve a greater number of the larger,
well-established mortgage originators. The Company's delegated underwriting
program accounted for 44% of traditional flow applications received in 2002
compared to 40% in 2001. Many lenders who are not part of the delegated
underwriting program participate in the Stick With Triad underwriting program.
The performance of loans insured under the delegated underwriting program has
been comparable to the Company's non-delegated business.
The Company utilizes its underwriting staff as well as contract personnel
to provide contract underwriting services to customers. For a fee, Triad
underwrites applications for secondary market compliance, while at the same time
assessing the application for mortgage insurance, if applicable. In addition,
the Company offers Fannie Mae's Desktop Originator(R) and Desktop Underwriter(R)
and Freddie Mac's Loan Prospector(R), as well as the personnel to conduct the
underwriting tasks, as a service to its contract underwriting customers. These
products, which are designed to streamline and reduce costs in the mortgage
origination process, supply the Company's customers with fast and accurate
service regarding loan compliance and Fannie Mae's or Freddie Mac's decision for
loan purchase or securitization.
UNDERWRITING STRUCTURED BULK TRANSACTIONS
The Company employs a risk review process in underwriting structured bulk
transactions that is designed to identify the loans which pose the greatest risk
of nonperformance. High risk loans are identified based on an analysis of
14
multiple risk factors including, but not limited to, credit score,
loan-to-value, documentation type, loan purpose, and loan amount. The pertinent
risk characteristics of each loan are evaluated to determine the impact on the
transaction's frequency and severity of loss and persistency. The Company may
utilize an outside due diligence firm in this process as well as mortgage risk
analysis systems such as Standard & Poor's Levels. The Company's pricing for
structured bulk transactions is commensurate with a transaction's risk profile.
The Company also employs an audit procedure to test the integrity of the loan
level data provided to Triad. The risk review and audit procedure may result in
a request by the Company to remove certain loans from the transaction.
OTHER RISK MANAGEMENT
A comprehensive audit plan determines whether underwriting decisions being
made are consistent with the policies, procedures, and expectations for quality
set forth by management. All areas of business activity which involve an
underwriting decision are examined, with emphasis on new products, new
procedures, contract underwritten loans, delegated loans, new employees, new
master policyholders, and new branches of an existing master policyholder. The
process used to identify categories of loans selected for audit begins with
identification and evaluation of certain defined and verifiable risk elements.
Each loan is then tested against these elements to identify loans which fail to
meet prescribed policies or an identified norm. The procedure allows the
Company's management to identify concerns, not only at the loan level, but also
portfolio concerns which may exist within a given category of business.
TECHNOLOGY
Triad's TAXI - Transactions Across the Internet - allows qualified
customers to view, update, and process certain data within their borrowers'
private mortgage insurance records. TAXI is an internet-based service. Business
areas that can be addressed through TAXI include applying for mortgage
insurance, contract underwriting through eU Xpress, loan servicing, claims and
default processing, and risk-sharing performance.
eU Xpress is an internet-based service that automates the contract
underwriting and mortgage insurance commitment process. The Company introduced
eU Xpress in 2002. eU Xpress is accessed through TAXI and provides an interface
with automated underwriting systems.
FINANCIAL STRENGTH RATING
Credit ratings generally are considered an important element in a mortgage
insurer's ability to compete for new business, indicating the insurer's present
financial strength and capacity to pay future claims. Certain national mortgage
15
lenders and a large segment of the mortgage securitization market, including
Fannie Mae and Freddie Mac, generally will not purchase high LTV mortgages or
mortgage-backed securities unless the insurer issuing private mortgage insurance
coverage has a financial strength rating of at least "AA-" by either Standard &
Poor's Ratings Services ("S&P") or Fitch Ratings ("Fitch") or a rating of at
least "Aa3" from Moody's Investors Service ("Moody's"). Fannie Mae and Freddie
Mac require mortgage guaranty insurers to maintain two ratings of "AA- " or
better. Triad is rated "AA" by both S&P and Fitch and "Aa3" by Moody's. Private
mortgage insurers are not rated by any other independent nationally-recognized
insurance industry rating organization or agency (such as the A.M. Best
Company).
S&P defines insurers rated "AA" as having very strong financial security
characteristics, differing only slightly from those rated higher. Fitch defines
insurance companies rated "AA" as possessing very strong capacity to meet
policyholder and contract obligations, risk factors that are modest, and the
impact of any adverse business and economic factors is expected to be very
small. Moody's defines insurers rated "Aa" as offering exceptional financial
security but appearing to have somewhat larger long-term risks than companies
rated "Aaa". Ratings from S&P and Fitch are modified with a "+" or "-" sign to
indicate the relative position of a company within its category. Moody's uses
numeric modifiers to refer to the ranking within a group - with "1" being the
highest and "3" being the lowest.
When assigning a financial strength rating, S&P, Fitch, and Moody's
generally consider: (i) the specific risks associated with the mortgage
insurance industry, such as regulatory climate, market demand, growth, and
competition; (ii) management depth, corporate strategy, and effectiveness of
operations; (iii) historical operating results and expectations of current and
future performance; and, (iv) long-term capital structure, the ratio of debt to
equity, the ratio of risk to capital, near-term liquidity, and cash flow levels,
as well as any reinsurance relationships and the financial strength ratings of
such reinsurers. Ratings are based on factors relevant to policyholders, agents,
insurance brokers, and intermediaries. Such ratings are not directed to the
protection of investors and do not apply to any securities issued by the
Company.
Rating agencies issue financial strength ratings based, in part, upon a
company's performance sensitivity to various economic depression scenarios. In
determining capital levels required to maintain a company's rating, the rating
agencies allow the use of different forms of capital including statutory
capital, reinsurance and debt. In January 1998, the Company completed a $35
million private offering of notes due January 15, 2028. The notes, which are
rated "A" by S&P and "A+" by Fitch, were issued to provide additional capital
considered in the rating agency's depression models.
S&P, Fitch, and Moody's will periodically review Triad's rating, as they do
with all rated insurers. Ratings can be withdrawn or changed at any time by a
rating agency. A reduction in the Company's rating by S&P, Fitch, or Moody's
could materially impact the ability of the Company to write new business.
In January of 2003, Fitch revised its rating outlook for the U.S. private
mortgage insurance industry to "Negative" from "Stable". As it relates to the
mortgage insurance industry, Fitch defines a negative industry outlook as the
16
expectation that insurers' ratings or ratings outlook downgrades will exceed
upgrades during a 12-18 month time frame and that the number of downgrades are
expected to be material to the rated universe. As of the end of 2002, Fitch,
S&P, and Moody's all report a "Stable" ratings outlook for Triad. A reduction in
the Company's rating outlook by Fitch, S&P, or Moody's could adversely impact
the Company's operations.
REINSURANCE
The use of reinsurance as a source of capital and as a risk management tool
is well established within the mortgage insurance industry. Reinsurance does not
legally discharge an insurer from its primary liability for the full amount of
the risk it insures, although it does make the reinsurer liable to the primary
insurer. There can be no assurance that the Company's reinsurers will be able to
meet their obligations under the reinsurance agreements.
RISK-SHARING ARRANGEMENTS
Triad's product offerings include captive mortgage reinsurance programs
whereby an affiliate of a lender reinsures a portion of the insured risk on
loans originated or purchased by the lender. Triad entered the captive
reinsurance market in 1999 with the LEAPSM (Lower Entry- Additional
Profitability) program. The LEAP program is an excess of loss mortgage
reinsurance program that provides lenders an opportunity to share in the risk
and return of mortgage insurance on loans the lender originates or services.
Under LEAP, the lender may elect a risk band with a flexible entry and exit
point. LEAP also permits cessions greater than the 25% industry standard
arrangements that existed prior to this program. Ceded premium under captive
reinsurance agreements represented 12.7% of direct written premiums in 2002
compared to 6.6% in 2001.
In November 1999, Triad formed Triad Re Insurance Corporation ("Triad Re")
as a wholly-owned sponsored captive reinsurance company domiciled in Vermont.
Triad Re was formed to allow small and mid-sized lenders to participate in
captive reinsurance arrangements with reduced up-front capital costs and without
co-mingling its risk with other lenders. Triad Re was initially capitalized in
February 2000, with regulatory capital of $1.0 million. As of December 31, 2002,
approximately $5 million of Triad's risk in force had been ceded to sponsored
captive reinsurer cells under participating agreements with Triad Re.
Triad's captive reinsurance agreements provide for trust arrangements
whereby the captive reinsurer is the grantor of the trust and Triad is the
beneficiary of the trust. Trusts are established to support the reinsurers'
obligations under the reinsurance agreements. The trust agreement includes
covenants regarding minimum and ongoing capitalization, required reserves,
authorized investments, and withdrawal of assets and is funded by ceded premium
and investment earnings on trust assets as well as capital contributions by the
reinsurer.
The Company also has in place an agreement with a non-affiliated reinsurer
in association with certain of the Company's non-captive risk sharing programs,
which will indemnify the Company with respect to losses covered as defined by
17
the agreement. In 2002, less than one percent of the Company's direct written
premium was ceded under this agreement as compared to 2.1% in 2001.
At the end of 2002, 45.7% of Triad's insurance in force had been insured
under some type of risk-sharing arrangement as compared to 34.6% at the end of
2001. Risk-sharing arrangements represented 50.5% of Triad's traditional flow
insurance written in 2002 as compared to 57.9% in 2001.
OTHER REINSURANCE
Certain premiums and losses are assumed from and ceded to non-affiliated
insurance companies under various quota share reinsurance agreements. The ceding
agreement principally provides the Company with increased capacity to write
business and achieve a more favorable geographic dispersion of risk. Less than
0.1% of Triad's risk in force at December 31, 2002 and direct premiums written
in 2002 were ceded in quota share arrangements to non-affiliated reinsurance
companies.
Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie
Mac, certain loans eligible for sale to such agencies with a loan-to-value ratio
over 90% require insurance with a coverage percentage of 30% or more. Certain
states limit the amount of risk a mortgage insurer may retain with respect to
coverage of an insured loan to 25% of the claim amount, and, as a result, the
deeper coverage portion of such insurance must be reinsured. To minimize
reliance on third-party reinsurers and to permit the Company to retain the
premiums and related risk on deeper coverage business, Triad reinsures this
deeper coverage business with its wholly-owned subsidiary, Triad Guaranty
Assurance Corporation ("TGAC"). As of December 31, 2002, TGAC had assumed
approximately $59.4 million in risk from Triad.
The Company continues to maintain excess of loss reinsurance arrangements
designed to protect the Company in the event of a catastrophic level of losses.
The Company currently maintains $125 million of excess of loss reinsurance
through non-affiliated reinsurers that have financial strength ratings of "AA"
or better from Standard & Poor's.
DEFAULTS AND CLAIMS
DEFAULTS
The claim process on private mortgage insurance begins with the insurer's
receipt of notification from the lender of a default on an insured's loan.
Default is defined in the primary master policy as the failure by the borrower
to pay, when due, an amount at least equal to the scheduled monthly mortgage
payment under the terms of the mortgage. The master policy requires lenders to
notify the Company of default on a mortgage payment within 10 days of either (i)
the date on which the borrower becomes four months in default or (ii) the date
18
on which any legal proceeding affecting the loan commences, whichever occurs
first. Notification is required within 45 days of default if it occurs when the
first payment is due. The incidence of default is affected by a variety of
factors including, but not limited to, changes in borrower income, unemployment,
divorce, illness, the level of interest rates, and general borrower
creditworthiness. Defaults that are not cured generally result in a claim to the
Company. Borrowers may cure defaults by making all delinquent loan payments or
by selling the property and satisfying all amounts due under the mortgage.
The following table shows default statistics as of December 31, 2002, and
the preceding four year ends:
Default Statistics
December 31
-----------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Number of insured loans in force.......................... 190,480 159,400 123,046 108,623 97,222
Number of loans in default................................ 2,379 1,420 740 690 518
Percentage of loans in default (default rate)............. 1.25% 0.89% 0.60% 0.64% 0.53%
Number of insured loans in force excluding bulk loans..... 171,723 141,220 - - -
Number of loans in default excluding bulk loans........... 2,120 1,420 - - -
Percentage of loans in default excluding bulk loans....... 1.23% 1.01% - - -
Number of bulk loans in force............................. 18,757 18,180 - - -
Number of bulk loans in default........................... 259 0 - - -
Percentage of bulk loans in default....................... 1.38% 0.00% - - -
The number of loans in default includes all reported delinquencies that are
three or more payments in arrears at the reporting date and all reported
delinquencies that were previously three or more payments in arrears and have
not made payments to the current date.
CLAIMS
Claims result from defaults that are not cured. The frequency of claims
does not directly correlate to the frequency of defaults due, in part, to the
Company's loss mitigation efforts and the borrower's ability to overcome
temporary financial setbacks. The likelihood that a claim will result from a
default, and the amount of such claim, principally depend on the borrower's
equity at the time of default and the borrower's (or the lender's) ability to
sell the home for an amount sufficient to satisfy all amounts due under the
mortgage, as well as the effectiveness of loss mitigation efforts. The ability
to mitigate a claim is affected by the local housing market, interest rates,
employment growth, the housing supply, and the borrower's desire to avoid
foreclosure. During the default period, the Company works with the insured as
well as the borrower in an effort to either reinstate the loan or sell the
property for an amount which results in a reduced claim prior to foreclosure.
The payment of claims is not evenly spread through the coverage period.
Relatively few claims are paid during the first two years following issuance of
19
insurance. A period of rising claim payments follows, which, based on industry
experience, has historically reached its highest level in the third through
sixth years after the loan origination. Thereafter, the number of claim payments
made has historically declined at a gradual rate, although the rate of decline
can be affected by local economic conditions. There can be no assurance that the
historical pattern of claims will continue in the future.
Generally, the Company does not pay a claim for loss under the master
policy if the application for insurance for the loan in question contains
fraudulent information, material omissions, or misrepresentations which increase
the risk characteristics of the loan. The Company's master policy also excludes
any cost or expense related to the repair or remedy of any physical damage
(other than "normal wear and tear") to the property collateralizing an insured
mortgage loan. Such physical damage may be caused by accident, natural
occurrence or otherwise.
Under the terms of the master policy, the lender is required to file a
claim with the Company no later than 60 days after it has acquired borrower's
title to the underlying property through foreclosure or a deed-in-lieu of
foreclosure. A primary insurance claim amount includes (i) the amount of unpaid
principal due under the loan; (ii) the amount of accumulated delinquent interest
due on the loan (excluding late charges) to the date of claim filing; (iii)
expenses advanced by the insured under the terms of the master policy, such as
hazard insurance premiums, property maintenance expenses and property taxes
prorated to the date of claim filing; and (iv) certain foreclosure and other
expenses, including attorneys fees. Such claim amount is subject to review and
possible adjustment by the Company. Depending on the applicable state
foreclosure law, an average of about 12 months elapses from date of default to
payment of claim on an uncured default. The Company's experience indicates that
the claim amount on a policy generally ranges from 110% to 115% of the unpaid
principal amount of a foreclosed loan.
Within 60 days after the claim has been filed, the Company has the option
of either (i) paying the coverage percentage specified on the certificate of
insurance (usually 12% to 40% of the claim), with the insured retaining title to
the underlying property and receiving all proceeds from the eventual sale of the
property, or (ii) paying 100% of the claim amount in exchange for the lender's
conveyance of good and marketable title to the property to the Company, with the
Company selling the property for its own account. The Company chooses the claim
settlement option believed to cost the least. In most cases, the Company settles
claims by paying the coverage percentage of the claim amount. At December 31,
2002, the Company held properties with a combined net realizable value of $1.6
million which were acquired by electing to pay 100% of the claim amount.
LOSS MITIGATION
Once a default notice is received, the Company attempts to mitigate its
loss. Through proactive intervention with insured lenders and borrowers, the
Company has been successful in reducing the number and severity of its claims
for loss. Loss mitigation techniques include pre-foreclosure sales, property
20
sales after foreclosure, advances to assist distressed borrowers who have
suffered a temporary economic setback, and the use of repayment schedules,
refinances, loan modifications, forbearance agreements, and deeds-in-lieu of
foreclosure. Such mitigation efforts typically result in a savings to the
Company over the percentage coverage amount payable under the certificate of
insurance. Through loss mitigation efforts, the Company paid out approximately
65% of its potential exposure on claims in 2002 and 69% of its ever-to-date
exposure.
LOSS RESERVES
The Company establishes reserves to provide for the estimated costs of
settling claims on loans reported in default and estimates of loans in default
which have not been reported. Consistent with industry accounting practices, the
Company does not establish loss reserves for future claims on insured loans
currently not in default. Although the Company believes that overall reserve
levels at December 31, 2002, are adequate to meet future obligations, due to the
inherent uncertainty of the reserving process there can be no assurance that
reserves will prove to be adequate to cover ultimate loss developments.
In determining the liability for unpaid losses related to outstanding
defaults, the Company establishes loss reserves using estimated claim rates
(frequency) and claim amounts (severity) to estimate ultimate losses. The
Company relies on historical experience in the estimation of claim rates and
claim amounts. The Company also establishes reserves for the estimated costs of
settling claims ("loss adjustment expenses" or "LAE"), which include, but are
not limited to, legal fees and general expenses of administering the claims
settlement process, and for losses and loss adjustment expenses incurred from
defaults which have occurred but have not yet been reported to the insurer
("Incurred But Not Reported" or "IBNR").
Management periodically reviews the loss reserve process in order to
improve its estimate of ultimate losses. In 2001, management refined its
methodology for setting loss reserves for outstanding defaults and for IBNR
defaults. The enhancements made to the reserving process incorporate a more
multi-dimensional analytical form, which gives effect to current economic
conditions and profiles delinquencies by such factors as age, policy year,
geography, and chronic late payment characteristics.
The Company's reserving process is based upon the assumption that past
experience, adjusted for the anticipated effect of current economic conditions
and projected future economic trends, provides a reasonable basis for estimating
future events. However, estimation of loss reserves is a difficult and inexact
process. Economic conditions that have affected the development of loss reserves
in the past may not necessarily affect development patterns in the future in
either a similar manner or degree. Due to the inherent uncertainty in estimating
reserves for losses and loss adjustment expenses, there can be no assurance that
reserves will be adequate to cover ultimate loss developments on loans in
default, currently or in the future. The Company's profitability and financial
condition could be adversely affected to the extent that the Company's estimated
reserves are insufficient to cover losses on loans in default.
21
The following table represents a reconciliation of the beginning and
ending loss reserves (net of reinsurance) for the periods indicated:
Reconciliation of Losses and Loss Adjustment Expense Reserves
Year Ended December 31
----------------------
(in thousands)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Reserve for losses and LAE, net of related reinsurance
recoverables, at beginning of year........................... $17,981 $14,976 $14,723 $12,116 $ 8,909
Add losses and LAE incurred in respect of defaults
occurring in:
Current year (1)........................................ 14,798 14,219 11,229 9,322 7,953
Prior years (1) (2)..................................... (735) (5,200) (3,642) (2,211) (944)
------- ------- ------- ------- -------
Total incurred losses and LAE................................ 14,063 9,019 7,587 7,111 7,009
Deduct losses and LAE paid in respect of defaults
occurring in:
Current year............................................ 508 286 574 236 267
Prior years............................................. 10,181 5,728 6,760 4,268 3,535
------- ------- ------- ------- -------
Total payments............................................... 10,689 6,014 7,334 4,504 3,802
Reserve for losses and LAE, net of related reinsurance
recoverables, at end of year ................................ 21,355 17,981 14,976 14,723 12,116
Reinsurance recoverables on unpaid losses and LAE, at
the end of year ............................................. 5 10 11 28 27
------- ------- ------- ------- -------
Reserve for unpaid losses and LAE, before deduction
of reinsurance recoverables on unpaid losses, at
end of year.................................................. $21,360 $17,991 $14,987 $14,751 $12,143
======= ======= ======= ======= =======
- ---------------------------
(1) Includes loss and LAE reserves relating to loans which are in default but
for which default notices have not been received.
(2) Indicates a cumulative redundancy in loss reserves at the beginning of each
period. Redundancies result from overestimating ultimate claim amounts.
The top section of the above table shows losses incurred on insurance
policies with respect to defaults which occurred in the current and prior
periods. The amount of losses incurred relating to defaults occurring in the
22
current period represents the estimated amount to be ultimately paid on defaults
occurring in that period. The amount of losses incurred relating to defaults
occurring in prior periods represents an adjustment made in the current period
for defaults which were included in the loss reserve at the end of the prior
period.
The middle section of the above table shows claims paid on insurance
policies with respect to defaults which occurred in the current period and in
prior periods, respectively. Since it takes, on average, about 12 months for a
default which is not cured to eventually develop into a paid claim, most losses
paid relate to defaults occurring in prior periods.
ANALYSIS OF DIRECT RISK IN FORCE
A foundation of the Company's business strategy is proactive risk
selection. The Company analyzes its portfolio in a number of ways to identify
any concentrations of risk or imbalances in risk dispersion. The Company
believes that the quality of its insurance portfolio is affected predominantly
by (i) the quality of loan originations (including the strength of the borrower
and the marketability of the property); (ii) the attributes of loans insured
(including LTV ratio, purpose of the loan, type of loan instrument and type of
underlying property securing the loan); (iii) the seasoning of the loans
insured; (iv) the geographic dispersion of the underlying properties subject to
mortgage insurance; and, (v) the quality and integrity of lenders from which the
Company receives loans to insure.
23
LENDER AND PRODUCT CHARACTERISTICS
The following table reflects the percentage of direct gross risk in force
(as determined on the basis of information available on the date of mortgage
origination) by the categories indicated on December 31, 2002 and 2001:
Direct Risk in Force
December 31
-----------
PRODUCT TYPE: 2002 2001
---- ----
Primary............................................. 100.0% 100.0%
Pool................................................ 0.0% 0.0%
------ ------
Total............................................... 100.0% 100.0%
====== ======
Direct Primary Risk in Force
December 31
-----------
2002 2001
---- ----
DIRECT PRIMARY RISK IN FORCE (dollars in millions).. $5,791 $4,582
Lender Concentration (excludes bulk):
Top 10 lenders (by original applicant).............. 58.9% 42.3%
LTV:
95.01% and above.................................... 5.1% 2.3%
90.01% to 95.00%.................................... 42.0% 41.4%
90.00% and below.................................... 52.9% 56.3%
------ ------
Total............................................... 100.0% 100.0%
====== ======
Loan Type:
Fixed............................................... 87.3% 86.2%
ARM (positive amortization) (1)..................... 12.7% 13.8%
ARM (potential negative amortization) (2)........... 0.0% 0.0%
ARM (scheduled negative amortization) (2)........... 0.0% 0.0%
Other............................................... 0.0% 0.0%
------ ------
Total............................................... 100.0% 100.0%
====== ======
Mortgage Term:
15 years and under.................................. 5.2% 3.8%
Over 15 years....................................... 94.8% 96.2%
------ ------
Total............................................... 100.0% 100.0%
====== ======
Property Type:
Noncondominium (principally single-family detached). 94.6% 95.2%
Condominium......................................... 5.4% 4.8%
------ ------
Total............................................... 100.0% 100.0%
====== ======
Occupancy Status:
Primary residence................................... 94.4% 95.9%
Second home......................................... 2.1% 1.7%
Nonowner occupied................................... 3.5% 2.4%
------ ------
Total............................................... 100.0% 100.0%
====== ======
Mortgage Amount:
$200,000 or less.................................... 72.2% 70.8%
Over $200,000....................................... 27.8% 29.2%
------ ------
Total............................................... 100.0% 100.0%
====== ======
- ---------------
(1) Refers to loans where payment adjustments are the same as mortgage interest
rate adjustments.
(2) Scheduled negative amortization is defined by the Company as the increase
in loan balance that will occur if interest rates do not change. Loans with
potential negative amortization will not have increasing principal balances
unless interest rates increase.
24
An important determinant of claim incidence is the relative amount of
borrower's equity in the home (which at the time of origination is the down
payment). For the industry as a whole, historical evidence indicates that claim
incidence on loans having a LTV ratio in excess of 90% is greater than claim
incidence on loans with LTV ratios equal to or less than 90%. The Company
believes the higher premium rates charged on high LTV loans adequately reflects
the additional risk.
Approximately 5.1% of the Company's risk in force is comprised of loans
with an LTV greater than 95%. These high LTV loans are offered primarily to low
and moderate income borrowers. The Company believes that these loans have higher
risks than its other insured business and has often attracted borrowers with
weak credit histories, generally resulting in higher loss ratios. In keeping
with the Company's established risk strategy, the Company has not aggressively
solicited this segment of the industry. The Company does not routinely delegate
the underwriting of high LTV loans.
In 2000 the State of Illinois Insurance Department, as well as the
insurance departments of several other states, began to permit mortgage insurers
to write coverage on loans with LTV's in excess of 97% up to 100% and, in
certain instances, up to 103%. This determination was made in response to the
development by certain entities in the mortgage securitization market, including
Fannie Mae and Freddie Mac, of programs that allowed LTV's in excess of 97%.
These programs are designed to accommodate the credit-worthy borrower who lacks
the ability or otherwise chooses not to provide a down payment on a home. The
Company accepts loans with LTV's greater than 97% on a limited basis.
The Company actively pursues only positively amortizing ARMs with industry
standard caps. Payments on these loans adjust fully with interest rate
adjustments. To date, the performance of the Company's ARM loans has been
consistent with that of its fixed rate portfolio. However, since historical
claim frequency data on ARMs has not yet been tested during a prolonged period
of economic stress, there can be no assurance that claim frequency on ARMs may
not eventually be higher, particularly during a period of rising interest rates
combined with decreasing housing prices. In its normal course of operations, the
Company's existing underwriting policy does not permit coverage of ARMs with
"scheduled" negative amortization. ARMs with "potential" negative amortization
characteristics due to possible interest rate increases and borrower payment
option changes are accepted under limited conditions for approved lenders.
Historical evidence indicates that higher-priced properties experience
wider fluctuations in value than moderately priced residences. These
fluctuations exist primarily because there is a smaller pool of qualified buyers
for higher-priced homes which, in turn, reduces the likelihood of achieving a
quick sale at fair market value when necessary to avoid a default.
The Company believes that 15-year mortgages present a lower level of risk
than 30-year mortgages, primarily as a result of the faster amortization and the
more rapid accumulation of borrower equity in the property. Accordingly, the
Company charges lower premium rates on these loans than on comparable 30-year
mortgages.
25
The Company believes that the risk of claim is also affected by the type of
property securing the insured loan. In management's opinion, loans on
single-family detached housing are subject to less risk of claim incidence than
loans on other types of properties. The Company believes that attached housing
types, particularly condominiums and cooperatives, are a higher risk because in
most areas condominiums and cooperatives tend to be more susceptible to downward
fluctuations in value than single-family detached dwellings in the same market.
Loans on primary residences that were owner occupied at the time of loan
origination constituted approximately 94% of the Company's risk in force at
December 31, 2002. Because management believes that loans on non-owner occupied
properties represent a substantially higher risk of claim incidence and are
subject to greater value declines than loans on primary homes, the Company does
not actively pursue these loans.
The Company's book of business is less mature than that of the private
mortgage insurance industry as a whole, with the Company's direct risk in force
having a weighted average life of 2.3 years at December 31, 2002 and 2.6 years
at December 31, 2001, compared to an estimated industry average of 2.8 years at
December 31, 2002.
26
The following table shows the percentage of direct risk in force as of
December 31, 2002, for policies written from 1988 through 2002, as well as the
cumulative loss ratio (calculated as direct losses paid divided by direct
premiums written, in each case for a particular certificate year) which has
developed through December 31, 2002, for the policies written during the years
indicated and excludes the effects of reinsurance:
Certificate Percent Cumulative Ratio of Losses
Year Direct Risk in Force of Total Paid to Premiums Written(1)
---- -------------------- -------- ---------------------------
(in millions)
1988 $ 0.4 0.0% 15.3%
1989 0.4 0.0 24.0
1990 0.9 0.0 18.7
1991 3.7 0.1 11.9
1992 9.4 0.2 8.5
1993 34.2 0.6 5.2
1994 30.0 0.5 10.1
1995 50.1 0.9 12.4
1996 79.9 1.4 13.1
1997 148.8 2.5 8.4
1998 403.0 7.0 4.6
1999 346.4 6.0 3.7
2000 314.4 5.4 11.2
2001 1,730.8 29.9 1.4
2002 2,638.5 45.5 0.0
--------- -----
Total $ 5,790.9 100.0%
========= =====
- ---------------------
(1) Claim activity is not spread evenly throughout the coverage period of the
book of business. Based on the Company's and the industry's historical
experience, claims incidence is highest in the third through sixth years after
loan origination, and relatively few claims are paid during the first two years
after loan origination. Thus, the cumulative loss experience of recent
certificate years is not indicative of ultimate losses.
The above table reflects a relatively higher cumulative ratio of losses
paid to premium written for the 2000 policy year at this stage of development.
This is due, in part, to the high level of refinancing for this policy year and
the resulting lower aggregate level of premium written.
27
GEOGRAPHIC DISPERSION
The following tables reflect the percentage of direct risk in force on the
Company's book of business (by location of property) for the top ten states and
the top ten metropolitan statistical areas ("MSAs") as of December 31, 2002:
Top Ten States Top Ten MSAs
-------------- ------------
December 31 December 31
2002 2002
---- ----
California 11.9% Chicago, IL 4.6%
Florida 7.8 Atlanta, GA 3.1
Texas 7.7 Los Angeles/Long Beach, CA 2.8
North Carolina 5.6 Phoenix/Mesa, AZ 2.7
Georgia 5.5 Houston, TX 2.1
Illinois 5.1 Riverside/San Bernardino, CA 1.7
Pennsylvania 3.9 Dallas, TX 1.5
Arizona 3.7 New York, NY 1.5
Colorado 3.4 Denver, CO 1.4
New Jersey 3.3 Philadelphia, PA 1.3
----- -----
Total 57.9% Total 22.7%
===== =====
While the Company continues to diversify its risk in force geographically,
a prolonged regional recession, particularly in its high concentration areas, or
a prolonged national economic recession, could significantly increase loss
development.
INVESTMENT PORTFOLIO
Income from its investment portfolio is one of the Company's primary
sources of cash flow to support its operations and claims payments. The Company
has an investment advisory agreement with CML for management of its portfolio.
The Company follows an investment policy which requires: (i) 80% of its
investment portfolio (together with cash assets) to consist of cash, short-term
investments, and debt securities (including redeemable preferred stocks) which,
at the date of purchase, were rated investment grade by a nationally recognized
rating agency (e.g.,"BBB-" or better by S&P), and (ii) at least 50% of its
investment portfolio (together with cash assets) to consist of cash, cash
equivalents, and securities which, at the date of purchase, were rated one of
the two highest investment grades by a nationally recognized rating agency.
28
At December 31, 2002, the Company's total investment portfolio had a fair
market value of $344.6 million. The investment portfolio was composed of
approximately 87% fixed maturity securities, 3% equities, and 10% short-term
investments.
Liquidity is sought through cash equivalent investments and through
diversification and investment in publicly traded securities. The Company
attempts to maintain a level of liquidity and a duration in its investment
portfolio consistent with its business outlook and the expected timing,
direction, and degree of changes in interest rates. As of December 31, 2002, no
investment in the securities of any single issuer (other than the U.S.
government and its agencies) exceeded 2% of the Company's investment portfolio.
The Company actively monitors investment securities considered to be at
risk for impairment. When the Company determines that a decline in the value of
a security below its amortized cost is other-than-temporary, an impairment loss
has occurred. In the event of impairment, the Company writes down the cost basis
of the security to its fair value and recognizes a realized loss for the amount
of the writedown. During 2002, the Company realized approximately $2.0 million
of impairment writedowns on securities held in its portfolio.
The Company's investment policies and strategies are subject to change
depending upon regulatory, economic, and market conditions and the existing or
anticipated financial condition and operating requirements, including the tax
position, of the Company.
The following table shows the results of the Company's investment portfolio
for the periods indicated:
INVESTMENT PORTFOLIO RESULTS
(dollar amounts in thousands)
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Average investments (1)................ $301,434 $252,509 $212,029 $183,988 $151,712
Pre-tax net investment income.......... $ 16,099 $ 14,765 $ 12,645 $ 10,546 $ 9,289
Effective pre-tax yield (1)............ 5.3% 5.8% 6.0% 5.7% 6.1%
Tax-equivalent yield-to-maturity (2)... 7.9% 8.0% 8.2% 7.7% 7.9%
Pre-tax realized investment (loss) gain $(2,519) $ 297 $ 286 $ 1,153 $ 881
- -----------------
(1) Based on historical cost adjusted for amortization and accretion of premium
and discount.
(2) Based on book value and the Company's marginal tax rate.
29
The diversification of the Company's investment portfolio at December 31,
2002, is shown in the table below:
Investment Portfolio Diversification
(dollar amounts in thousands)
December 31, 2002
-----------------
Amortized Cost Fair Value Percent(1)
-------------- ---------- -------
Available-for-sale securities:
Fixed maturity securities:
U. S. government obligations............... $ 10,189 $ 10,596 3.1%
Mortgage-backed bonds...................... 167 186 0.1
State and municipal bonds.................. 231,210 242,336 70.3
Corporate bonds............................ 43,171 45,352 13.2
-------- --------
Total fixed maturities................. 284,737 298,470
Equity securities............................ 11,266 10,808 3.1
-------- --------
Total available-for-sale securities.... 296,003 309,278
Short-term investments....................... 35,303 35,303 10.2
-------- -------- ------
$331,306 $344,581 100.0%
======== ======== ======
- ---------------------
(1) Percentage of fair value.
The following table shows the scheduled maturities at December 31, 2002, of
the fixed maturity securities held in the Company's investment portfolio:
Investment Portfolio Scheduled Maturity
(dollar amounts in thousands)
December 31, 2002
-----------------
Fair Value Percent
---------- -------
One year or less......................... $ 4,115 1.4%
After one year through five years........ 17,000 5.7
After five years through ten years....... 35,366 11.8
After ten years though twenty years...... 165,662 55.5
After twenty years....................... 76,141 25.5
Mortgage-backed securities (1)........... 186 0.1
-------- ------
Total.......................... $298,470 100.0%
======== ======
---------------------
(1)Substantially all of these securities are guaranteed by U.S. Government
Agencies.
30
The following table shows the ratings of the Company's investment portfolio
as of December 31, 2002 and December 31, 2001:
Investment Portfolio by Rating
(dollar amounts in thousands)
December 31, 2002 December 31, 2001
------------------ -----------------
Rating(1) Fair Value Percent Fair Value Percent
-------- ---------- ------- ---------- -------
Fixed maturities:
U.S. Treasury and U.S. agency bonds..... $ 9,040 3.0% $ 12,923 5.3%
AAA..................................... 185,346 62.1 119,418 48.5
AA...................................... 32,114 10.8 28,574 11.6
A....................................... 42,433 14.2 42,724 17.4
BBB..................................... 14,784 5.0 26,086 10.6
BB...................................... 8,534 2.9 9,348 3.8
B....................................... 2,437 0.8 4,420 1.8
C....................................... 361 0.1 215 0.1
D....................................... 38 0.0 120 0.0
NR...................................... 3,383 1.1 2,157 0.9
-------- ------ -------- ------
Total fixed maturities............. $298,470 100.0% $245,985 100.0%
======== ====== ======== ======
Equities:
AAA..................................... $ 361 3.3% $ 359 2.9%
AA...................................... 1,432 13.2 2,301 18.4
A....................................... 4,622 42.8 4,860 39.0
BBB..................................... 2,132 19.7 1,404 11.2
BB...................................... 180 1.7 632 5.1
B....................................... 2,081 19.3 2,920 23.4
-------- ------ -------- ------
Total equities.................... $ 10,808 100.0% $ 12,476 100.0%
======== ====== ======== ======
Total portfolio.................................. $309,278 $258,461
======== ========
- -------------------------------
(1) Current ratings as assigned by the NRSRO (Nationally Recognized Statistical
Rating Organization). The NRSRO includes the following nationally
recognized rating agencies: S&P, Moody's, and Fitch.
31
REGULATION
DIRECT REGULATION
The Company's insurance subsidiaries are subject to comprehensive, detailed
regulation, principally for the protection of policyholders and their borrowers
rather than for the benefit of investors, by the insurance departments of the
various states in which each insurer is licensed to transact business. Although
their scope varies, state insurance laws in general grant broad powers to
supervisory agencies or officials to examine companies and to enforce rules or
exercise discretion touching almost every significant aspect of the insurance
business. These include the licensing of companies to transact business, and
varying degrees of control over claims handling practices, reinsurance
requirements, premium rates, the forms and policies offered to customers,
financial statements, periodic financial reporting, permissible investments, and
adherence to financial standards relating to statutory surplus, dividends, and
other criteria of solvency intended to assure the satisfaction of obligations to
policyholders.
All states have enacted legislation that requires each insurance company in
a holding company system to register with the insurance regulatory authority of
its state of domicile and furnish to the regulator financial and other
information concerning the operations of companies within the holding company
system that may materially affect the operations, management, or financial
condition of the insurers within the system. Generally, all transactions within
a holding company system between an insurer and its affiliates must be fair and
reasonable and the insurer's statutory policyholders' surplus following any
transaction with an affiliate must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Most states also regulate
transactions between insurance companies and their parents and/or affiliates.
There can be no assurance that state regulatory requirements will not become
more stringent in the future and have an adverse effect on the Company.
Because the Company is an insurance holding company and Triad is an
Illinois domiciled insurance company, the Illinois insurance laws regulate,
among other things, certain transactions in the Company's Common Stock and
certain transactions between Triad and the Company or affiliates. Specifically,
no person may, directly or indirectly, offer to acquire or acquire beneficial
ownership of more than 10% of any class of outstanding securities of the Company
or its subsidiaries unless such person files a statement and other documents
with the Illinois Director of Insurance and obtains the Director's prior
approval. In addition, material transactions between Triad and the Company or
affiliates are subject to certain conditions, including that they be "fair and
reasonable." These restrictions generally apply to all persons controlling or
under common control with the insurance companies. "Control" is presumed to
exist if 10% or more of Triad's voting securities is owned or controlled,
directly or indirectly, by a person, although the Illinois Director may find
that "control" in fact does or does not exist where a person owns or controls
either a lesser or greater amount of securities. Other states in addition to
Illinois may regulate affiliated transactions and the acquisition of control of
the Company or its insurance subsidiaries.
32
Triad is required by Illinois insurance laws to provide for a contingency
reserve in an amount equal to at least 50% of earned premiums in its statutory
financial statements. Such reserves must be maintained for a period of 10 years
except in circumstances where high levels of losses exceed regulatory
thresholds. The contingency reserve, designed to provide a cushion against the
effect of adverse economic cycles, has the effect of reducing statutory surplus
and restricting dividends and other distributions by Triad. At December 31,
2002, Triad had statutory policyholders' surplus of $112.9 million and a
statutory contingency reserve of $245.0 million. At December 31, 2001, Triad had
statutory policyholders' surplus of `$105.3 million and a statutory contingency
reserve of $193.7 million. Triad's statutory earned surplus was $29.2 million at
December 31, 2002 and $21.6 million at December 31, 2001, reflecting growth in
statutory net income greater than the increase in the statutory contingency
reserve.
The insurance laws of Illinois provide that Triad may pay dividends only
out of statutory earned surplus and further establish standards limiting the
maximum amount of dividends which may be paid without prior approval by the
Illinois Director. Under such standards, Triad may pay dividends during any
12-month period equal to the greater of (i) 10% of the preceding year-end
statutory policyholders' surplus or (ii) the preceding year's net income. In
addition, insurance regulatory authorities have broad discretion to limit the
payment of dividends by insurance companies.
Although not subject to a rating law in Illinois, premium rates for
mortgage insurance are subject to regulation in most states to protect
policyholders against the adverse effects of excessive, inadequate, or unfairly
discriminatory rates and to encourage competition in the insurance marketplace.
Any increase in premium rates must be justified, generally on the basis of the
insurer's loss experience, expenses, and future trend analysis. The general
mortgage default experience also may be considered.
TGAC was organized as a subsidiary of Triad under the insurance laws of the
state of Illinois in December 1994, and as an Illinois domiciled insurer, is
subject to all Illinois insurance regulatory requirements applicable to Triad.
Triad Re was organized as a subsidiary of Triad under the insurance laws of
the state of Vermont in November 1999, and as a Vermont domiciled insurer, is
subject to Vermont insurance regulatory requirements.
Triad, TGAC, and Triad Re are each subject to examination of their affairs
by the insurance departments of every state in which they are licensed to
transact business. The Illinois Insurance Director and Vermont Insurance
Commissioner periodically conduct financial examinations of insurance companies
domiciled in their states. The most recent examinations of Triad and TGAC were
issued by the Illinois Insurance Department on February 3, 2000, and covered the
33
period January 1, 1995, through December 31, 1998. No material recommendations
were made as a result of these examinations.
A number of states generally limit the amount of insurance risk which may
be written by a private mortgage insurer to 25 times the insurer's total
policyholders' surplus. This restriction is commonly known as the
risk-to-capital requirement.
Mortgage insurers are generally restricted by state insurance laws and
regulations to writing residential mortgage guaranty insurance business only.
This restriction generally prohibits Triad from using its capital resources in
support of other types of insurance and restricts its noninsurance business.
However, noninsurance businesses of the Company would not generally be subject
to regulation under state insurance laws.
Regulation of reinsurance varies by state. Except for Illinois, Wisconsin,
New York, Ohio, and California, most states have no special restrictions on
reinsurance that would apply to private mortgage insurers other than standard
reinsurance requirements applicable to property and casualty insurance
companies. Certain restrictions, including reinsurance trust fund or letter of
credit requirements, apply under Illinois law to domestic companies and under
the laws of several other states to any licensed company ceding business to
unlicensed reinsurers. If a reinsurer is not admitted or approved, the company
doing business with the reinsurer cannot take credit in its statutory financial
statements for the risk ceded to such reinsurer absent compliance with the
reinsurance security requirements. In addition, some states in which Triad does
business have limited private mortgage insurers to a maximum policy coverage
limit of 25% of the insured's claim amount and require coverages in excess of
25% to be reinsured through another licensed mortgage insurer.
The National Association of Insurance Commissioners ("NAIC") adopted a
risk-based capital ("RBC") formula designed to help regulators identify property
and casualty insurers in need of additional capital. The RBC formula establishes
minimum capital needs based upon risks applicable to individual insurers,
including asset risks, off-balance sheet risks (such as guarantees for
affiliates and contingent liabilities), and credit risks (such as reinsurance
ceded and receivables). The NAIC and the Illinois Department of Insurance
currently do not require mortgage guaranty insurers to file RBC analysis in
their annual statements.
As the dominant purchasers and sellers of conventional mortgage loans and
beneficiaries of private mortgage guaranty insurance, Government Sponsored
Enterprises (GSEs) Fannie Mae and Freddie Mac impose requirements on private
mortgage insurers in order for such insurers to be eligible to insure loans sold
to such agencies. Freddie Mac's current eligibility requirements impose
limitations on the types of risk insured, standards for geographic and customer
diversification of risk, procedures for claims handling, acceptable underwriting
practices, and financial requirements which generally mirror state insurance
regulatory requirements. These requirements are subject to change from time to
time. Freddie Mac most recently modified its eligibility guidelines in March
2002.
Fannie Mae is in the process of revising its approval requirements for
mortgage insurers. The new requirements, which have not yet been finalized,
34
would require prior approval by Fannie Mae for many of Triad's activities and
new products, allow for other approved types of mortgage insurers rated less
than "AA," and give Fannie Mae increased rights to revise the eligibility
standards of mortgage insurers. The form the eligibility guidelines ultimately
will take is unknown at this time, but new guidelines, if issued, could have an
adverse effect on the Company.
Triad is an approved mortgage insurer for both Fannie Mae and Freddie Mac
and meets all existing eligibility requirements. There can be no assurance,
however, that such requirements or the interpretation of the requirements will
not change or that Triad will continue to meet such requirements. In addition,
to the extent Fannie Mae or Freddie Mac assumes default risk for itself that
would otherwise be insured, changes current guarantee fee arrangements, allows
alternative credit enhancements, alters or liberalizes underwriting guidelines
on low down payment mortgages it purchases, or otherwise changes its business
practices or processes with respect to such mortgages, private mortgage insurers
may be affected. Triad could be particularly adversely affected if changes in
eligibility requirements regarding captive arrangements that permit premium
cessions greater than 25% were to impede Triad's ability to offer this form of
captive reinsurance.
Fannie Mae and Freddie Mac both accept reduced mortgage insurance coverage
from lenders that deliver loans approved by the their automated underwriting
services, Desktop Underwriter and Loan Prospector, respectively. Generally,
Fannie Mae's and Freddie Mac's reduced mortgage insurance coverage options
provide for: (i) across-the-board reductions in required MI coverage on 30-year
fixed-rate loans recommended for approval by the their automated underwriting
services to the levels in effect in 1994; (ii) reduction in required MI coverage
for loans with only a 5% down payment (a 95% LTV) from 30% to 25% of the
mortgage loan covered by MI; and, (iii) reduction in required MI coverage for
loans with a 10% down payment (a 90% LTV loan) from 25% to 17% of the mortgage
loan covered by MI. In addition, Fannie Mae and Freddie Mac have implemented
other programs that further reduce MI coverage upon the payment of an additional
fee by the lender. Under this option, a 95% LTV loan will require 18% of the
mortgage loan to have mortgage insurance coverage. Similarly, a 90% LTV loan
will require 12% of the mortgage loan to have mortgage insurance. In order for
the homebuyer to have MI at these levels, such loans would require a payment at
closing or a higher note rate.
Certain national mortgage lenders and a large segment of the mortgage
securitization market, including Fannie Mae and Freddie Mac, generally will not
purchase mortgages or mortgage-backed securities unless the private mortgage
insurance on the mortgages has been issued by an insurer with a financial
strength rating of at least "AA-" from S&P or Fitch or a rating of at least
"Aa3" from Moody's. Fannie Mae and Freddie Mac require mortgage guaranty
insurers to maintain two ratings of "AA-" or better. Triad has a financial
strength rating of "AA" from S&P and Fitch and a rating of "Aa3" from Moody's.
S&P, Fitch, and Moody's consider Triad's consolidated operations and financial
35
position in determining the rating. There can be no assurance that Triad's
rating, the method by which this rating is determined, or the eligibility
requirements of Fannie Mae and Freddie Mac will not change.
The Real Estate Settlement and Procedures Act of 1974 ("RESPA") applies to
most residential mortgages insured by Triad, and related regulations provide
that the provision of services involving mortgage insurance is a "settlement
service" for purposes of loans subject to RESPA. Subject to limited exceptions,
RESPA prohibits persons from accepting anything of value for referring real
estate settlement services to any provider of such services. Although many
states prohibit mortgage insurers from giving rebates, RESPA has been
interpreted to cover many non-fee services as well.
Various lawsuits filed in US district court in Augusta, Georgia as well as
other jurisdictions against each of the national mortgage insurers, including
the Company, assert that defendant mortgage insurers have violated RESPA
guidelines by offering pool insurance, captive reinsurance, contract
underwriting, and other services at preferential below market prices as an
illegal inducement to persuade lenders to use those mortgage insurers for
primary insurance coverage. The lawsuits seek class action status. Four mortgage
insurers have entered into settlements of the lawsuits. In August 2000, Triad
filed a motion for summary judgment in the case which was granted on February
13, 2001. The summary judgment was overturned by the 11th Circuit Court of
Appeals in January 2002. In overturning the judgment, the court addressed the
applicability of the McCarron-Ferguson Act (regarding federal preemption of
state law) to the case; it did not address the merits of the case. Triad
subsequently filed a motion opposing class certification which was granted.
Plaintiffs have appealed this decision. Triad believes that its products and
services comply with RESPA as well as all other applicable laws and regulations.
While the ultimate outcome of the RESPA litigation is uncertain, the litigation
is not expected to have a material adverse affect on the financial position of
the Company.
Most originators of mortgage loans are required to collect and report data
relating to a mortgage loan applicant's race, nationality, gender, marital
status, and census tract to HUD or the Federal Reserve under the Home Mortgage
Disclosure Act of 1975 ("HMDA"). The purpose of HMDA is to detect possible
discrimination in home lending and, through disclosure, to discourage such
discrimination. Mortgage insurers are not required pursuant to any law or
regulation to report HMDA data, although under the laws of several states,
mortgage insurers are currently prohibited from discriminating on the basis of
certain classifications. The active mortgage insurers, through their trade
association, the Mortgage Insurance Companies of America ("MICA"), have entered
into an agreement with the Federal Financial Institutions Examinations Council
("FFIEC") to report the same data on loans submitted for insurance as is
required for most mortgage lenders under HMDA.
Upon request by an insured, Triad must cancel the mortgage insurance for a
mortgage loan. Fannie Mae and Freddie Mac guidelines, as well as several
existing and proposed state statutes, contain various provisions which give
borrowers the right to request cancellation of borrower-paid mortgage insurance
when specified conditions are met.
The Homeowners Protection Act of 1998 provides for certain termination and
cancellation requirements for borrower-paid mortgage insurance and requires
mortgage lenders to periodically update borrowers about their private mortgage
36
insurance. Under the legislation, borrowers may generally request termination of
mortgage insurance once the LTV reaches 80%, provided that certain conditions
are met. The legislation further requires lenders to automatically cancel
borrower-paid private mortgage insurance when home equity reaches 78% if certain
conditions are met. The legislation also requires lenders to notify borrowers
that they have private mortgage insurance and requires certain disclosures to
borrowers of their rights under the law. Because most mortgage borrowers who
obtain private mortgage insurance do not achieve 20% equity in their homes
before the homes are sold or the mortgages refinanced, the Company has not lost
and does not expect to lose a significant amount of its insurance in force due
to the enactment of this legislation.
INDIRECT REGULATION
The Company, Triad, and Triad's subsidiaries are also indirectly, but
significantly, impacted by regulations affecting purchasers of mortgage loans,
such as Fannie Mae and Freddie Mac, and regulations affecting governmental
insurers, such as the FHA and the Department of Veterans Affairs ("VA"), as well
as lenders. Private mortgage insurers, including Triad, are highly dependent
upon federal housing legislation and other laws and regulations which affect the
demand for private mortgage insurance and the housing market generally. For
example, housing legislation enacted in 1992 permits up to 100% of borrower
closing costs to be financed by loans insured by FHA, a significant increase
from the previous 57% limit. Also, in 1994, HUD reduced the initial premium
(payable at loan origination) for FHA insurance from 3.0% to 2.25%. FHA loan
limits are adjusted in response to changes in the Freddie Mac/Fannie Mae
conforming loan limits. Currently, the maximum individual loan amount that the
FHA can insure is $280,749. The maximum FHA loan amount is subject to adjustment
and may increase in the future. While there is no maximum VA loan amount,
lenders will generally limit VA loans to $240,000 according to the VA. This
implied maximum VA loan amount may also increase in the future. Any future
legislation that increases the number of persons eligible for FHA or VA
mortgages could have an adverse effect on Triad's ability to compete with the
FHA or VA.
Pursuant to the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA"), the Office of Thrift Supervision ("OTS") issued
risk-based capital rules for savings institutions. These rules establish a lower
capital requirement for a low down payment loan that is insured with private
mortgage insurance, as opposed to remaining uninsured. Furthermore, the
guidelines for real estate lending policies applicable to savings institutions
and commercial banks provide that such institutions should require appropriate
credit enhancement in the form of either mortgage insurance or readily
marketable collateral for any high LTV mortgage. To the extent FIRREA's
risk-based capital rules or the guidelines for real estate lending policies
applicable to savings institutions and commercial banks are changed in the
future, some of the benefits of FIRREA and the guidelines for real estate
lending policies to the mortgage insurance industry, including Triad, may be
curtailed or eliminated.
In the first quarter of 2002, the Office of Federal Housing Enterprise
Oversight (OFHEO) released its risk-based capital rules for Fannie Mae and
Freddie Mac. The regulation provides capital guidelines for Fannie Mae and
Freddie Mac in connection with their use of various types of credit protection
37
counterparties including a more preferential capital credit for insurance from a
"AAA" rated private mortgage insurer than for insurance from a "AA" rated
private mortgage insurer. The phase-in period for the new rule is ten years. The
Company does not believe the new rules had an adverse impact on it in 2002 nor
that the new rules will have a significant adverse impact on the Company in the
future. However, if the new capital guidelines result in future changes to the
preferences of Fannie Mae and Freddie Mac regarding their use of the various
types of credit enhancements or their choice of mortgage insurers based on their
credit rating, the Company's financial condition could be significantly harmed.
Fannie Mae and Freddie Mac each provide their own automated underwriting
system to be used by mortgage originators selling mortgages to them. These
systems, which are provided by Triad as a service to the Company's contract
underwriting customers, streamline the mortgage process and reduce costs. The
increased acceptance of these products is driving the automation of the process
by which mortgage originators sell loans to Fannie Mae and Freddie Mac, a trend
which is expected to continue. As a result, Fannie Mae and Freddie Mac could
develop the capability to become the decision maker regarding selection of a
private mortgage insurer for loans sold to them, a decision traditionally made
by the mortgage originator. The Company, however, is not aware of any plans to
do so. The concentration of purchasing power that would be attained if such
development in fact occurred could adversely affect, from the Company's
perspective, the terms on which mortgage insurance is written on loans sold to
Fannie Mae and Freddie Mac.
Additionally, proposals have been advanced which would allow Fannie Mae and
Freddie Mac additional flexibility in determining the amount and nature of
alternative recourse arrangements or other credit enhancements which they could
utilize as substitutes for private mortgage insurance. The Company cannot
predict if or when any of the foregoing legislation or proposals will be
adopted, but if adopted and depending upon the nature and extent of revisions
made, demand for private mortgage insurance may be adversely affected. There can
be no assurance that other federal laws affecting such institutions and entities
will not change, or that new legislation or regulation will not be adopted.
In 1996, the Office of the Comptroller of the Currency ("OCC") granted
permission to national banks to have a reinsurance company as a wholly-owned
operating subsidiary for the purpose of reinsuring mortgage insurance written on
loans originated, purchased, or serviced by such banks. Several subsequent
applications by banks to offer reinsurance have been approved by the OCC
including at least one request to engage in quota share reinsurance. The OTS,
which regulates thrifts and savings institutions, has approved applications for
such captive arrangements as well. The reinsurance subsidiaries of national
banks or savings institutions could become significant competitors of the
Company in the future.
In November 1999, the Gramm-Leach-Bliley Act, also known as the Financial
Services Modernization Act of 1999, became effective and allows holding
companies of banks also to own a company that underwrites insurance. As a result
38
of this Act, banking organizations that previously were not allowed to be
affiliated with insurance companies may now do so. Management does not know to
what extent this expanded opportunity for banks will be utilized or how it will
affect the mortgage insurance industry. However, the evolution of federal law
making it easier for banks to engage in the mortgage guaranty business through
affiliates may subject mortgage guaranty insurers to more intense competition
and risk-sharing with bank lender customers.
WEB SITE ACCESS TO COMPANY REPORTS
The Company makes available, free of charge, through its Web site, its
Annual Report on Form 10-K, quarterly reports on Form 10-Q, and current reports
on Form 8-K, and amendments to those reports as soon as reasonably practicable
after this material is electronically filed with or furnished to the Securities
and Exchange Commission. This material may be accessed by visiting the
Investors/Financial Information/SEC Filing Information section of the Company's
Web site at www.triadguaranty.com.
39
EMPLOYEES
As of December 31, 2002, the Company employed 209 persons. Employees are
not covered by any collective bargaining agreement. The Company considers its
employee relations to be satisfactory.
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
Name Position Age
- ---- -------- ---
William T. Ratliff, III Chairman of the Board of 49
the Company and Triad
Darryl W. Thompson President, Chief Executive 62
Officer, and Director of the
Company and Triad
Ron D. Kessinger Executive Vice President and 48
Chief Financial Officer of the
Company and Triad
Kenneth N. Lard Executive Vice President of the 44
Company and Executive Vice
President, Sales and Marketing
of Triad
Earl F. Wall Senior Vice President, Secretary, 45
and General Counsel of the
Company and Triad
Michael R. Oswalt Senior Vice President, Treasurer, 41
and Principal Accounting Officer
of the Company and Triad
Kenneth C. Foster Senior Vice President of Triad 54
40
WILLIAM T. RATLIFF, III has been the Chairman of the Board of the Company
since 1993. Mr. Ratliff has also been Chairman of the Board of Triad since 1989,
President of CIC since 1990 and was President and General Partner of CML from
1987 to 1995. Since 1995, he has served as President of Collat, Inc., CML's
corporate general partner. Mr. Ratliff has been Chairman of New South Federal
Savings Bank ("New South") since 1986 and President and Director of New South
Bancshares, Inc., New South's parent company, since 1994. From March 1994, until
December 1996, Mr. Ratliff served as President of Southwide Life Insurance
Corp., of which he had been Executive Vice President since 1993. Mr. Ratliff
joined CML in 1981 after completing his doctoral degree with a study of planning
processes in an insurance company. Previously, he worked as an educator,
counselor, and organizational consultant.
DARRYL W. THOMPSON has been the President, Chief Executive Officer and a
Director of the Company since 1993. Mr. Thompson has also been President, Chief
Executive Officer, and a Director of Triad since its inception in 1987. From
1986 to 1989, Mr. Thompson also served as President and Chief Executive Officer
of Triad Life Insurance Company, which sold mortgage insurance products. From
1976 to 1985, Mr. Thompson served as Senior Vice President/Southeast Division
Manager of MGIC. Mr. Thompson joined MGIC in 1972.
RON D. KESSINGER has been Executive Vice President and Chief Financial
Officer of the Company since December 1999. Mr. Kessinger has been Chief
Financial Officer of Triad since November 1999 and Executive Vice President of
Insurance Operations of Triad since June 1996. Mr. Kessinger was Vice President
of Claims and Administration of Triad from January 1991 to June 1996. From 1985
to 1991, Mr. Kessinger was employed by Integon Mortgage Guaranty Insurance
Corporation, most recently serving as Senior Vice President of Operations. Prior
to joining Integon Mortgage Guaranty Insurance Corporation, Mr. Kessinger was
employed by the parent company of Integon Mortgage Guaranty Insurance
Corporation.
KENNETH N. LARD has been Executive Vice President of the Company and
Executive Vice President, Sales and Marketing of Triad since February 2003. Mr.
Lard was Senior Vice President, Sales and Marketing of Triad from June 2002 to
January 2003. From November 1997 to May 2002, Mr. Lard was Senior Vice
President, National Sales Director of Triad. From November 1995 to September
1996 Mr. Lard was Vice President, National Accounts of Triad. Prior to joining
Triad, Mr. Lard was employed by Signet Bank from 1987 to 1995, as Vice
President, Capitol Markets Division and most recently as Vice President,
Secondary Marketing. Mr. Lard has been with Triad for 7 years and has over 20
years experience in the mortgage industry.
41
EARL F. WALL has been Senior Vice President of Triad since November 1999,
General Counsel of Triad since January 1996, and Secretary since June 1996. Mr.
Wall was Vice President of Triad from 1996 till 1999. Mr. Wall has been Senior
Vice President of the Company since December 1999, and Secretary and General
Counsel of the Company since September 1996. Mr. Wall was Vice President of the
Company from 1996 to 1999. From 1982 to 1995, Mr. Wall was employed by Integon
in a number of capacities including Vice President, Associate General Counsel,
and Director of Integon Life Insurance Corporation and Georgia International
Life Insurance Corporation, Vice President, and General Counsel of Integon
Mortgage Guaranty Insurance Corporation, and Vice President, General Counsel,
and Director of Marketing One, Inc.
MICHAEL R. OSWALT has been Senior Vice President and Treasurer of the
Company since December 1999. Mr. Oswalt has been a Senior Vice President and
Treasurer of Triad since November 1999. Mr. Oswalt was Controller of the Company
from March 1994 to October 2001 and he was Controller of Triad from June 1996 to
October 2001. Mr. Oswalt was Vice President of the Company and Triad from
December 1994 to December 1999. Mr. Oswalt previously served as Vice President
and Controller of CIC and Southwide Life Insurance Corp. from February 1994,
until June 1996. From January 1993, to February 1994, Mr. Oswalt was employed by
Complete Health Services, Inc. where he performed internal audit services. From
1991 to 1993, Mr. Oswalt was employed by Arthur Andersen & Co. Prior to joining
Arthur Andersen & Co., Mr. Oswalt was employed by Deloitte & Touche from 1988 to
1991. Mr. Oswalt is a certified public accountant.
KENNETH C. FOSTER has been Senior Vice President, Risk Management of Triad
since April 2002. From June 2001 to April 2002 Mr. Foster was Senior Vice
President, Product Development of Triad. Prior to joining Triad, Mr. Foster was
Principal of Applied Mortgage Solutions from 1994 to 2001. Previously Mr. Foster
was employed by MGIC from 1980 to 1994, most recently as Vice President of
Business/Information Development. Mr. Foster has been associated with Triad for
8 years and in the insurance/mortgage industry for over 30 years.
Officers of the Company serve at the discretion of the Board of Directors of the
Company.
ITEM 2. PROPERTIES.
As of December 31, 2002, the Company leases office space in its
Winston-Salem headquarters and its twelve underwriting offices located
throughout the country comprising approximately 77,000 square feet under leases
expiring between 2003 and 2012 and which require annual lease payments of
approximately $1.3 million in 2003. With respect to all facilities, the Company
either has renewal options or believes it will be able to obtain lease renewals
on satisfactory terms. The Company believes its existing properties are well
utilized and are suitable and adequate for its present circumstances.
42
The Company maintains mid-range and micro-computer systems from its
corporate data center located in its headquarters building to support its data
processing requirements for accounting, claims, marketing, risk management, and
underwriting. The Company has in place back-up procedures in the event of
emergency situations.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in litigation in the ordinary course of business.
No pending litigation is expected to have a material adverse affect on the
financial position of the Company.
Triad is a defendant in Patton v. Triad. This action was commenced on June
30, 2000 with the filing of a complaint in Federal District Court for the
Southern District of Georgia seeking class action status on behalf of a
nationwide class of home mortgage borrowers. The complaint alleges that Triad
violated the Real Estate Settlement Procedures Act ("RESPA") by entering into
transactions with lenders (including captive mortgage reinsurance and contract
underwriting) that were not properly priced, in return for the referral of
mortgage insurance. In August 2000, Triad filed a motion for summary judgement
in the case which was granted on February 13, 2001. The summary judgement was
overturned by the 11th Circuit Court of Appeals in January 2002. In overturning
the judgement, the court addressed the applicability of the McCarron-Ferguson
Act (regarding federal preemption of state law) to the case; it did not address
the merits of the case. Triad subsequently filed a motion opposing class
certification which was granted. Plaintiffs have appealed this decision. While
the ultimate outcome of the RESPA litigation is uncertain, the litigation is not
expected to have a material adverse affect on the financial position of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
43
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock trades on The Nasdaq National Market(R) under
the symbol "TGIC." At December 31, 2002, 14,159,601 shares were issued and
outstanding. The following table sets forth the highest and lowest closing
prices of the Company's Common Stock, $0.01 par value, as reported by Nasdaq
during the periods indicated.
2002 2001
---- ----
High Low High Low
---- --- ---- ---
First Quarter.......... $43.470 $34.740 $35.438 $26.688
Second Quarter......... $48.470 $40.270 $40.000 $30.125
Third Quarter.......... $46.000 $32.400 $39.750 $29.650
Fourth Quarter ........ $41.610 $31.002 $36.530 $30.400
As of March 12, 2003, the number of stockholders of record of Company
Common Stock was approximately 200. In addition, there were an estimated 3,600
beneficial owners of shares held by brokers and fiduciaries.
Payments of future dividends are subject to declaration by the Company's
Board of Directors. The dividend policy is dependent also on the ability of
Triad to pay dividends to the Company. Because of regulatory dividend
restrictions by the Illinois Department of Insurance and Triad's need to
maintain capital levels required by rating agencies, the Company has no present
intention to pay dividends.
44
ITEM 6. SELECTED FINANCIAL DATA.
Year Ended December 31
----------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Income Statement Data (for period ended): (Dollars in thousands, except per share amounts)
Premiums written:
Direct.................................. $ 124,214 $ 95,551 $ 76,867 $ 65,381 $ 52,974
Assumed..................................... 3 4 8 11 13
Ceded....................................... (18,348) (10,557) (4,993) (1,665) (1,090)
----------- ----------- ----------- ------------ ------------
$ 105,869 $ 84,998 $ 71,882 $ 63,727 $ 51,897
=========== =========== =========== ============ ============
Earned premiums.................................. $ 105,067 $ 84,356 $ 71,843 $ 63,970 $ 52,822
Net investment income............................ 16,099 14,765 12,645 10,546 9,289
Net realized investment (losses) gains .......... (2,519) 297 286 1,153 880
Other income..................................... 72 1,892 37 13 14
----------- ----------- ----------- ------------ ------------
Total revenues.......................... 118,719 101,310 84,811 75,682 63,005
Net losses and loss adjustment expenses.......... 14,063 9,019 7,587 7,111 7,009
Interest expense on debt......................... 2,771 2,771 2,770 2,780 2,554
Amortization of deferred policy acquisition cost. 13,742 11,712 8,211 6,955 5,955
Other operating expenses (net of acquisition
cost deferred)............................. 22,900 18,136 16,008 15,061 12,435
----------- ----------- ----------- ------------ ------------
Income before income taxes....................... 65,243 59,672 50,235 43,775 35,052
Income taxes..................................... 20,140 18,413 15,237 13,365 10,678
----------- ----------- ----------- ------------ ------------
Net income....................................... $ 45,103 $ 41,259 $ 34,998 $ 30,410 $ 24,374
=========== =========== =========== ============ ============
Basic earnings per share ................... $ 3.21 $ 3.05 $ 2.63 $ 2.28 $ 1.83
Diluted earnings per share ................. $ 3.15 $ 2.95 $ 2.55 $ 2.23 $ 1.76
----------- ----------- ----------- ------------ ------------
Weighted average common and common share
equivalents outstanding
Basic .................................. 14,060,420 13,545,725 13,321,901 13,312,104 13,342,749
Diluted................................. 14,331,581 13,977,435 13,726,088 13,640,716 13,843,382
Balance Sheet Data (at year end):
Total assets (1)............................ $ 482,886 $ 396,455 $ 328,377 $ 263,141 $ 230,512
Total invested assets....................... $ 344,581 $ 277,200 $ 232,025 $ 191,564 $ 177,301
Losses and loss adjustment expenses......... $ 21,360 $ 17,991 $ 14,987 $ 14,751 $ 12,143
Unearned premiums........................... $ 8,539 $ 7,650 $ 6,933 $ 6,831 $ 7,055
Long-term debt ............................. $ 34,479 $ 34,473 $ 34,467 $ 34,462 $ 34,457
Stockholders' equity........................ $ 309,407 $ 246,070 $ 199,831 $ 157,072 $ 137,531
Statutory Ratios (2):
Loss ratio.................................. 13.4% 10.7% 10.6% 11.1% 13.3%
Expense ratio............................... 38.0% 39.9% 37.4% 40.5% 42.3%
----------- ----------- ----------- ------------ ------------
Combined ratio.............................. 51.4% 50.6% 48.0% 51.6% 55.6%
=========== =========== =========== ============ ============
GAAP Ratios:
Loss ratio.................................. 13.4% 10.7% 10.6% 11.1% 13.3%
Expense ratio............................... 34.6% 35.1% 33.7% 34.5% 35.4%
----------- ----------- ----------- ------------ ------------
Combined ratio.............................. 48.0% 45.8% 44.3% 45.6% 48.7%
=========== =========== =========== ============ ============
Other Statutory Data (dollars in millions) (2):
Direct insurance in force................... $ 25,379.1 $ 21,726.0 $ 15,123.5 $ 13,038.0 $ 11,256.6
Direct risk in force (gross)................ $ 5,790.9 $ 4,581.5 $ 3,760.0 $ 3,222.5 $ 2,777.4
Risk-to-capital............................. 15.5:1 15.0:1 14.8:1 15.4:1 16.2:1
(1) Periods prior to 1999 have been restated to reflect reclassification of Tax
and Loss bonds.
(2) Based on statutory accounting practices and derived from consolidated
statutory financial statements of Triad.
45
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
2002 COMPARED TO 2001
Net income for 2002 increased 9.3% to $45.1 million from $41.3 million in
2001. Net income per share on a diluted basis increased 6.6% to $3.15 for 2002
from $2.95 per share for 2001. This improvement in net income was led by a 24.6%
increase in earned premiums and a 9.0% increase in net investment income. Net
income for 2002 includes net realized investment losses of $2.5 million, or
$0.11 per diluted share, while net income for 2001 included net realized
investment gains of $297,000, or $0.01 per diluted share. Also included in net
income for 2001 was the receipt of a nonrecurring incentive payment of
approximately $1.9 million, or $0.09 per diluted share, relating to the
voluntary cancellation of one of the Company's excess of loss reinsurance
contracts. The payment was reported as other income in the first quarter of
2001.
Operating earnings, which exclude realized investment gains and losses net
of related taxes, increased 13.8% to $46.7 million in 2002 compared to $41.1
million in 2001. Operating earnings per share were $3.26 for 2002 compared to
$2.94 for 2001, an increase of 11.0%. Management believes operating earnings and
operating earnings per share are relevant and useful information, and they are
primary measurements used by management in assessing the Company's performance.
Management does not believe that net realized investment gains and losses are
strong indicators of trends in operations. Operating earnings and operating
earnings per share results, as described above, may not be comparable to
similarly titled measures reported by other companies. Excluding the effects of
the nonrecurring incentive payment from operating results, operating earnings
increased 17.3%, and operating earnings per diluted share increased
approximately 14.4% for 2002 compared to 2001.
Total insurance written in 2002 was $13.4 billion compared to $13.3 billion
in 2001, an increase of 1.3%. Total insurance written includes insurance written
from traditional flow production and insurance written attributable to
structured bulk transactions. Total direct insurance in force reached $25.4
billion at December 31, 2002, compared to $21.7 billion at December 31, 2001, an
increase of 16.8%. Significant refinance activity in 2002 drove a high level of
policy cancellations that partially offset the impact that the high level of
insurance written had on in force growth.
Traditional flow insurance written for 2002 increased 42.8% to $12.2
billion from $8.5 billion in 2001. The increase in insurance written from
traditional flow production was primarily the result of expanding relationships
with national lenders, strong demand for risk-sharing arrangements, and a lower
interest rate environment. Insurance written in 2002 attributable to structured
bulk transactions totaled $1.2 billion compared to $4.7 billion in 2001.
Structured bulk transactions are generally initiated by secondary mortgage
market participants who wish to use mortgage insurance as a credit enhancement.
The Company competes against other mortgage insurers as well as other forms of
credit enhancements provided by capital markets for these transactions.
46
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
Insurance written attributed to structured bulk transactions is likely to vary
significantly from period to period due to the relatively small number of
transactions that encompass this market (as opposed to the traditional flow
market), competitiveness with other mortgage insurers, the attractiveness in the
marketplace of mortgage insurance versus other forms of credit enhancements, and
the changing loan composition of the market. The Company has evaluated all
segments of the bulk market - Prime (predominantly fully underwritten loans,
high credit scores, high percentage of low LTVs), Alternative-A (generally high
credit score, low to moderate LTV loans that have been underwritten with reduced
documentation), and Sub-prime (generally fully underwritten loans with credit
impaired borrowers). All insurance written through the bulk channel in 2002 and
2001 was in the Prime segment and the Alternative-A segment of the bulk market.
Consolidation within the mortgage origination industry and Triad's
continued focus on national lenders has resulted in a greater percentage of
production volume being concentrated among a smaller customer base. The
Company's ten largest customers were responsible for 58.9%, 42.3%, and 30.0% of
traditional flow risk in force at December 31, 2002, 2001, and 2000,
respectively. The loss of one or more of these significant customers could have
a significant adverse effect on the Company's business. According to industry
data, Triad's national market share of net new primary insurance written, which
includes insurance written on a traditional flow basis as well as that
attributed to structured bulk transactions, was 3.7% for 2002 (3.9% for the
fourth quarter) compared to 3.6% for 2001 (4.0% for the fourth quarter). Triad's
national market share of net new primary insurance written on a traditional flow
basis was 4.3% for 2002 (4.7% for the fourth quarter) compared to 3.4% for 2001
(4.1% in the fourth quarter). Net new primary insurance written excludes
insurance placed on loans more than 12 months after loan origination, insurance
placed on loans already covered by primary mortgage insurance, and insurance
placed on loans where lender exposure is effectively reduced below defined
minimums. This treatment is consistent with the definitions adopted by the
Company and the industry in the third quarter of 2001 regarding the computation
of new insurance written for market share purposes.
Total direct premiums written were $124.2 million for 2002, an increase of
30.0% compared to $95.6 million for 2001. Net premiums written increased by
24.6% to $105.9 million in 2002 from $85.0 million for 2001. Earned premiums
increased 24.6% to $105.1 million for 2002 from $84.4 million for 2001. This
growth in written and earned premium resulted from record levels of insurance
written offset by the impact of a declining persistency rate due to a high level
of refinance activity.
Growth in direct premiums written was partially offset by an increase in
ceded premiums written. Driven primarily by increases in risk-sharing
arrangements and also by excess of loss reinsurance, ceded premiums written
increased 73.8% to $18.3 million in 2002 from $10.6 million in 2001. The
Company's premium cede rate (the ratio of ceded premiums written to direct
premiums written) was 14.8% for 2002 compared to 11.0% for 2001. The Company's
premium cede rate for captive reinsurance was 12.7% for 2002 compared to 6.6%
for 2001. Approximately 51% of flow insurance written (46% of total insurance
47
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
written including structured bulk transactions) during 2002 is subject to
captive mortgage reinsurance and other risk-sharing arrangements compared to 58%
of flow insurance written (37% of total insurance written including structured
bulk transactions) in 2001. The decline in the percentage of flow insurance
written subject to risk-sharing arrangements from 2001 to 2002 is primarily a
result of increased production in the Company's lender-paid mortgage insurance
program which is generally not subject to risk-sharing arrangements. Through
December 31, 2002, insurance written attributable to structured bulk
transactions has not been subject to captive mortgage reinsurance or other
risk-sharing arrangements. Approximately 45.7% of direct insurance in force is
subject to risk-sharing arrangements at December 31, 2002, compared to 34.6% at
December 31, 2001. This increase in insurance in force subject to risk-sharing
arrangements is due primarily to the increased market penetration of the
Company's risk-sharing arrangements and the high level of refinance activity
during the past twelve months, as policies that were previously not subject to
risk-sharing arrangements refinanced and new policies issued were subject to
risk-sharing arrangements. Management anticipates that ceded premiums will
continue to increase as a result of the expected increase in insurance written
and growth in the Company's risk-sharing programs.
The Company currently participates in excess of loss risk-sharing
arrangements with various entrance and exit attachment points. One of the
Company's competitors has announced that as of March 31, 2003, it will not
participate in excess of loss risk-sharing arrangements where the net premium
cede rate is greater than 25%. The Company believes that its risk-sharing
arrangements provide valuable reinsurance protection and potentially reduce the
risk of volatility in the Company's earnings. The Company plans to continue to
participate in its excess of loss risk-sharing arrangements. It is uncertain at
this time what impact, if any, the competitor's decision to exit this business
will have on the Company's direct insurance in force subject to risk-sharing
arrangements and its market share.
Refinance activity was 40.1% of insurance written (47.0% in the fourth
quarter) in 2002 compared to 35.8% (43.3% in the fourth quarter) in 2001.
Excluding structured bulk transactions, refinance activity was 40.1% of
insurance written (47.0% in the fourth quarter) in 2002 compared to 37.5% of
insurance written (44.4% in the fourth quarter) in 2001. Persistency, or the
percentage of insurance in force remaining from one year prior, was 60.9% at
December 31, 2002, compared to 67.6% at December 31, 2001. The high level of
refinance activity and the resulting decrease in persistency is reflective of
the low interest rate environment that has been in place during the past year.
Low persistency results in an acceleration of the amortization of deferred
policy acquisition costs and a reduction in renewal premiums. The annualized
quarterly persistency run rate for the fourth quarter of 2002 was 32.1% compared
to 40.8% for the fourth quarter of 2001.
The Company defines persistency as the percentage of insurance in force
remaining from 12 months prior. Run off, defined as cancelled or terminated
policies, of production originated during the past 12 months is not considered
in the Company's calculation of persistency. The Company calculates persistency
48
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
by determining the run off over the prior 12 months of each individual policy
year (exclusive of current year production). This method of calculating
persistency may vary from that of other mortgage insurers. The Company believes
that its calculation presents an accurate measure of the percentage of insurance
in force remaining from 12 months prior. The Company's current method of
calculating persistency is consistent with the methodology used by the Company
in prior years.
Net investment income for 2002 was $16.1 million, a 9.0% increase over
$14.8 million in 2001. This increase is the result of growth in the average
balance of invested assets by $48.9 million to $301.4 million for the year ended
December 31, 2002, from $252.5 million for 2001. The growth in invested assets
is attributable to normal operating cash flow. The pre-tax yield on average
invested assets decreased to 5.3% for 2002 compared to 5.8% for 2001, reflecting
the current low interest rate environment for new money investments and the
disposal of a number of higher yielding corporate bonds with lower credit
quality during the past twelve months to enhance the overall quality of the
portfolio. The portfolio's tax-equivalent yield-to-maturity was 7.9% at December
31, 2002, versus 8.0% at December 31, 2001. Based on fair value, approximately
81% and 72% of the Company's fixed maturity portfolio at December 31, 2002 and
2001, respectively, was composed of state and municipal tax-preferred
securities. At December 31, 2002, based on fair value, approximately 95% of the
Company's fixed maturity portfolio was either a U.S. government or U.S. agency
obligation or was rated investment grade by at least one nationally recognized
securities rating organization compared to approximately 93% of the Company's
fixed maturity portfolio at December 31, 2001.
The Company actively monitors investment securities considered to be at
risk for impairment. When the Company determines that a decline in the value of
a security below its amortized cost is other-than-temporary, an impairment loss
has occurred. In the event of impairment, the Company writes down the cost basis
of the security to its fair value and recognizes a realized loss for the amount
of the writedown. Net realized losses of $2.5 million during 2002 included
impairment writedowns of approximately $2.0 million on securities held in the
Company's portfolio. The net realized gain of $154,000 during the fourth quarter
of 2002 included approximately $403,000 of impairment writedowns. The writedowns
primarily involved securities in the telecommunications and technology sectors
and, to a lesser degree, the airline, energy, electronic manufacturing, and
textile manufacturing industries.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 55.9% in 2002 to $14.1 million from $9.0 million in 2001. The rise
reflects an increase in paid losses and delinquent loans as the Company's
insurance in force grows and the condition of the economy remains weak. Net paid
losses and loss adjustment expenses increased to $10.7 million during 2002 from
$6.0 million during 2001. Reported delinquent loans totaled 2,379 at December
31, 2002, compared to 1,420 at December 31, 2001, an increase of 67.5%. The
delinquency inventory count includes all reported delinquencies that are three
or more payments in arrears at the reporting date and all reported delinquencies
49
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
that were previously three or more payments in arrears and have not made
payments to the current due date. Reserves are established for all insured loans
reported as delinquent to the Company by the loan servicer. The Company's loss
ratio (the ratio of net incurred losses to net earned premiums) was 13.4% for
2002 compared to 10.7% for 2001. The loss ratio was 15.4% for the fourth quarter
of 2002 and 13.2% for the fourth quarter of 2001.
As of December 31, 2002, approximately 83% of the Company's insurance in
force was originated in the last 36 months. Management believes, based upon its
experience and industry data, that claims incidence for it and other private
mortgage insurers is generally highest in the third through sixth years after
loan origination. Although the claims experience on insurance written in
previous years has been quite favorable, management does not expect losses to
remain at the low levels currently reported. The Company expects its incurred
losses to increase as a greater amount of its insurance in force reaches its
anticipated highest claim frequency years. Furthermore, changes in the economic
environment could accelerate paid and incurred loss development. Due to the
inherent uncertainty of future premium levels, losses, economic conditions, and
other factors that affect earnings, it is difficult to predict with any degree
of certainty the impact of such higher claim frequencies on future earnings.
Amortization of deferred policy acquisition costs increased by 17.3% to
$13.7 million in 2002 from $11.7 million for 2001. The increase in amortization
reflects growth in deferred policy acquisition costs related to the growth of
the Company's insurance in force and accelerated amortization due to higher
cancellations from refinance activity in 2002. The Company's model calculates
the amortization of deferred policy acquisition costs separately for each book
year. The model accelerates the amortization of deferred policy acquisition
costs through a dynamic adjustment when persistency for a book year is lower
than a historical baseline level in order to match the amortization expense with
the life of the policies on which the acquisition costs were originally
deferred. Low persistency levels during the past two years resulted in
additional amortization of deferred policy acquisition costs through dynamic
adjustments totaling $2.6 million in 2002 and $2.1 million in 2001.
Other operating expenses increased 26.3% to $22.9 million for 2002 from
$18.1 million for 2001. This increase in expenses is primarily attributable to
personnel, technology amortization, and equipment and software costs required to
support the Company's increased levels of production, product development,
system enhancements, and geographic expansion. The expense ratio (ratio of the
amortization of deferred policy acquisition costs and other operating expenses
to net premiums written) for 2002 was 34.6% compared to 35.1% for 2001.
The effective tax rate was 30.9% for both 2002 and 2001. Management expects
the Company's effective tax rate to remain at about the same annual rate as long
as yields from new funds invested in tax-preferred securities remain favorable
in relation to fully taxable securities.
50
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
2001 COMPARED TO 2000
Net income for 2001 increased 17.9% to $41.3 million from $35.0 million in
2000. This improvement was led by a 17.4% increase in earned premiums and a
16.8% increase in net investment income. Net income for 2001 also included the
receipt of a nonrecurring payment of approximately $1.9 million related to the
voluntary cancellation of an excess of loss reinsurance contract. The payment
was reported as "other income" in the first quarter of 2001.
Net income per share on a diluted basis increased 15.8% to $2.95 for 2001
from $2.55 per share for 2000. Operating earnings per share were $2.94 for 2001
compared to $2.54 for 2000, an increase of 15.8%. Operating earnings per share
exclude approximately $297,000 of net realized investment gains in 2001 and
$286,000 in 2000. Operating earnings in 2001 include approximately $0.09 per
share related to the nonrecurring payment.
Insurance written for 2001 was $13.3 billion compared to $4.4 billion in
2000, an increase of 199%. Traditional flow production was $8.5 billion in 2001
compared to $4.4 billion in 2000, an increase of 92.6%. The increase in
insurance written from traditional flow production was driven primarily by new
and expanding relationships with national lenders, strong demand for
risk-sharing arrangements, and a lower interest rate environment which increased
refinance activity and overall mortgage origination activity. Insurance written
for 2001 also included approximately $4.7 billion attributable to structured
bulk transactions. For the comparable period of 2000, there was no insurance
written attributable to these transactions. According to industry data, Triad's
national market share of net new primary insurance written increased to 3.6% for
all of 2001 from 2.7% for all of 2000. Total direct insurance in force reached
$21.7 billion at December 31, 2001, compared to $15.1 billion at December 31,
2000, an increase of 43.7%.
Total direct premiums written were $95.6 million for 2001, an increase of
24.3% compared to $76.9 million for 2000. Net premiums written increased by
18.2% to $85.0 million in 2001 from $71.9 million for 2000. Earned premiums
increased 17.4% to $84.4 million for 2001 from $71.8 million for 2000. This
growth in written and earned premium resulted from record levels of insurance
written offset by the impact of a declining persistency rate due to a high level
of mortgage refinancings.
Growth in direct premiums written was partially offset by the increase in
ceded premiums written. Driven primarily by increases in risk-sharing
arrangements and also by excess of loss reinsurance, ceded premiums written
increased 111% to $10.6 million from $5.0 million in 2000. The Company's premium
cede rate (the ratio of ceded premiums written to direct premiums written) was
11.0% for 2001 compared to 6.5% for 2000. Approximately 37.3% of insurance
written (57.9% excluding bulk transactions) during 2001 was subject to captive
mortgage reinsurance and other risk-sharing arrangements compared to 42.9% of
insurance written in 2000.
Refinance activity was 35.8% of insurance written in 2001 compared to 13.2%
in 2000. Persistency, or the amount of insurance in force remaining from one
year prior, was 67.6% at December 31, 2001, compared to 82.6% at December 31,
2000. The increase in refinance activity and the decrease in persistency were
reflective of the low interest rate environment during 2001.
Net investment income for 2001 was $14.8 million, a 16.8% increase over
$12.6 million in 2000. This increase was the result of growth in the average
balance of invested assets by $40.5 million to $252.5 million for 2001, from
51
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
$212.0 million for 2000. The growth in invested assets was attributable to
normal operating cash flow. The pre-tax yield on average invested assets
decreased to 5.8% for 2001 as compared to 6.0% for all of 2000, reflecting the
low interest rate environment during 2001. The portfolio's tax-equivalent
yield-to-maturity was 8.0% at December 31, 2001, versus 8.2% at December 31,
2000. Based on fair value, approximately 72% of the Company's fixed maturity
portfolio at December 31, 2001, was composed of state and municipal
tax-preferred securities as compared to approximately 70% at December 31, 2000.
At December 31, 2001, based on fair value, approximately 93% of the Company's
fixed maturity portfolio was either a U.S. government or U.S. agency obligation
or was rated investment grade by at least one nationally recognized securities
rating organization compared to approximately 92% of the Company's fixed
maturity portfolio at December 31, 2000.
In the first quarter of 2001, the Company recognized a nonrecurring
incentive payment of approximately $1.9 million related to voluntary
cancellation of an excess of loss reinsurance contract maintained by the Company
with a non-affiliated reinsurer. This payment was accounted for as "other
income". The Company also established excess of loss reinsurance coverage
through a separate third-party reinsurer in the first quarter of 2001 under
terms similar to the cancelled agreement.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 18.9% in 2001 to $9.0 million from $7.6 million in 2000. This rise
reflected increased levels of insurance in force. The Company's loss ratio was
10.7% for 2001 compared to 10.6% for 2000. As of December 31, 2001, there were
no incurred losses related to the Company's bulk business.
Approximately 76% of the Company's insurance in force at December 31, 2001,
was originated in the prior 36 months.
Amortization of deferred policy acquisition costs increased by 42.6% to
$11.7 million in 2001 from $8.2 million for 2000. The increase in amortization
reflected growth in deferred policy acquisition costs related to the expansion
of the Company's insurance in force and accelerated amortization due to higher
cancellations from refinance activity in 2001.
Other operating expenses increased 13.3% to $18.1 million for 2001 from
$16.0 million for 2000. This increase in expenses was primarily attributable to
personnel, technology amortization, and equipment costs required to support the
Company's product development, system enhancements, and expanded production. The
expense ratio for 2001 was 35.1% compared to 33.7% for 2000.
The effective tax rate for 2001 was 30.9% compared to 30.3% in 2000. The
increase in the effective tax rate was due to a lower percentage of pre-tax
income being generated from tax-preferred securities as well as the recognition,
on a taxable basis, of previously deferred income.
52
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating funds consist primarily of premiums
written and investment income. Operating cash flow is applied primarily to the
payment of claims, interest, expenses, and taxes.
The Company generated positive cash flow from operating activities for 2002
of $47.0 million compared to $43.8 million for 2001 and $32.7 million for 2000.
The increase in cash flow from operating activities in 2002 reflects the growth
in premium and investment income and the effects of tax benefits resulting from
the exercise of stock options offset partially by the increase in underwriting
expenses and losses paid. The Company's business does not routinely require
significant capital expenditures other than for enhancements to its computer
systems and technological capabilities. Positive cash flows are invested pending
future payments of claims and expenses. Cash flow shortfalls, if any, could be
funded through sales of short-term investments and other investment portfolio
securities.
The parent company's cash flow is dependent on interest income and payments
from Triad including management fees and interest payments under surplus notes.
The Illinois Insurance Department permits expenses of the parent company to be
reimbursed by Triad in the form of management fees. Payment of dividends is also
permitted, although none have been paid to date.
The insurance laws of the State of Illinois impose certain restrictions on
dividends that Triad can pay the parent company. These restrictions, based on
statutory accounting practices, include requirements that dividends may be paid
only out of statutory earned surplus and that limit the amount of dividends that
may be paid without prior approval of the Illinois Insurance Department.
Consolidated invested assets were $344.6 million at December 31, 2002,
compared to $277.2 million at December 31, 2001. Fixed maturity securities and
equity securities classified as available-for-sale totaled $309.3 million at
December 31, 2002. Net unrealized investment gains were $13.7 million on fixed
maturity securities and net unrealized investment losses were $458,000 on equity
securities at December 31, 2002. Based on fair value, the fixed maturity
portfolio consisted of approximately 81% municipal securities, 15% corporate
securities, and 4% U.S. government obligations at December 31, 2002. At December
31, 2001, the fixed maturity portfolio consisted of approximately 72% municipal
securities, 23% corporate securities, and 5% U.S. government obligations. The
weighted-average duration to maturity of the Company's fixed maturity portfolio
was 12.1 years at December 31, 2002, compared to 11.2 years at December 31,
2001. This increase in duration was due to shifts in the portfolio from
corporate securities to municipal securities, where the yield curve was more
attractive on longer duration investments.
53
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
Fixed maturity securities represented approximately 87% of the Company's
invested assets at December 31, 2002, and the fair value of these fixed rate
securities generally bears an inverse relationship to changes in prevailing
market interest rates. The Company's long-term debt bears interest at a fixed
rate of 7.9% per annum, and as a result, the fair value of this debt is
sensitive to changes in prevailing interest rates. A 10% relative increase or
decrease in market interest rates that affect the Company's financial
instruments would not have a material impact on earnings during the next fiscal
year, and would not materially affect the fair value of the Company's financial
instruments.
The Company's loss and loss adjustment expense reserves increased to $21.4
million at December 31, 2002, compared to $18.0 million at December 31, 2001.
Loss and loss adjustment expense reserves are established when notices of
default on insured mortgage loans are received. Reserves also are established
for estimated losses incurred on notices of default not yet reported by the
lender. Consistent with industry practices, the Company does not establish loss
reserves for future claims on insured loans that are not currently in default.
The growth in loss reserves is the result of the increase in reported defaults
and the maturing of the Company's risk in force. The Company expects loss
reserves to continue to grow, reflecting the growth and aging of its insurance
in force. Including bulk loans, the Company's delinquency ratio (the ratio of
delinquent insured loans to total insured loans) was 1.25% at December 31, 2002,
compared to 0.89% at December 31, 2001. The Company's delinquency ratios for
traditional flow and bulk loans were 1.23% and 1.38%, respectively, at December
31, 2002. There were no reported delinquencies for bulk loans at December 31,
2001.
Reserves are established by management using estimated claim rates
(frequency) and claim amounts (severity) to estimate ultimate losses. The
reserving process incorporates numerous factors in a formula that gives effect
to current economic conditions and profiles delinquencies by such factors as
policy year, geography, chronic late payment characteristics, and the number of
months the policy has been in default. Because the estimate for loss reserves is
sensitive to the estimates of claims frequency and severity, management performs
sensitivity analyses to test the reasonableness of the best estimate generated
by the loss reserve process. These sensitivity analyses allow management to use
alternative assumptions related to claims frequency and claims severity to
develop a range of reasonably possible loss reserve outcomes that can be used to
challenge the best estimate. The loss reserve estimation process and the
sensitivity analyses support the reasonableness of the best estimate of loss
reserves recorded as a liability in the financial statements. Management
periodically reviews the loss reserve process in order to improve its estimate
of ultimate losses on loans currently in default. Adjustments to reserve
estimates are reflected in the financial statements in the periods in which the
adjustments are made.
Triad cedes business to captive reinsurance subsidiaries of certain
mortgage lenders ("captives") primarily under excess of loss reinsurance
agreements. Generally, reinsurance recoverables on loss reserves and unearned
premiums ceded to these captives are backed by trust funds or letters of credit.
54
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
Total stockholders' equity increased to $309.4 million at December 31,
2002, from $246.1 million at December 31, 2001. This increase resulted primarily
from net income of $45.1 million, an increase in net unrealized gains on
invested assets classified as available-for-sale of $7.7 million (net of income
tax), and additional paid-in-capital of $10.2 million resulting from the
exercise of employee stock options and the related tax benefit.
Triad's total statutory policyholders' surplus increased to $112.9 million
at December 31, 2002, from $105.3 million at December 31, 2001. Triad's
statutory earned surplus increased to $29.2 million at December 31, 2002, from
$21.6 million at December 31, 2001. The increase in Triad's statutory
policyholders' surplus and statutory earned surplus resulted, primarily, from
statutory net income of $61.8 million which exceeded the net increase in the
statutory contingency reserve of $51.2 million and the increase in the statutory
deferred tax liability of $3.0 million. The balance in the statutory contingency
reserve was $245.0 million at December 31, 2002, compared to $193.7 million at
December 31, 2001.
Triad's ability to write insurance depends on the maintenance of its
financial strength ratings and the adequacy of its capital in relation to risk
in force. A significant reduction of capital or a significant increase in risk
may impair Triad's ability to write additional insurance. A number of states
also generally limit Triad's risk-to-capital ratio to 25-to-1. As of December
31, 2002, Triad's risk-to-capital ratio was 15.5-to-1 as compared to 15.0-to-1
at December 31, 2001, and 11.1-to-1 for the industry as a whole at December 31,
2001, the latest industry data available.
Triad is rated "AA" by both Standard & Poor's Ratings Services and Fitch
Ratings and "Aa3" by Moody's Investors Service.
Fannie Mae is in the process of revising its approval requirements for
mortgage insurers. The new requirements, which have not yet been finalized,
would require prior approval by Fannie Mae for many of Triad's activities and
new products, allow for other approved types of mortgage insurers rated less
than "AA," and give Fannie Mae increased rights to revise the eligibility
standards of mortgage insurers. The final form the eligibility guidelines will
take is unknown at this time, but new guidelines, if issued, could have an
adverse effect on the Company.
The Office of Federal Housing Enterprise Oversight (OFHEO) issued its
risk-based capital rules for Fannie Mae and Freddie Mac in the first quarter of
2002. The regulation provides capital guidelines for Fannie Mae and Freddie Mac
in connection with their use of various types of credit protection
counterparties including a more preferential capital credit for insurance from a
"AAA" rated private mortgage insurer than for insurance from a "AA" rated
private mortgage insurer. The phase-in period for the new rules is ten years.
The Company does not believe the new rules had an adverse impact in 2002 nor
55
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
that the new rules will have a significant adverse impact on the Company in the
future. However, if the new capital guidelines result in future changes to the
preferences of Fannie Mae and Freddie Mac regarding their use of the various
types of credit enhancements or their choice of mortgage insurers based on their
credit rating, the Company's financial condition could be significantly harmed.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Management's Discussion and Analysis and this Report contain
forward-looking statements relating to future plans, expectations, and
performance which involve various risks and uncertainties, including but not
limited to the following: interest rates may increase or decrease from their
current levels; housing transactions and mortgage insurance may decrease for
many reasons including changes in interest rates or economic conditions; the
Company's market share may change as a result of changes in underwriting
criteria or competitive products or rates; the amount of insurance written could
be adversely affected by changes in federal housing legislation, including
changes in the Federal Housing Administration loan limits and coverage
requirements of Freddie Mac and Fannie Mae; the Company's financial condition
and competitive position could be affected by legislation impacting the mortgage
guaranty industry specifically and the financial services industry in general;
rating agencies may revise methodologies for determining the Company's financial
strength ratings and may revise or withdraw the assigned ratings at any time;
decreases in persistency, which are affected by loan refinancings in periods of
low interest rates, may have an adverse effect on earnings; the amount of
insurance written and the growth in insurance in force or risk in force as well
as the performance of the Company may be adversely impacted by the competitive
environment in the private mortgage insurance industry, including the type,
structure, and pricing of products and services offered by the Company and its
competitors; if the Company fails to properly underwrite mortgage loans under
contract underwriting service agreements, the Company may be required to assume
the costs of repurchasing those loans; with consolidation occurring among
mortgage lenders and the Company's concentration of insurance in force generated
through relationships with significant lender customers, the loss of a
significant customer may have an adverse effect on earnings; the Company's
performance may be impacted by changes in the performance of the financial
markets and general economic conditions; economic downturns in regions where
Triad's risk is more concentrated could have a particularly adverse effect on
Triad's financial condition and loss development; new OFHEO risk-based capital
rules could severely limit the Company's ability to compete against various
types of credit protection counterparties, including "AAA" rated private
mortgage insurers; changes in the eligibility guidelines of Fannie Mae or
Freddie Mac could have an adverse effect on the Company.
Accordingly, actual results may differ from those set forth in the
forward-looking statements. Attention also is directed to other risk factors set
forth in documents filed by the Company with the Securities and Exchange
Commission.
56
ITEM 7 (A). QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS.
- ----------- ------------------------------------------------------------
The response to this item is submitted on page 54 of this report under the
section titled "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
- ------- --------------------------------------------
The Financial Statements and Supplementary Data are presented in a separate
section of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
- ------- ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
---------------------------------------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
- -------- ---------------------------------------------------
Information regarding directors and nominees for directors of the Company
is included in the Company's Proxy Statement for the 2003 Annual Meeting of
Stockholders, and is hereby incorporated by reference.
For information regarding the executive officers of the Company, reference
is made to the section entitled "Executive Officers" in Part I, Item 1 of this
Report.
ITEM 11. EXECUTIVE COMPENSATION.
- ------- ----------------------
This information is included in the Company's Proxy Statement for the 2003
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
- -------- ---------------------------------------------------------------
This information is included in the Company's Proxy Statement for the 2003
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
- -------- -----------------------------------------------
This information is included in the Company's Proxy Statement for the 2003
Annual Meeting of Stockholders, and is hereby incorporated by reference.
57
ITEM 14. CONTROLS AND PROCEDURES
- -------- -----------------------
Within the 90 days prior to the filing date of this report the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures pursuant to the Exchange Act of 1934, Rule 13a-15. The
evaluation was conducted under the supervision and with the participation of
management, including the Chief Executive Officer (CEO) and Chief Financial
Officer (CFO). Based on that evaluation, management, including the CEO and CFO,
concluded that the Company's disclosure controls and procedures were effective.
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in the Company's reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect the Company's internal
controls subsequent to the date management carried out its evaluation.
58
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT
- ------- SCHEDULES, AND REPORTS ON FORM 8-K.
-----------------------------------
(a)(1) and (2) The response to this portion of Item 15 is submitted as
a separate section of this report.
(a)(3) Listing of Exhibits - The response to this portion of Item 15
is submitted as a separate section of this report.
(b)Reports on Form 8-K.
No reports on form 8-K were filed during the quarter ended
December 31, 2002.
(c) Exhibits - The response to this portion of Item 15 is submitted
as a separate section of this report.
(d) Financial Statement Schedules - The response to this portion of
Item 15 is submitted as a separate section of this report.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 21st day of
March, 2003.
By /s/ Darryl W. Thompson
-------------------------
Darryl W. Thompson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the 21st day of March, 2003 by the following
persons on behalf of the Registrant in the capacities indicated.
SIGNATURE TITLE
/s/ William T. Ratliff, III Chairman of the Board
---------------------------
William T. Ratliff, III
/s/ Darryl W. Thompson President, Chief Executive Officer, and
---------------------------- Director
Darryl W. Thompson
/s/ Ron D. Kessinger Executive Vice President and Chief Financial
--------------------------- Officer
Ron D. Kessinger
/s/ Michael R. Oswalt Senior Vice President, Treasurer, and
--------------------------- Principal Accounting Officer
Michael R. Oswalt
/s/ David W. Whitehurst Director
---------------------------
David W. Whitehurst
/s/ Robert T. David Director
---------------------------
Robert T. David
/s/ Michael A. F. Roberts Director
---------------------------
Michael A. F. Roberts
60
Form 10-K
CERTIFICATIONS
I, Darryl W. Thompson, certify that:
1. I have reviewed this annual report on Form 10-K of Triad Guaranty
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
61
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 27, 2003
/s/Darryl W. Thompson
---------------------------
Darryl W. Thompson
President, Chief Executive Officer
62
Form 10-K
CERTIFICATIONS
I, Ron D. Kessinger, certify that:
1. I have reviewed this annual report on Form 10-K of Triad Guaranty
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
63
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
March 27, 2003
/s/Ron D. Kessinger
-----------------------
Ron D. Kessinger
Executive Vice President and
Chief Financial Officer
64
Triad Guaranty Inc.
Certification of Periodic Financial Report
Pursuant to 18 U.S.C. Section 1350
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, each of the undersigned officers of Triad
Guaranty Inc. (the "Company") certifies that, to his knowledge, the Annual
Report on Form 10-K of the Company for the year ended December 31, 2002 fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and information contained in that Form 10-K fairly
presents, in all material respects, the financial condition and results of
operations of the Company.
Dated: March 27, 2003 /s/Darryl W. Thompson
----------------------
Darryl W. Thompson
President, Chief Executive Officer
Dated: March 27, 2003 /s/Ron D. Kessinger
-----------------------
Ron D. Kessinger
Executive Vice-President and
Chief Financial Officer
This certification is made solely for the purpose of 18 U.S.C. Section 1350
and not for any other purpose.
65
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 15(a)(1) and (2), (3), (c), and (d)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
INDEX TO EXHIBITS
CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
YEAR ENDED DECEMBER 31, 2002
TRIAD GUARANTY INC.
WINSTON-SALEM, NORTH CAROLINA
66
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(Item 15(a) 1 and 2)
CONSOLIDATED FINANCIAL STATEMENTS Page
--------------------------------- ----
Report of Independent Auditors..................................... 70
Consolidated Balance Sheets at December 31, 2002 and 2001.......... 71 - 72
Consolidated Statements of Income for each of the three
years in the period ended December 31, 2002...................... 73
Consolidated Statements of Changes in Stockholders'
Equity for each of the three years in
the period ended December 31, 2002............................... 74
Consolidated Statements of Cash Flows for each of
the three years in the period ended December 31, 2002............ 75
Notes to Consolidated Financial Statements......................... 76 - 95
FINANCIAL STATEMENT SCHEDULES
-----------------------------
Schedules at and for each of the three years in the period ended
December 31, 2002
Schedule I - Summary of Investments - Other Than
Investments in Related Parties..................... 96
Schedule II - Condensed Financial Information of Registrant..... 97 - 101
Schedule IV - Reinsurance....................................... 102
All other schedules are omitted since the required information is not present or
is not present in amounts sufficient to require submission of the schedules, or
because the information required is included in the consolidated financial
statements and notes thereto.
67
Index To Exhibits
(Item 15(a) 3)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------ ----------------------
3.1 Certificate of Incorporation of the Registrant, as amended (5)
(Exhibit 3.1)
*3.2 By-Laws of the Registrant as amended March 21, 2003 (Exhibit 3.2(c))
4.1 Form of Common Stock certificate (1) (Exhibit 4(a))
4.2 Indenture Between Triad Guaranty Inc. and Banker's Trust Co.(6)
(Exhibit 4.2)
10.1 1993 Long-Term Stock Incentive Plan (1)(3) (Exhibit 10(a))
10.3 Agreement for Administrative Services among Triad Guaranty Insurance
Corporation and Collateral Investment Corp. and Collateral Mortgage,
Ltd. (1) (Exhibit 10(c))
10.4 Investment Advisory Agreement between Triad Guaranty Insurance
Corporation and Collateral Mortgage, Ltd. (1) (Exhibit 10(d))
10.6 Registration Agreement among the Registrant, Collateral Investment
Corp. and Collateral Mortgage, Ltd. (2) (Exhibit 10.6)
10.7 Employment Agreement between the Registrant and Darryl W. Thompson
(2)(3) (Exhibit 10.7)
10.10 Employment Agreement between the Registrant and Henry B. Freeman
(2)(3) (Exhibit 10.10)
10.11 Employment Agreement between the Registrant and Ron D. Kessinger
(2)(3) (Exhibit 10.11)
10.16 Economic Value Added Incentive Bonus Program (Senior Management) (4)
(Exhibit 10.16)
10.17 Amendment to Employment Agreement between the Registrant and Darryl
W. Thompson (3)(4) (Exhibit 10.17)
10.19 Amendment to Employment Agreement between the Registrant and Henry B.
Freeman (3)(4) (Exhibit 10.19)
10.20 Amendment to Employment Agreement between the Registrant and Ron D.
Kessinger (3)(4) (Exhibit 10.20)
10.21 Excess of Loss Reinsurance Agreement between Triad Guaranty Insurance
Corporation, Capital Mortgage Reinsurance Company, and Federal
Insurance Company. (7) (Exhibit 10.21)
68
10.22 Excess of Loss Reinsurance Agreement between Triad Guaranty Insurance
Corporation and Ace Capital Mortgage Reinsurance Company. (8)(Exhibit
10.22)
10.23 Employment Agreement between the Registrant and Earl F. Wall (3)(9)
(Exhibit 10.23)
10.24 Employment Agreement between the Registrant and Michael R. Oswalt
(3)(9) (Exhibit 10.24)
*10.25 Employment Agreement between the Registrant and Kenneth N. Lard (3)
(Exhibit 10.25)
*10.26 Employment Agreement between the Registrant and Kenneth C. Foster
(3) (Exhibit 10.26)
21.1 Subsidiaries of the Registrant (7) (Exhibit 21.1)
*23.1 Consent of Ernst & Young LLP (Exhibit 23.1)
- -----------------
* Filed Herewith.
(1) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Registration Statement on Form S-1 filed
October 22, 1993 and amendments thereto.
(2) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1993 Form 10-K.
(3) Denotes management contract or compensatory plan of arrangement required to
be filed as an exhibit to this report pursuant to Item 601 of Regulation
S-K.
(4) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1996 Form 10-K.
(5) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the June 30, 1997 Form 10-Q.
(6) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1997 Form 10-K.
(7) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1999 Form 10-K.
(8) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 2000 Form 10-K.
(9) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the June 30, 2002 Form 10-Q.
69
Report of Independent Auditors
Board of Directors
Triad Guaranty Inc.
We have audited the accompanying consolidated balance sheets of Triad Guaranty
Inc. and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Triad Guaranty
Inc. and subsidiaries at December 31, 2002 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.
/s/ERNST & YOUNG LLP
Greensboro, North Carolina
January 22, 2003
70
Triad Guaranty Inc.
Consolidated Balance Sheets
December 31
2002 2001
---------------------------------
(In thousands, except share data)
Assets
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost:
2002 - $284,737; 2001 - $245,662) $ 298,470 $ 245,985
Equity securities (cost:
2002 - $11,266; 2001 - $11,308) 10,808 12,476
Short-term investments 35,303 18,739
---------------------------------
344,581 277,200
Cash 233 853
Real estate 1,561 162
Accrued investment income 3,088 3,196
Deferred policy acquisition costs 28,997 25,944
Property and equipment, at cost less accumulated
depreciation (2002 - $8,146; 2001 - $6,120) 9,533 11,170
Prepaid federal income tax 77,786 62,619
Reinsurance recoverable 396 5
Other assets 16,711 15,306
---------------------------------
Total assets $ 482,886 $ 396,455
=================================
See accompanying notes.
71
Triad Guaranty Inc.
Consolidated Balance Sheets
December 31
2002 2001
-----------------------------------
(In thousands, except share data)
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses $ 21,360 $ 17,991
Unearned premiums 8,539 7,650
Amounts payable to reinsurer 3,415 2,445
Current taxes payable 598 40
Deferred income taxes 94,241 74,773
Unearned ceding commission 1,386 2,324
Long-term debt 34,479 34,473
Accrued interest on debt 1,275 1,275
Accrued expenses and other liabilities 8,186 9,414
----------------------------------
Total liabilities 173,479 150,385
Commitments and contingencies (Notes 5, 7, and 14)
Stockholders' equity:
Preferred stock, par value $.01 per share -
authorized 1,000,000 shares, no shares
issued and outstanding - -
Common stock, par value $.01 per share -
authorized 32,000,000 shares, issued and
outstanding 14,159,601 shares at December 31,
2002, and 13,691,672 at December 31, 2001
142 137
Additional paid-in capital 80,169 69,058
Accumulated other comprehensive income, net of
income tax liability of $4,646 at
December 31, 2002, and $521 at December 31, 2001 8,634 975
Deferred compensation (658) (117)
Retained earnings 221,120 176,017
----------------------------------
Total stockholders' equity 309,407 246,070
----------------------------------
Total liabilities and stockholders' equity $ 482,886 $ 396,455
==================================
72
Triad Guaranty Inc.
Consolidated Statements of Income
Year ended December 31
2002 2001 2000
--------------------------------------------------
(In thousands, except share data)
Revenue:
Premiums written:
Direct $ 124,214 $ 95,551 $ 76,867
Assumed 3 4 8
Ceded (18,348) (10,557) (4,993)
--------------------------------------------------
Net premiums written 105,869 84,998 71,882
Change in unearned premiums (802) (642) (39)
--------------------------------------------------
Earned premiums 105,067 84,356 71,843
Net investment income 16,099 14,765 12,645
Net realized investment (losses) gains (2,519) 297 286
Other income 72 1,892 37
--------------------------------------------------
118,719 101,310 84,811
Losses and expenses:
Losses and loss adjustment expenses 14,064 9,020 7,562
Reinsurance recoveries (1) (1) 25
--------------------------------------------------
Net losses and loss adjustment expenses 14,063 9,019 7,587
Interest expense on debt 2,771 2,771 2,770
Amortization of deferred policy acquisition costs 13,742 11,712 8,211
Other operating expenses (net of acquisition costs
deferred) 22,900 18,136 16,008
--------------------------------------------------
53,476 41,638 34,576
--------------------------------------------------
Income before income taxes 65,243 59,672 50,235
Income taxes:
Current 667 187 15
Deferred 19,473 18,226 15,222
--------------------------------------------------
20,140 18,413 15,237
--------------------------------------------------
Net income $ 45,103 $ 41,259 $ 34,998
==================================================
Earnings per common and common equivalent share:
Basic $ 3.21 $ 3.05 $ 2.63
==================================================
Diluted $ 3.15 $ 2.95 $ 2.55
==================================================
Shares used in computing earnings per common
and common equivalent share:
Basic 14,060,420 13,545,725 13,321,901
==================================================
Diluted 14,331,581 13,977,435 13,726,088
==================================================
See accompanying notes.
73
Triad Guaranty Inc.
Consolidated Statements of Changes in Stockholders' Equity
(In thousands, except share data)
Accumulated
Additional Other
Common Paid-In Comprehensive Deferred Retained
Stock Capital Income Compensation Earnings Total
----------------------------------------------------------------------------------
Balance at December 31, 1999 $ 133 $ 61,972 $ (4,724) $ (69) $ 99,760 $ 157,072
Net income - - - - 34,998 34,998
Other comprehensive income - net of
tax:
Change in unrealized (loss) gain - - 7,075 - - 7,075
---------------
Comprehensive income 42,073
Issuance of 41,500 shares of common
stock under stock option plans 1 471 - - - 472
Tax effect of exercise of
non-qualified stock options - 130 - - - 130
Issuance of 7,000 shares of
restricted stock - 151 - (151) - -
Amortization of deferred
compensation - - - 85 - 85
---------------------------------------------------------------------------------
Balance at December 31, 2000 134 62,724 2,351 (135) 134,758 199,832
Net income - - - - 41,259 41,259
Other comprehensive income - net of
tax:
Change in unrealized gain - - (1,376) - - (1,376)
---------------
Comprehensive income 39,883
Issuance of 336,628 shares of
common stock under stock option
plans 3 2,871 - - - 2,874
Tax effect of exercise of
non-qualified stock options - 3,363 - - - 3,363
Issuance of 3,350 shares of
restricted stock - 100 - (100) - -
Amortization of deferred
compensation - - - 118 - 118
---------------------------------------------------------------------------------
Balance at December 31, 2001 137 69,058 975 (117) 176,017 246,070
Net income - - - - 45,103 45,103
Other comprehensive income - net of
tax:
Change in unrealized gain - - 7,659 - - 7,659
---------------
Comprehensive income 52,762
Issuance of 444,349 shares of
common stock under stock option
plans 5 5,684 - - - 5,689
Tax effect of exercise of
non-qualified stock options - 4,494 - - - 4,494
Issuance of 23,580 shares of
restricted stock - 933 - (933) - -
Amortization of deferred
compensation - - - 392 - 392
---------------------------------------------------------------------------------
Balance at December 31, 2002 $ 142 $ 80,169 $ 8,634 $ (658) $ 221,120 $ 309,407
=================================================================================
See accompanying notes.
74
Triad Guaranty Inc.
Consolidated Statements of Cash Flows
Year ended December 31
2002 2001 2000
------------------------------------------------
(In thousands)
Operating activities
Net income $ 45,103 $ 41,259 $ 34,998
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss and unearned premium reserves 4,258 3,720 338
Accrued expenses and other liabilities (2,624) 1,359 1,167
Current taxes payable 558 (45) 15
Amounts due to/from reinsurer 492 1,082 931
Accrued investment income 108 (299) (305)
Policy acquisition costs deferred (16,795) (14,840) (11,119)
Amortization of policy acquisition costs 13,742 11,712 8,211
Net realized investment losses (gains) 2,519 (297) (286)
Provision for depreciation 2,778 2,246 859
Accretion of discount on investments (4,601) (3,128) (1,578)
Deferred income taxes 19,473 18,226 15,222
Prepaid federal income taxes (15,167) (13,244) (13,959)
Unearned ceding commission (938) 842 1,081
Other assets (1,318) (4,819) (2,993)
Other operating activities (636) 56 136
------------------------------------------------
Net cash provided by operating activities 46,952 43,830 32,718
Investing activities
Securities available-for-sale:
Purchases - fixed maturities (94,889) (76,932) (51,835)
Sales - fixed maturities 59,696 36,576 23,280
Purchases - equities (2,160) (4,999) (1,663)
Sales - equities 1,797 3,899 5,608
Net change in short-term investments (16,564) (1,727) (3,104)
Purchases of property and equipment (1,141) (4,181) (4,179)
------------------------------------------------
Net cash used in investing activities (53,261) (47,364) (31,893)
Financing activities
Proceeds from exercise of stock options 5,689 2,874 472
-----------------------------------------------
Net cash provided by financing activities 5,689 2,874 472
Net change in cash (620) (660) 1,297
Cash at beginning of year 853 1,513 216
-----------------------------------------------
Cash at end of year $ 233 $ 853 $ 1,513
===============================================
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage
Guaranty Tax and Loss Bonds $ 16,024 $ 13,270 $ 13,959
Interest 2,765 2,765 2,765
See accompanying notes.
75
Triad Guaranty Inc.
Notes to Consolidated Financial Statements
December 31, 2002
1. ACCOUNTING POLICIES
NATURE OF BUSINESS
Triad Guaranty Inc. (the "Company") is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"),
provides private mortgage insurance coverage in the United States to mortgage
lenders or investors to protect the lender or investor against loss from
defaults on low down payment residential mortgage loans.
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States,
which vary in some respects from statutory accounting practices which are
prescribed or permitted by the various insurance departments.
CONSOLIDATION
The consolidated financial statements include the amounts of Triad Guaranty Inc.
and its wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad")
and Triad's wholly-owned subsidiaries, Triad Guaranty Assurance Corporation
("TGAC") and Triad Re Insurance Corporation ("Triad Re"). All significant
intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
INVESTMENTS
Securities classified as "available-for-sale" are carried at fair value and
unrealized gains and losses on such securities, net of tax, are reported as a
separate component of accumulated other comprehensive income. The Company does
not have any securities classified as "held-to-maturity" or "trading."
76
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
Fair value generally represents quoted market value prices for securities traded
in the public market or prices analytically determined using bid or closing
prices for securities not traded in the public marketplace. Realized investment
gains or losses are determined on a specific identification basis. The Company
evaluates its investments regularly to determine whether there are declines in
value that are other-than-temporary. When the Company determines that a security
has experienced an other-than-temporary impairment, the impairment loss is
recognized as a realized investment loss. Short-term investments are defined as
short-term, highly liquid investments both readily convertible to known amounts
of cash and having maturities of twelve months or less upon acquisition by the
Company.
The Company writes covered call options on certain equity securities it owns as
a yield enhancement vehicle. Call options convey to the option holder the right
to buy (call) a certain stock at or before a specified date for a contracted
price (strike price) from the Company. The contract can expire without being
exercised in the event that the price of the underlying stock is below the
strike price. In this case, the fee received for granting the option is
recognized as a realized gain. The Company has no credit risk related to these
covered call options. The Company's financial risk in this activity is limited
to the increase of the market price of the security in excess of the sum of the
option's strike price and the fee received for the option. The options are
carried at fair value as other liabilities on the accompanying Consolidated
Balance Sheets, with changes in the fair value of these options reported as
realized gains or losses. The liability recorded for these options was $10,800
and $145,500 at December 31, 2002 and 2001, respectively.
DEFERRED POLICY ACQUISITION COSTS
The costs of acquiring new business, principally commissions and certain policy
underwriting and issue costs, which vary with and are primarily related to the
production of new business, are deferred. Amortization of such policy
acquisition costs is charged to expense in proportion to premium revenue
recognized over the estimated policy life. The Company reviews the persistency
of policies in force and makes appropriate adjustments to reflect policy
cancellations.
77
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and is depreciated principally on a
straight-line basis over the estimated useful lives, generally three to five
years, of the depreciable assets. Property and equipment primarily consists of
computer hardware and software and furniture and equipment.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Reserves are provided for the estimated costs of settling claims in respect of
loans reported to be in default and estimates of loans in default which have not
been reported to the Company. Consistent with industry accounting practices, the
Company does not establish loss reserves for future claims on insured loans that
are not currently in default. Loss reserves are established by management using
historical experience and by making various assumptions and judgments about
claim rates (frequency) and claim amounts (severity) to estimate ultimate losses
to be paid on loans in default. The Company's reserving methodology gives effect
to current economic conditions and profiles delinquencies by such factors as
age, policy year, geography, and chronic late payment characteristics. The
estimates are continually reviewed and, as adjustments to these liabilities
become necessary, such adjustments are reflected in current operations.
REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. Reinsurance premiums, loss
reimbursement, and reserves related to reinsurance business are accounted for on
a basis consistent with that used in accounting for the original policies issued
and the terms of the reinsurance contracts. The Company may receive a ceding
commission in connection with ceded reinsurance. If so, the ceding commission is
earned on a monthly pro rata basis in the same manner as the premium and is
recorded as a reduction of other operating expenses.
78
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets, net of a valuation
allowance, and deferred tax liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Triad purchases ten-year non-interest bearing United States Mortgage Guaranty
Tax and Loss Bonds ("Tax and Loss Bonds") in lieu of paying federal income
taxes. Purchases of these Tax and Loss Bonds are treated as prepaid federal
income taxes because the payment for Tax and Loss Bonds is essentially a
prepayment of federal income taxes that will become due in ten years when the
Tax and Loss Bonds mature. Current income tax expense is primarily associated
with the maturing of a portion of Triad's Tax and Loss Bonds.
INCOME RECOGNITION
The Company writes policies that are guaranteed renewable contracts at the
borrower's option on single premium, annual premium, and monthly premium bases.
The Company does not have the option to reunderwrite these contracts. Premiums
written on annual policies are earned on a monthly pro rata basis. Single
premium policies covering more than one year are amortized over the estimated
policy life in accordance with the expiration of risk. Premiums written on a
monthly basis generally are earned when received.
SIGNIFICANT CUSTOMERS
Approximately 11 percent of the Company's revenue in 2002 was from a single
customer. No single customer accounted for 10 percent or more of the Company's
revenue in 2001 or 2000.
79
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS
The Company grants stock options to employees and directors for a fixed number
of shares with an exercise price equal to or greater than the fair value of the
shares at the date of grant. The Company accounts for stock option grants using
the intrinsic value method prescribed in Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees", and accordingly, recognizes no
compensation expense for the stock option grants.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Had compensation
expense for stock options been recognized using the fair value method on the
grant date, net income and earnings per share on a pro forma basis would have
been (in thousands, except for earnings per share information):
2002 2001 2000
-------------------------------------
Net income - as reported $ 45,103 $ 41,259 $ 34,998
Net income - pro forma $ 44,261 $ 40,375 $ 34,107
Earnings per share - as reported:
Basic $ 3.21 $ 3.05 $ 2.63
Diluted $ 3.15 $ 2.95 $ 2.55
Earnings per share - pro forma:
Basic $ 3.15 $ 2.98 $ 2.56
Diluted $ 3.09 $ 2.89 $ 2.48
EARNINGS PER SHARE
Basic and diluted earnings per share are based on the weighted-average daily
number of shares outstanding. For diluted earnings per share, the denominator
includes the dilutive effect of employee stock options on the weighted-average
shares outstanding. There are no other reconciling items between the denominator
used in basic earnings per share and diluted earnings per share. The numerator
used in basic earnings per share and diluted earnings per share is the same for
all periods presented.
80
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME
The only element of other comprehensive income applicable to the Company is
changes in unrealized gains and losses on securities classified as
available-for-sale, which is displayed in the following table, along with
related tax effects (in thousands):
2002 2001 2000
---------------------------------------
Unrealized gains (losses) arising
during the period, before taxes $ 9,265 $ (1,820) $ 11,170
Income taxes (3,243) 637 (3,909)
---------------------------------------
Unrealized gains (losses) arising
during the period,net of taxes 6,022 (1,183) 7,261
---------------------------------------
Less reclassification adjustment:
(Losses) gains realized in net income (2,519) 297 286
Income taxes 882 (104) (100)
---------------------------------------
Reclassification adjustment for
(losses) gains realized in net income (1,637) 193 186
---------------------------------------
Other comprehensive income $ 7,659 $ (1,376) $ 7,075
=======================================
RECLASSIFICATION
Certain amounts in the 2001 and 2000 Consolidated Statements of Cash Flows have
been reclassified to conform to the 2002 presentation. These reclassifications
have no effect on previously reported stockholders' equity, net income, or net
cash provided by operating activities.
81
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS
The amortized cost and the fair value of investments are as follows (in
thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------
At December 31, 2002
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 43,171 $ 3,131 $ 950 $ 45,352
U.S. Government 10,189 439 32 10,596
Mortgage-backed 167 19 - 186
State and municipal 231,210 11,610 484 242,336
-----------------------------------------------------------------
Total 284,737 15,199 1,466 298,470
Equity securities 11,266 733 1,191 10,808
-----------------------------------------------------------------
Total $ 296,003 $ 15,932 $ 2,657 $ 309,278
=================================================================
At December 31, 2001
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 55,464 $ 1,879 $ 2,329 $ 55,014
U.S. Government 12,164 546 65 12,645
Mortgage-backed 253 25 - 278
State and municipal 177,781 3,483 3,216 178,048
-----------------------------------------------------------------
Total 245,662 5,933 5,610 245,985
Equity securities 11,308 1,449 281 12,476
-----------------------------------------------------------------
Total $ 256,970 $ 7,382 $ 5,891 $ 258,461
=================================================================
82
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of investments in fixed maturity
securities, at December 31, 2002, are summarized by stated maturity as follows
(in thousands):
Available-for-Sale
-------------------------------
Fair
Amortized Cost Value
Maturity:
One year or less $ 3,997 $ 4,115
After one year through five years 16,158 17,000
After five years through ten years 33,800 35,366
After ten years 230,615 241,803
Mortgage-backed securities 167 186
--------------------------------
Total $ 284,737 $ 298,470
================================
Realized gains and losses on sales of investments are as follows (in thousands):
Year ended December 31
2002 2001 2000
---------------------------------------
Securities available-for-sale:
Fixed maturity securities:
Gross realized gains $ 1,833 $ 1,203 $ 226
Gross realized losses (3,948) (1,485) (2,255)
Equity securities:
Gross realized gains 15 940 2,561
Gross realized losses (576) (417) (402)
Covered call options:
Gross realized gains 189 113 163
Gross realized losses (32) (57) (7)
---------------------------------------
Net realized (losses) gains $ (2,519) $ 297 $ 286
=======================================
Net unrealized appreciation (depreciation) on fixed maturity securities changed
by $13,409,656, $(1,821,394), and $11,543,909 in 2002, 2001, and 2000,
respectively; the corresponding amounts for equity securities were $(1,625,907),
$(290,284), and $(665,174).
83
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS (CONTINUED)
Major categories of the Company's net investment income are summarized as
follows (in thousands):
Year ended December 31
2002 2001 2000
-----------------------------------------
Income:
Fixed maturities $ 15,809 $ 14,188 $ 11,755
Preferred stocks 438 468 490
Common stocks 179 157 230
Cash and short-term investments 270 495 635
-----------------------------------------
16,696 15,308 13,110
Expenses 597 543 465
-----------------------------------------
Net investment income $ 16,099 $ 14,765 $ 12,645
=========================================
At December 31, 2002 and 2001, investments with an amortized cost of $6,634,066
and $6,645,745, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
3. DEFERRED POLICY ACQUISITION COSTS
An analysis of deferred policy acquisition costs is as follows (in thousands):
Year ended December 31
2002 2001 2000
----------------------------------------
Balance at beginning of year $ 25,944 $ 22,816 $ 19,908
Acquisition costs deferred:
Sales compensation 6,291 5,929 5,219
Underwriting and issue expenses 10,504 8,911 5,900
----------------------------------------
16,795 14,840 11,119
Amortization of acquisition expenses 13,742 11,712 8,211
----------------------------------------
Net increase 3,053 3,128 2,908
----------------------------------------
Balance at end of year $ 28,997 $ 25,944 $ 22,816
========================================
84
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
4. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity for the reserve for losses and loss adjustment expenses for 2002, 2001,
and 2000 is summarized as follows (in thousands):
2002 2001 2000
----------------------------------
Reserve for losses and loss
adjustment expenses at January 1,
net of reinsurance recoverables $ 17,981 $ 14,976 $ 14,723
Incurred losses and loss adjustment
expenses net of reinsurance recoveries
(principally in respect of default
notices occurring in):
Current year 14,798 14,219 11,229
Redundancy on prior years (735) (5,200) (3,642)
----------------------------------
Total incurred losses and loss
adjustment expenses 14,063 9,019 7,587
Loss and loss adjustment expense
payments net of reinsurance recoveries
(principally in respect of default
notices occurring in):
Current year 508 286 574
Prior years 10,181 5,728 6,760
----------------------------------
Total loss and loss adjustment
expense payments 10,689 6,014 7,334
----------------------------------
Reserve for losses and loss
adjustment expenses at December 31,
net of reinsurance recoverables of
$5, $10, and $11 in 2002, 2001,
and 2000, respectively $ 21,355 $ 17,981 $ 14,976
==================================
The foregoing reconciliation shows a redundancy in reserves has emerged for each
of the years presented. These redundancies resulted principally from settling
case-basis reserves on default notices occurring in prior years for amounts less
than expected or reducing incurred but not reported reserves.
85
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
5. COMMITMENTS
The Company leases certain office facilities and equipment under operating
leases. Rental expense for all leases was $1,792,237, $1,656,706, and $1,398,586
for 2002, 2001, and 2000, respectively. Future minimum payments under
noncancellable operating leases at December 31, 2002, are as follows (in
thousands):
2003 $ 1,814
2004 1,663
2005 1,405
2006 1,159
2007 1,131
Thereafter 5,630
-----------
$ 12,802
===========
The Company entered into a new ten-year lease on its corporate headquarters in
2002. The Company has options to renew this lease for up to ten additional years
at the fair market rental rate at the time of the renewal.
6. FEDERAL INCOME TAXES
Income tax expense differed from the amounts computed by applying the Federal
statutory income tax rate to income before taxes as follows (in thousands):
2002 2001 2000
------------------------------------
Income tax computed at statutory rate $ 22,835 $ 20,885 $ 17,582
(Decrease) increase in taxes
resulting from:
Tax-exempt interest (3,933) (3,105) (2,641)
Other 1,238 633 296
------------------------------------
Income tax expense $ 20,140 $ 18,413 $ 15,237
====================================
86
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
6. FEDERAL INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and deferred tax liabilities at December 31, 2002 and
2001, are presented below (in thousands):
2002 2001
------------------------------
Deferred tax liabilities
Statutory contingency reserve $ 78,420 $ 62,996
Deferred policy acquisition costs 10,149 9,080
Unrealized investment gain 4,646 521
Other 3,083 3,353
------------------------------
Total deferred tax liabilities 96,298 75,950
Deferred tax assets
Unearned premiums 685 604
Losses and loss adjustment expenses 516 437
Other 856 136
------------------------------
Total deferred tax assets 2,057 1,177
------------------------------
Net deferred tax liability $ 94,241 $ 74,773
==============================
At December 31, 2002 and 2001, Triad was obligated to purchase approximately
$1,017,000 and $1,228,000, respectively, of Tax and Loss Bonds.
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION, AND STATUTORY RESULTS
At December 31, 2002, approximately 52 percent of Triad's direct risk in force
was concentrated in eight states, with 12 percent in California, 8 percent each
in Florida and Texas, 6 percent in North Carolina, 5 percent each in Georgia and
Illinois, and 4 percent each in Pennsylvania and Arizona. While Triad continues
to diversify its risk in force geographically, a prolonged recession in its high
concentration areas could result in higher incurred losses and loss adjustment
expenses.
87
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION, AND STATUTORY RESULTS (CONTINUED)
Insurance regulations limit the writing of mortgage guaranty insurance to an
aggregate amount of insured risk no greater than twenty-five times the total of
statutory capital and surplus and the statutory contingency reserve. The amount
of net risk for insurance in force at December 31, 2002 and 2001, as presented
below, was computed by applying the various percentage settlement options to the
insurance in force amounts, adjusted by risk ceded under reinsurance agreements
and by any applicable aggregate stop-loss limits. Triad's ratio is as follows
(dollars in thousands):
2002 2001
----------------------------------
Net risk $ 5,534,420 $ 4,471,705
==================================
Statutory capital and surplus $ 112,874 $ 105,306
Contingency reserve 245,006 193,747
----------------------------------
Total $ 357,880 $ 299,053
==================================
Risk-to-capital ratio 15.5 to 1 15.0 to 1
==================================
Triad and its wholly-owned subsidiaries, TGAC and Triad Re, are each required
under their respective domiciliary states' insurance code to maintain a minimum
level of statutory capital and surplus. Triad, an Illinois domiciled insurer, is
required under the Illinois Insurance Code (the "Code") to maintain minimum
capital and surplus of $5,000,000.
The Code permits dividends to be paid only out of earned surplus and also
requires prior approval of extraordinary dividends. An extraordinary dividend is
any dividend or distribution of cash or other property, the fair market value of
which, together with that of other dividends or distributions made within a
period of twelve consecutive months, exceeds the greater of (a) ten percent of
statutory surplus as regards policyholders, or (b) statutory net income for the
calendar year preceding the date of the dividend. Consolidated net income as
determined in accordance with statutory accounting practices was $61,787,339,
$55,448,185, and $47,830,174 for the years ended December 31, 2002, 2001, and
2000, respectively. At December 31, 2002, the amount of the Company's equity
that can be paid out in dividends to the stockholders is $29,158,197, which is
the earned surplus of Triad on a statutory basis.
88
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION, AND STATUTORY RESULTS (CONTINUED)
The NAIC revised the Accounting Practices and Procedures Manual in a process
referred to as Codification. The revised manual was effective January 1, 2001.
The domiciliary states of Triad and its subsidiaries adopted the provisions of
the revised manual. The revised manual changed, to some extent, prescribed
statutory accounting practices and resulted in changes to the accounting
practices that Triad and its subsidiaries use to prepare their statutory-basis
financial statements. Triad recorded a $2,561,388 reduction in surplus in its
statutory-basis financial statements during 2001 as the cumulative effect of
changes in accounting principles from the adoption of Codification.
8. RELATED PARTY TRANSACTIONS
The Company pays unconsolidated affiliated companies for management, investment,
and other services. The total expense incurred for such items was $500,731,
$433,167, and $398,872 in 2002, 2001, and 2000, respectively. In addition, the
Company provides certain investment accounting, reporting and maintenance
functions for an affiliate. Income earned during 2002, 2001, and 2000,
respectively, for such services was $48,628, $23,487, and $21,780. Management
believes that the income and expenses incurred for such services approximate
costs that the Company and affiliates would have incurred if those services had
been provided by unaffiliated third parties.
9. EMPLOYEE BENEFIT PLAN
Substantially all employees participate in the Company's 401(k) Profit Sharing
Plan. Under the plan, employees elect to defer a portion of their wages, with
the Company matching deferrals at the rate of 50 percent of the first 8 percent
of the employee's salary deferred. The Company's expense associated with the
plan totaled $373,877, $353,004, and $301,281 for the years ended December 31,
2002, 2001, and 2000, respectively.
10. REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. The ceding agreements
principally provide Triad with increased capacity to write business and achieve
a more favorable geographic dispersion of risk.
89
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
10. REINSURANCE (CONTINUED)
Reinsurance activity for the years ended December 31, 2002, 2001, and 2000,
respectively, is as follows (in thousands):
2002 2001 2000
------------------------------------------------
Earned premiums ceded $ 18,260 $ 10,482 $ 4,930
Losses ceded 1 1 (25)
Earned premiums assumed 4 5 9
Losses assumed (1) 1 9
The Company cedes business to captive reinsurance subsidiaries of certain
mortgage lenders ("captives") primarily under excess of loss reinsurance
agreements. Generally, reinsurance recoverables on loss reserves and unearned
premiums ceded to these captives are backed by trust funds or letters of credit.
The Company maintains $125 million of excess of loss reinsurance through
non-affiliated reinsurers. The excess of loss reinsurance agreements are
designed to protect the Company in the event of a catastrophic level of losses.
In 2001, the Company recognized a nonrecurring incentive payment of $1,863,000
related to voluntary cancellation of an excess of loss reinsurance contract
maintained by the Company with a non-affiliated reinsurer. This payment is
included as other income in the accompanying Consolidated Statement of Income
for 2001.
Reinsurance contracts do not relieve Triad from its obligations to
policyholders. Failure of the reinsurer to honor its obligation could result in
losses to Triad; consequently, allowances are established for amounts deemed
uncollectible. Triad evaluates the financial condition of its reinsurers and
monitors credit risk arising from similar geographic regions, activities, or
economic characteristics of its reinsurers to minimize its exposure to
significant losses from reinsurer insolvency.
90
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN
In August 1993, the Company adopted the 1993 Long-Term Stock Incentive Plan (the
"Plan"). Under the Plan, certain directors, officers, and key employees are
eligible to be granted various stock-based awards. The number of shares of
common stock which may be issued or sold or for which options or stock
appreciation rights may be granted under the Plan is 2,600,000 shares.
Information concerning the stock option plan is summarized below:
Weighted-
Number of Option Average
Shares Price Exercise Price
--------------------------------------------
2000
Outstanding, beginning of year 1,334,447 $4.58 - 49.08 $14.48
Granted 193,875 18.56 - 28.00 26.91
Exercised 41,500 4.58 - 27.88 11.36
Canceled 2,100 17.00 - 41.94 23.19
Outstanding, end of year 1,484,722 4.58 - 49.08 16.17
Exercisable, end of year 1,257,142 4.58 - 49.08 14.41
2001
Outstanding, beginning of year 1,484,722 4.58 - 49.08 16.17
Granted 169,950 29.65 - 39.00 36.33
Exercised 336,628 4.58 - 27.88 8.54
Canceled 9,270 8.92 - 41.94 23.06
Outstanding, end of year 1,308,774 4.58 - 49.08 20.71
Exercisable, end of year 1,097,213 4.58 - 49.08 18.56
2002
Outstanding, beginning of year 1,308,774 4.58 - 49.08 20.71
Granted 88,640 32.96 - 47.60 40.48
Exercised 444,349 4.58 - 41.94 12.80
Canceled 2,760 29.65 - 39.49 35.92
Outstanding, end of year 950,305 4.58 - 49.08 25.94
Exercisable, end of year 804,652 4.58 - 49.08 23.91
91
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning stock options outstanding and exercisable at December 31,
2002, is summarized below:
Outstanding Exercisable
- ------------------------------------------------- --------------------------
Weighted- Weighted- Weighted-
Average Average Average
Number of Exercise Remaining Number of Exercisable
Shares Option Price Price Life Shares Price
- ------------------------------------------------ --------------------------
157,900 $ 4.58 - 8.83 $ 6.45 1.77 157,900 $ 6.45
102,495 10.17 - 18.56 13.03 3.82 99,495 12.86
400,546 20.07 - 34.80 25.82 6.56 356,046 25.10
218,589 37.75 - 39.75 39.13 7.60 134,936 39.05
70,775 41.40 - 49.08 48.04 5.94 56,275 48.60
- -------- ---------
950,305 804,652
======== =========
At December 31, 2002, 1,422,453 shares of the Company's common stock were
reserved and 472,148 shares were available for issuance under the Plan.
The options issued under the Plan in 2002, 2001, and 2000 vest over three years.
Certain of the options will immediately vest in the event of a change in control
of the Company. Options granted under the Plan terminate no later than 10 years
following the date of grant.
Pro forma information required by Financial Accounting Standards Board Statement
No. 123, Accounting for Stock-Based Compensation, has been estimated as if the
Company had accounted for stock-based awards under the fair value method of that
Statement. The fair value of options granted in 2002, 2001, and 2000 was
estimated at the date of the grant using a Black-Scholes option pricing model
with the following weighted-average input assumptions: risk-free interest rate
of 3.63 percent for 2002, 4.86 percent for 2001, and 5.30 percent for 2000;
dividend yield of 0.0 percent; expected volatility of .39 for 2002, .40 for
2001, and .42 for 2000; and a weighted-average expected life of the option of
seven years.
92
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
The following table summarizes the fair value of options granted in 2002, 2001,
and 2000:
Weighted-Average Weighted-Average
Exercise Price Fair Value
Type of Option 2002 2001 2000 2002 2001 2000
- --------------------------------------------------------------------------------
Stock Price = Exercise Price $40.48 $31.89 $22.38 $13.21 $11.14 $8.17
Stock Price < Exercise Price $ - $39.00 $27.95 $ - $ 8.81 $6.70
12. LONG-TERM DEBT
In January of 1998, the Company completed a $35 million private offering of
notes due January 15, 2028. Proceeds from the offering, net of debt issue costs
of $547,102, totaled $34,452,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9 percent per annum and
are non-callable.
93
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values and fair values of financial instruments as of December 31,
2002 and 2001 are summarized below (in thousands):
2002 2001
------------------------ ------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------------------ ------------------------
Financial Assets
Fixed maturity securities
available-for-sale $ 298,470 $ 298,470 $ 245,985 $ 245,985
Equity securities
available-for-sale 10,808 10,808 12,476 12,476
Financial Liabilities
Long-term debt 34,479 38,430 34,473 36,673
The fair values of cash and short-term investments approximate their carrying
values due to their short-term maturity or availability.
The fair values of fixed maturity securities and equity securities have been
determined using quoted market prices for securities traded in the public market
or prices using bid or closing prices for securities not traded in the public
marketplace.
The fair value of the Company's long-term debt is estimated using discounted
cash flow analysis based on the Company's current incremental borrowing rates
for similar types of borrowing arrangements.
14. CONTINGENCIES
A lawsuit has been filed against the Company in the ordinary course of the
Company's business. In the opinion of management, the ultimate resolution of
this pending litigation will not have a material adverse effect on the financial
position or results of operations of the Company.
94
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
15. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 2002 and 2001 (in thousands except per share data):
2002 Quarter
-----------------------------------
First Second Third Fourth Year
----------------------------------------------
Net premiums written $24,492 $25,291 $28,281 $27,805 $105,869
Earned premiums 24,535 25,499 27,351 27,682 105,067
Net investment income 3,764 3,953 4,156 4,226 16,099
Net losses incurred 2,516 2,879 4,392 4,276 14,063
Underwriting and other expenses 9,748 9,516 9,657 10,492 39,413
Net income 10,038 11,290 11,765 12,010 45,103
Basic earnings per share .73 .80 .83 .85 3.21
Diluted earnings per share .71 .78 .82 .84 3.15
2001 Quarter
-----------------------------------
First Second Third Fourth Year
----------------------------------------------
Net premiums written $19,812 $19,777 $20,822 $24,587 $ 84,998
Earned premiums 19,683 20,143 20,517 24,013 84,356
Net investment income 3,477 3,657 3,804 3,827 14,765
Net losses incurred 2,203 2,134 1,519 3,163 9,019
Underwriting and other expenses 7,378 7,660 8,051 9,530 32,619
Net income 10,920 9,830 10,338 10,171 41,259
Basic earnings per share .82 .73 .76 .74 3.05
Diluted earnings per share .79 .71 .73 .72 2.95
95
Schedule I
Summary of Investments - Other Than Investments in Related Parties
Triad Guaranty Inc.
December 31, 2002
Amount at Which
Amortized Fair Shown in Balance
Type of Investment Cost Value Sheet
-----------------------------------------
(dollars in thousands)
Fixed maturity securities,
available-for-sale:
Bonds:
U.S. Government obligations........ $ 10,189 $ 10,596 $ 10,596
Mortgage-backed securities......... 167 186 186
State and municipal bonds.......... 231,210 242,336 242,336
Corporate bonds.................... 42,533 44,724 44,724
Public utilities................... 638 628 628
-------- ------- --------
Total 284,737 298,470 298,470
-------- ------- --------
Equity securities, available-for-sale:
Common stocks:
Bank, trust, and insurance....... 511 586 586
Industrial and miscellaneous..... 4,573 3,867 3,867
Preferred stock ..................... 6,182 6,355 6,355
-------- ------- --------
Total............................... 11,266 10,808 10,808
-------- ------- --------
Short-term investments.................. 35,303 35,303 35,303
-------- ------- --------
Total investments other than
investments in related parties.......... $331,306 $344,581 $344,581
======== ======== ========
96
Schedule II - Condensed Financial Information of Registrant
Condensed Balance Sheets
Triad Guaranty Inc.
(Parent Company)
December 31
2002 2001
---- ----
(dollars in
thousands)
Assets:
Fixed maturities, available-for-sale.......... $ 13,315 $ 9,071
Equity securities, available-for-sale......... 760 501
Notes receivable from subsidiary.............. 25,000 25,000
Investment in subsidiary...................... 302,559 244,464
Short-term investments........................ 1,995 1,219
Cash.......................................... 196 152
Accrued investment income..................... 1,294 1,261
Deferred income taxes......................... - 99
Other assets.................................. 350 120
-------- ---------
Total assets.................................. $345,469 $281,887
======== =========
Liabilities and stockholders' equity:
Liabilities:
Current taxes payable......................... $ 52 $ 70
Long-term debt................................ 34,479 34,473
Deferred income taxes......................... 256 -
Accrued interest on long-term debt............ 1,275 1,275
-------- ---------
Total liabilities............................. 36,062 35,818
Stockholders' equity:
Common stock.................................. 142 137
Additional paid-in capital.................... 80,169 69,057
Accumulated other comprehensive income........ 8,634 975
Deferred compensation......................... (658) (117)
Retained earnings.............................221,120 176,017
-------- ---------
Total stockholders' equity....................... 309,407 246,069
-------- ---------
Total liabilities and stockholders' equity....... $345,469 $281,887
======== =========
See notes to condensed financial statements.
97
Schedule II - Condensed Financial Information of Registrant
Condensed Statements of Income
Triad Guaranty Inc.
(Parent Company)
Year Ended December 31
----------------------
2002 2001 2000
---- ---- ----
(dollars in thousands)
Revenues:
Net investment income............... $ 3,170 $ 3,000 $ 2,908
Realized investment losses.......... (1,168) (266) (373)
------- ------- -------
2,002 2,734 2,535
Expenses:
Interest on long-term debt.......... 2,771 2,771 2,770
Operating expenses.................. 885 396 90
------- ------- -------
3,656 3,167 2,860
------- ------- -------
Loss before federal income taxes
and equity in undistributed
income of subsidiary................. (1,654) (433) (325)
Income taxes:
Current............................. - (121) -
Deferred............................ (176) 172 (129)
------- ------- -------
(176) 51 (129)
Loss before equity in undistributed
income of subsidiary................. (1,478) (484) (196)
Equity in undistributed income
of subsidiary........................ 46,581 41,743 35,194
------- ------- -------
Net income............................. $45,103 $41,259 $34,998
======= ======= =======
See notes to condensed financial statements.
98
Schedule II - Condensed Financial Information of Registrant
Condensed Statements of Cash Flows
Triad Guaranty Inc.
(Parent Company)
Year Ended December 31
2002 2001 2000
---- ---- ----
(dollars in thousands)
Operating Activities
Net income................................... $45,103 $41,259 $34,998
Adjustments to reconcile net income
to net cash (used in) provided
by operating activities:
Equity in undistributed income of
subsidiary................................ (46,581) (41,743) (35,194)
Accrued investment income................... (33) (40) (15)
Other assets................................ (230) 96 (216)
Deferred income taxes....................... (176) 172 (129)
Current tax payable......................... (18) - -
Accretion of discount on investments........ (98) (52) (60)
Amortization of deferred compensation....... 392 118 85
Amortization of debt issue costs............ 6 6 5
Realized investment gain on securities...... 1,168 266 373
Other operating activities.................. 188 - -
------- ------- -------
Net cash (used in) provided by
operating activities....................... (279) 82 (153)
Investing Activities
Securities available-for-sale:
Fixed maturities:
Purchases........................... (8,600) (5,756) (2,951)
Sales............................... 4,258 3,369 2,501
Equity securities:
Purchases........................... (250) (500) -
Sales............................... 2 - -
Change in short-term investments.......... (776) (87) (4)
------- ------- -------
Net cash used in investing activities........ (5,366) (2,974) (454)
Financing Activities
Proceeds from exercise of stock options.... 5,689 2,874 472
------- ------- -------
Net cash provided by financing activities.... 5,689 2,874 472
------- ------- -------
Increase (decrease)in cash................... 44 (18) (135)
Cash at beginning of year.................... 152 170 305
------- ------- -------
Cash at end of year.......................... $ 196 $ 152 $ 170
======= ======= =======
See notes to condensed financial statements.
99
Schedule II - Condensed Financial Information of Registrant
Triad Guaranty Inc.
(Parent Company)
Supplementary Notes
NOTE 1
In the parent company financial statements, the Company's investment in its
subsidiaries is stated at cost plus equity in undistributed earnings of the
subsidiaries. The Company's share of net income of its subsidiaries is included
in income using the equity method. The accompanying Parent Company financial
statements should be read in conjunction with the Consolidated Financial
Statements and Notes to Consolidated Financial Statements included as part of
this Form 10-K.
Note 2
Triad Guaranty Inc. (the "Company") is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"),
provides private mortgage insurance coverage in the United States to mortgage
lenders to protect the lender against loss from defaults on low down payment
residential mortgage loans.
Note 3
The amortized cost and the fair value of investments held by the parent
company are as follows (dollars in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
At December 31, 2002 Cost Gains Losses Value
---------------------------------------------
Available-for-sale securities:
Fixed maturity securities:
Corporate $7,959 $389 $120 $8,228
Municipal 4,775 312 - 5,087
---------------------------------------------
Total 12,734 701 120 13,315
Equity securities 750 17 7 760
---------------------------------------------
Total $13,484 $718 $127 $14,075
=============================================
Gross Gross
Amortized Unrealized Unrealized Fair
At December 31, 2001 Cost Gains Losses Value
---------------------------------------------
Available-for-sale securities:
Fixed maturity securities:
Corporate $8,795 $159 $553 $8,401
Municipal 669 1 - 670
---------------------------------------------
Total 9,464 160 553 9,071
Equity securities 500 1 - 501
---------------------------------------------
Total $9,964 $161 $553 $9,572
=============================================
100
Schedule II - Condensed Financial Information of Registrant
Triad Guaranty Inc.
(Parent Company)
Supplementary Notes
NOTE 3 (CONTINUED)
Major categories of the parent company's investment income are summarized
as follows (dollars in thousands):
Year ended December 31
2002 2001 2000
Income: ------------------------------------
Fixed maturities $ 918 $ 770 $ 664
Equity securities 51 19 -
Cash and short-term investments 28 45 55
Note receivable from subsidiary 2,225 2,225 2,225
------------------------------------
3,222 3,059 2,944
Expenses 52 59 36
-------------------------------------
Net investment income $3,170 $3,000 $2,908
=====================================
NOTE 4
In January of 1998, the Company completed a $35 million private offering of
notes due January 15, 2028. Proceeds from the offering, net of debt issue costs
of $547,102, totaled $34,452,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable.
101
Schedule IV - Reinsurance
Triad Guaranty Inc.
Mortgage Insurance Premium Earned
Years Ended December 31, 2002, 2001 and 2000
Ceded To Assumed Percentage of
Gross Other From Other Net Amount Assumed
Amount Companies Companies Amount to Net
-------------------------------------------------------------------
(dollars in thousands)
2002....... $123,323 $18,260 $4 $105,067 0.0%
======== ======= == ========
2001....... $ 94,833 $10,482 $5 $ 84,356 0.0%
======== ======= == ========
2000....... $ 76,764 $ 4,930 $9 $ 71,843 0.0%
======== ======= == ========
102