UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission file number 0-22342

Triad Guaranty Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(336) 723-1282

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 þ         No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-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.    o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes þ         No o

     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: $508,291,271 as of June 30, 2004, 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 14, 2005, was 14,678,418.

TABLE OF CONTENTS

PART I

      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 many home purchases and refinancings involving conventional residential first mortgage loans to borrowers with equity of less than 20%. If the homeowner defaults on the mortgage, 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 not sold that have equity of less than 20%. Mortgage insurance is also 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 “flow” mortgage insurance and will be referred to as such throughout this document. Additionally, the Company participates in structured bulk transactions that involve underwriting and insuring a group of loans. This type of mortgage insurance is known as “structured bulk” or “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 17.6% and CML owns 17.6% 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.

Types of Mortgage Insurance Products

      Primary insurance provides mortgage default protection to lenders on individual loans and covers a percentage of 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. “Insurance written” is defined as the entire loan balance for which a lender has requested mortgage insurance and is generally utilized as a term to measure sales success. 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 loan amount, with most coverage from 12% to 37% as of December 31, 2004. 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’s 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 various factors including the loan–to–value (LTV) ratio, loan type, mortgage term, coverage amount, documentation required, credit score and use of property, which all affect the perceived risk of default on the insured mortgage loan. Usually, premium rates cannot be changed after issuance of coverage. Consistent with industry practice, the Company generally utilizes a nationally based, rather than a regional or local, premium rate structure for its flow business, although special risk rates are utilized as well.

      Premiums on flow mortgage insurance 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 that 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 that pays the premium to the Company. The lender may recover the premium through an increase in the borrower’s interest rate. Approximately 77% and 69% of the Company’s flow insurance was written under its borrower-paid plan during 2004 and 2003, respectively. The remainder was written under its lender-paid plan (23% and 31% of flow insurance during 2004 and 2003, respectively). The Company’s lender-paid volume is concentrated among larger mortgage lender customers.

      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, thereby making home ownership more affordable. Monthly premium plans represented approximately 92% and 76% of flow insurance written in 2004 and 2003, 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 plans, 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 8% and 23% of flow insurance written in 2004 and 2003, respectively.

      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 flow insurance written in 2004 and 2003.

      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 an aggregate stop loss limit and/or a deductible. The Company does not offer this traditional form of pool insurance.

      The Company participates in structured bulk transactions, which involve insuring a group of loans with individual coverage for each loan. Structured bulk transactions are typically 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. Insurance issued in structured bulk transactions is generally either primary, supplemental if the policy already has primary coverage, or a combination of both. Coverage on structured bulk transactions is determined at the individual loan level, sufficient to reduce the insured’s exposure on any loan in the transaction down to a stated percentage of the loan balance (“down-to” coverage). 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 submits a price for insuring the entire group of loans. The Company competes against other mortgage insurers as well as other forms of credit enhancement provided by capital markets for these transactions. During 2004, insurance written related to structured bulk transactions represented 39% of the total insurance written compared to 19% in 2003.

      Structured bulk transactions frequently include an aggregate stop-loss limit applied to the entire group of insured loans. Additionally, 81% of the structured bulk transactions entered into in 2004 and 60% in 2003 included deductibles putting the Company in a second loss position. Through December 31, 2004, insurance written through the structured bulk channel has not been subject to captive mortgage reinsurance or other risk-sharing arrangements.

      The Company offers mortgage insurance arrangements designed to allow lenders to share in the risks of mortgage insurance. One such arrangement 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 aggregate layers of coverage and a maximum exposure limit for the captive reinsurance company. Captive reinsurance programs may also take the form of a quota share arrangement, although the Company had no quota share arrangements in force as of December 31, 2004. Under its excess-of-loss programs, with respect to a given book year of business, Triad retains the first loss position on the first aggregate layer of risk and reinsures a second defined aggregate layer with the reinsurer. Triad generally retains the remaining risk above the layer reinsured. Of the reinsurance agreements in place at December 31, 2004, the first layer retained by Triad ranged from the first 3.0% to 6.5% of risk in force and the second layer ceded to reinsurers ranged from the next 4.0% to 10.0%. Ceded premiums, net of ceded commissions, under these arrangements ranged from 20.0% to 40.0% of premiums.

      Trust accounts are established with the counterparties to all of our reinsurance agreements to support the reinsurers’ obligations under the reinsurance agreements. The captive reinsurer is the grantor of the trust and Triad is the beneficiary of the trust. 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 ultimate impact on the Company’s financial performance of an excess-of-loss captive structure is primarily dependent on the total level of losses and the persistency rates during the life of a given book year of business. We define persistency as the percentage of insurance in force remaining from twelve months prior. 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 reduce the degree of volatility in the Company’s earnings from the development of such losses over time. At December 31, 2004 and 2003, 43% and 44% of insurance in force was subject to captive reinsurance programs.

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 determined 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, lenders are required to automatically cancel the borrower paid private mortgage insurance on most loans made on or after July 29, 1999, 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 the Company’s “insurance in force”, defined as the present loan balance outstanding of active policies remaining at any specific point in time, for which the lender had requested coverages at the end of the previous year that was canceled during 2004 and 2003 was 32% and 49%, respectively. The high cancellation level in 2003 was due to significant refinance activity, as mortgage rates dropped to historic lows. During periods of high refinance activity, the Company’s earnings and risk profile are more subject to fluctuations. See Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion on the effect of the cancellation levels.

Customers

      Residential mortgage lenders such as mortgage bankers, mortgage brokers, commercial banks, and savings institutions are the principal customers of flow insurance written by the Company.

      To obtain insurance from the Company written on a 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 upon evaluation of the lender’s financial position and demonstrated adherence to sound lending practices as well as other factors.

      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 each loan, subject to certain underwriting criteria, must be approved by the Company to effect coverage (except in the case of delegated underwriting or when the originator has the authority to approve coverage within certain guidelines).

      Consolidation within the mortgage origination industry has resulted in a greater percentage of production volume being concentrated among a smaller customer base. The top 30 lenders in the United States, as ranked by mortgage origination volume, accounted for approximately 84% of originated mortgage volume in 2004 compared to 79% in 2003. Many of these top 30 lenders are customers of the Company. In 2004, production from the Company’s top 10 lenders accounted for approximately 71% of the Company’s flow insurance written compared to 74% in 2003. The loss of one or more of the Company’s significant customers could have an adverse effect on its business.

      Premium revenue for the Company is comprised of premium from business originated in the current year plus renewal premiums from insurance originated in prior years. Those customers whose revenue comprised more than 10% of the Company’s consolidated revenue are listed below:

      See further discussion regarding significant customers in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Sales and Marketing

      The Company currently markets its insurance products through a dedicated sales force, including sales management, of approximately 40 professionals and an exclusive commissioned general agency serving a specific geographic market. The Company is licensed to do business in all 50 states and the District of Columbia.

      The Executive Vice President of Sales and Marketing oversees all of the Company’s sales and marketing activities and reports directly to the Chief Operating Officer of the Company. The Senior Vice President and National Sales Manager oversees all of the Company’s sales activities and reports to the Executive Vice President of Sales and Marketing. Division managers serve key regional accounts through area sales directors and account executives and report to the Senior Vice President and National Sales Manager. Also reporting to the Senior Vice President and National Sales Manager are the national account executives who are responsible for the Company’s sales efforts toward the larger national mortgage originators. This reporting structure allows the senior vice president in charge of all sales activities to coordinate all sales efforts and focus time on large, national accounts while maintaining responsibility for all other sales activities.

      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. The fee charged is intended to cover the cost of providing the services. 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. In addition, the Company offers Fannie Mae’s Desktop Originator® and Desktop Underwriter® and Freddie Mac’s Loan Prospector® 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 compliance with underwriting standards and Fannie Mae’s or Freddie Mac’s decision for loan purchase or securitization. The Company provides contract underwriting services through its own employees as well as independent contractors, and these services are 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. The potential remedies are not significant to the Company.

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 under which approximately 33% of high LTV loans were insured in 2004 compared to 36% in 2003. 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 affiliates of state housing agencies. Indirectly, the Company also competes with certain mortgage lenders that forego private mortgage insurance to 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 that should be maintained by lenders on loans that they purchase. Both Fannie Mae and Freddie Mac have programs that reduce the required amount of private mortgage insurance in exchange for an upfront delivery fee from the lender. 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, what effect they may have on the Company.

      The private mortgage insurance industry consists of seven major mortgage insurance companies including Triad, Mortgage Guaranty Insurance Corporation, PMI Mortgage Insurance Co., United Guaranty Corporation, Radian Guaranty Inc., Genworth Financial, Inc. and Republic Mortgage Insurance Company. Triad is the smallest private mortgage insurer based on 2004 market share and, according to estimated industry data, had a 6.0% share of total net new primary insurance written in 2004 compared to 4.9% in 2003.

      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 in the flow market. The Company competes in competitive bid transactions in the structured bulk market with both the other private mortgage insurers and providers of other forms of credit enhancements.

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.

      The Company’s Senior Vice President of Underwriting is responsible for the centralized underwriting department for flow business in the home office as well as the Company’s regional offices in Arizona, California, Georgia, Illinois, Ohio, Pennsylvania, and Texas. He has been in his position since shortly after the Company was formed. The Company’s Senior Vice President of Risk Management is responsible for assessing the risk factors used by the Company in its underwriting procedures. He has been with the Company since 2001 and has more than 20 years of industry experience.

      The Company employed an underwriting staff of approximately 35 at December 31, 2004. 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 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:

      The Company accepts applications for insurance under three basic programs: a 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 Freddie 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 the underwriting guidelines of Fannie Mae and Freddie Mac. Specific underwriting guidelines applicable to a given local, state, or regional market are utilized 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 that deviate in certain minor respects from the Company’s underwriting guidelines. More significant exceptions are subject to management approval. In all such cases, other compensating factors must be identified. The predominant deviations involve 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 factors such as excellent borrower credit history, the availability of satisfactory cash reserves after closing, and borrower employment stability.

      The Company also allows lenders to submit insurance applications with reduced documentation through automated and non-automated underwriting programs. Under the automated underwriting program, Triad issues a commitment of insurance based on the borrower’s FICO credit score or the approval of the loan through either Fannie Mae’s or Freddie Mac’s automated underwriting system. The Company issues a commitment of insurance without the standard underwriting process if certain program parameters are met and the borrower has a credit score above established thresholds. The Company audits lenders’ files on loans submitted under the automated underwriting program randomly and through specific identification of selected risk factors. Documentation submission requirements for non–automated underwritten loans vary depending on the borrower’s credit score.

      The Company utilizes a delegated underwriting program to serve many of the larger, well–established mortgage originators. Under this program, standards for type of loan, property type, and credit history of the borrower are established consistent with the Company’s risk strategy, and the lender’s underwriters are able to commit insurance to a loan based on these standards. Extensive practices including reunderwriting, reappraisal, and similar procedures are utilized following issuance of the policy to ensure quality control. The Company’s delegated underwriting program accounted for 41% of flow applications received in 2004 compared to 59% in 2003. To date, the performance of loans insured under the delegated underwriting program has been comparable to the Company’s non–delegated business. The use of Fannie Mae’s or Freddie Mac’s automated underwriting programs or the Company’s delegated underwriting programs with selected lenders could lead to loss development patterns different than those experienced when the Company controlled the entire underwriting process.

      The Company analyzes structured bulk transactions during the bid process to identify the individual loans that pose the greatest risk of nonperformance. High-risk loans are identified based on an analysis of multiple risk factors including, but not limited to, credit score, loan-to-value ratio, 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 models such as Standard & Poor’s Levels. The Company’s pricing for structured bulk transactions is commensurate with a transaction’s overall risk profile based upon its individual loan-by-loan analysis. The risk review may result in a request by the Company to remove certain loans from the transaction before the Company submits a competitive bid. The Company considers a transaction’s loan level risk profile and any associated stop loss level or deductible amount in submitting a bid for insurance. The Company does not bid on all structured bulk transactions it receives.

      As discussed earlier, the Company has expanded the risk characteristics that it is pursuing in both the flow and structured bulk marketplaces. That change has been overseen by the Company’s Credit Risk Committee, which is composed of all members of senior management. The Credit Risk Committee must approve all new product offerings and changes in types of risk that the Company is willing to assume. This includes approval of the expansion of credit characteristics and review of the overall underwriting guidelines utilized.

      Additionally, the Committee approves all structured bulk transactions before a bid is submitted. The Committee reviews the summary analysis of the transaction and challenges the conclusions reached concerning the pricing of a given structure based upon the estimated frequency and severity of projected losses and persistency. After all of these points are considered, the Committee decides whether or not to submit the bid on the transaction.

      The Company employs a comprehensive internal audit plan to determine whether underwriting decisions being made are consistent with the policies, procedures, and expectations for quality set forth by management. All areas of business activity that 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 that fail to meet prescribed policies or an identified norm. The procedure allows the Company’s management to identify concerns that may exist within individual loans as well as concerns that may exist within a given category of business.

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 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”). 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).

      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 of the insurer’s specific portfolio; 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. Such ratings are not directed to the protection of investors and do not apply to any securities issued by the Company.

      Some 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, while not anticipated, could materially impact the ability of the Company to write new business.

Reinsurance

      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. These programs are designed to allow the lenders to share in the risk of the business. See further discussion of these programs under the Risk-sharing Products section above.

      Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie Mac, certain loans eligible for sale to such enterprises 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, 2004 and 2003, TGAC assumed approximately $73 million and $59 million in risk from Triad, respectively.

      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.

      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.

Defaults and Claims

      The claim process on private mortgage insurance begins with the lender’s notification to the insurer 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 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, and the level of interest rates. Borrowers may cure defaults by making all delinquent loan payments or by selling the

property and satisfying all amounts due under the mortgage. Defaults that are not cured generally result in a claim to the Company. Refer to the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this document for default statistics at December 31 for the last two years.

      Claims result from defaults that are not cured. During the default period, the Company works with the insured as well as the borrower in an effort to reduce its losses through the loss mitigation efforts described below. 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 time frame from when the Company first receives a notice of default and when the ultimate claim is paid generally ranges from six to eighteen months. Changes in various macroeconomic conditions such as house price appreciation, employment, and other market conditions over that time frame also positively or negatively impact the amount of the ultimate claim paid.

      The payment of claims is not evenly spread through the coverage period. For flow business, relatively few claims are paid during the first two years following issuance of 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 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. For our structured bulk business, the claim pattern develops earlier, with the highest claim payment levels reached in the second through fourth years. 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 that 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 other conditions.

      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, a negotiated short sale, 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. 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, 2004, the Company held two properties with a combined net realizable value of approximately $211,000 that 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 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. As a result of loss mitigation efforts, the Company paid out only approximately 60% and 66% of its potential exposure on claims in 2004 and 2003, respectively.

Loss Reserves

      The Company establishes reserves to provide for the estimated costs of settling claims on loans reported in default and loans in default that are in the process of being reported to the Company. Consistent with industry practices, the Company does not establish loss reserves for future claims on insured loans that are not currently in default. The Company’s reserving process is based upon the assumption that long-term historical experience, adjusted for current economic events that the Company believes will significantly impact the long-term loss development, provides a reasonable basis for estimating future events. See the Financial Position section of Management’s Discussion and Analysis of Financial Condition and Results of Operations for a more detailed discussion of the loss reserving process, and see Note 4 to the Consolidated Financial Statements for a detailed analysis of the activity in this account for the year.

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, integrity and past performance of lenders from which the Company receives loans to insure.

      The Company reported $7.6 billion of direct risk in force as of December 31, 2004. Direct risk in force includes risk from both flow mortgage insurance as well as structured bulk transactions, adjusted for applicable stop loss limits.

      The following table provides information on risk in force (as determined on the basis of information available on the date of mortgage origination) by the categories indicated on December 31, 2004 and 2003.

Risk in Force(1)

      An important determinant of claim incidence is the relative amount of borrower’s equity in the home. For the industry as a whole, historical evidence indicates that, in general, claim incidence on loans with a higher LTV is greater than a loan with a lower LTV, all else being equal. The Company believes the higher premium rates charged on high LTV loans adequately reflect the additional risk.

      At December 31, 2004, approximately 9.5% 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 loans with lower LTVs and have 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 LTVs 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 LTVs 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 LTVs 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, because of possible interest rate increases and borrower payment option changes, are accepted under limited conditions for approved lenders.

      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.

      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 89% of the Company’s risk in force at December 31, 2004. 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.

      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 majority of the Company’s direct risk in force is on mortgages of $200,000 or below.

      The Company’s book of business is relatively unseasoned, having a weighted average life of 2.2 years at December 31, 2004, and 1.9 years at December 31, 2003.

      The following table shows the percentage of direct risk in force as of December 31, 2004, for policies written from 1990 through 2004 and the cumulative loss ratios (calculated as direct losses paid divided by direct premiums received, in each case for a particular policy year) that have developed through December 31, 2004 and 2003. It excludes the effects of reinsurance.

      The table above reflects a relatively higher cumulative ratio of losses paid to premium received for the 2000 policy year at this stage of development. This is due, in part, to a large portion of this business refinancing in recent years and the resulting lower aggregate level of premium received for this policy year.

      Most of the Company’s structured bulk production in the last two years has been classified as Alt-A, and a small but increasing share of the Company’s flow business also is classified as Alt-A. The following table shows the percentage of the Company’s insurance in force that was classified as Alt-A at December 31, 2004 and 2003:

      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, 2004.

      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

      See a complete discussion of the investment portfolio in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this document.

Regulation

      The Company’s insurance subsidiaries are subject to comprehensive, detailed regulation, principally for the protection of policyholders 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. 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.

      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, 2004, Triad had statutory policyholders’ surplus of $135.7 million and a statutory contingency reserve of $369.5 million. At December 31, 2003, Triad had statutory policyholders’ surplus of $128.2 million and a statutory contingency reserve of $302.7 million. Triad’s statutory earned surplus was $51.9 million at December 31, 2004, and $44.5 million at December 31, 2003, 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 that 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. Triad has never paid dividends to the Company.

      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, 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, 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 all Vermont insurance regulatory requirements applicable to Triad.

      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 condition 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 period January 1, 1995, through December 31, 1998. No material recommendations were made as a result of these examinations. The Illinois Insurance Department has begun its customary examination for the years 1999 through 2003 for Triad and TGAC. The examination is in the final stages and there have been no significant findings as a result of this examination. The Insurance Division of the State of Vermont has begun its customary examination for the years 1999 through 2003 for Triad Re. This examination is also in the final stages and there have been no significant findings as a result of this examination.

      A number of states generally limit the amount of insurance risk that 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.

      State insurance laws and regulations generally restrict mortgage insurers 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 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, Fannie Mae and Freddie Mac impose requirements on private mortgage insurers in order for such insurers to be eligible to insure loans sold to them. 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 generally mirror the financial requirements of statutory insurance regulations. These requirements are subject to change from time to time. Freddie Mac most recently modified its eligibility guidelines in March 2002.

      Fannie Mae has recently completed the process of revising its approval requirements for mortgage insurers. The new requirements 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. While continuing to study the final requirements, we do not see any material impact on our current or future operations as a result of the new rules, although a material impact could still occur if our interpretation is incorrect.

      While Triad is an approved mortgage insurer for both Fannie Mae and Freddie Mac and meets all existing eligibility requirements, there can be no assurance 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 their automated underwriting services. 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 their automated underwriting services to the levels in effect in 1994; (ii) a 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) a 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 coverage. 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 position in determining the rating. There can be no assurance that Triad’s ratings, the methods by which the ratings are 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.

      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. All but two of 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.

      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 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 are 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.

      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

regulation affecting lenders. Private mortgage insurers, including Triad, are highly dependent upon federal housing legislation and other laws and regulations that affect the demand for private mortgage insurance and the housing market. FHA loan limits are adjusted in response to changes in the Freddie Mac/ Fannie Mae conforming loan limits. Currently, the maximum single-family home mortgage that the FHA can insure is $312,895. The maximum FHA loan amount is subject to adjustment and may 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. Future changes, if any, to FIRREA’s risk–based capital rules or the guidelines for real estate lending policies applicable to savings institutions and commercial banks could affect demand for private mortgage insurance products.

      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 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 when issued or 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 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 that 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 that could be utilized 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 of this Act, banking organizations that previously were not allowed to be affiliated with insurance companies may now do so. This legislation has had very little impact on the Company to date. 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 in the future.

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, 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.

Employees

      As of December 31, 2004, the Company employed approximately 225 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:

      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 Senior Executive Vice President and Chief Operating Officer of the Company since October 2004. Mr. Kessinger has been Chief Financial Officer of the Company since December 1999 and of Triad since November 1999. Prior to this, he was the 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 Operations of Triad since October 2004. 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, Capital Markets Division and most recently as Vice President, Secondary Marketing. Mr. Lard has been with Triad for 9 years and has over 20 years experience in the mortgage industry.

      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.

      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 9 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.

      The Company leases office space in its Winston–Salem headquarters and its thirteen underwriting offices located throughout the country under leases expiring between 2005 and 2012 and which require annual lease payments of approximately $2.0 million in 2005. 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.

      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.

      The Company is involved in litigation in the ordinary course of business including the named cases below. No pending litigation is expected to have a material adverse affect on the financial position of the Company.

      Triad was a defendant in Patton v. Triad. The complaint alleged that Triad violated the Real Estate Settlement Procedures Act 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. This case was settled during 2004 for a nominal amount.

      Triad is a defendant in Broessel v. Triad. This action was commenced on January 15, 2004 with a filing in Federal District Court for the Western District of Kentucky seeking class action status on behalf of a nationwide class of home mortgage borrowers. The complaint alleges that Triad violated the Fair Credit Reporting Act (“FCRA”) by failing to provide notices to certain borrowers when mortgage insurance was offered to lenders with respect to those borrowers’ mortgage loans at a rate in excess of Triad’s lowest available rate. Triad has filed a motion for summary judgment. Discovery is currently underway with respect to this motion. While the ultimate outcome of the FCRA litigation is uncertain, the litigation is not expected to have a material adverse effect on the financial position of the Company.

      None.

PART II

      The Company’s Common Stock trades on The NASDAQ Stock Market®under the symbol “TGIC.” At December 31, 2004, 14,631,678 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.

      As of March 4, 2005, the number of stockholders of record of the Company’s Common Stock was approximately 200. In addition, there were an estimated 7,700 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 parent company. Because of Triad’s need to maintain capital levels required by rating agencies, there are no present intentions to pay dividends.

      Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the consolidated financial condition, changes in financial position, and results of operations for the three years ended December 31, 2004, of Triad Guaranty Inc. and its consolidated subsidiaries, collectively the Company. The discussion should be read in conjunction with the Consolidated Financial Statements and Notes.

      Certain of the statements contained herein, other than statements of historical fact, are forward-looking statements. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive, and legislative developments. These forward-looking statements are subject to change and uncertainty, which are, in many instances, beyond our control and have been made based upon our expectations and beliefs concerning future developments and their potential effect on us. Actual developments and their results could differ materially from those expected by us, depending on the outcome of certain factors, including the possibility of general economic and business conditions that are different than anticipated, legislative developments, changes in interest rates or the stock markets, stronger than anticipated competitive activity, and the factors described in the forward-looking statements.

Critical Accounting Estimates

      The preparation of financial statements, in conformity with accounting principles generally accepted in the United States, requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The ultimate outcome could differ from those estimates and assumptions utilized in the preparation of the financial statements.

      We have identified the following as critical accounting estimates in that they involve a higher degree of judgment and are subject to a significant degree of variability: reserves for losses and loss adjustment expenses, the timely identification of potentially impaired securities and valuation of those securities, and deferred policy acquisition costs. In developing these estimates, we make subjective and complex judgments that are inherently uncertain and subject to material change as facts and circumstances develop. Although variability is inherent in these estimates, we believe the amounts provided are appropriate based on the facts available upon compilation of the financial statements.

      We calculate our best estimate of reserves to provide for the estimated costs of settling claims on loans reported in default and loans in default that are in the process of being reported to us. Our reserving process incorporates various components in a formula that gives effect to current economic conditions and profiles delinquencies by such factors as policy year, geography, chronic late payment characteristics, the number of months the policy has been in default, as well as whether the defaults were underwritten as flow business or as part of a structured bulk transaction. The process is based upon the assumption that long-term historical experience, taking into consideration the above factors and adjusted for current economic events that we believe will significantly impact the long-term loss development, provides a reasonable basis for estimating projected claim rates (frequency) and claim amounts (severity). We consider severity and frequency to be the most significant assumptions in the establishment of our loss reserves. Estimation of loss reserves is a difficult and inexact process and there are inherent risks and uncertainties involved in making these assumptions. 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.

      Because the estimate for loss reserves is sensitive to the estimates of claims frequency and severity, we perform analyses to test the reasonableness of the best estimate generated by the loss reserve process. The loss

reserve estimation process and the analyses support the reasonableness of the best estimate of loss reserves recorded in our financial statements. See the Financial Position section below for a more detailed discussion of the reserves for losses and loss adjustment expenses.

      Valuing our investment portfolio involves a variety of assumptions and estimates, particularly for investments that are not actively traded. We rely on external pricing sources for highly liquid, publicly traded securities and use an internal pricing matrix for privately placed securities. This matrix relies on our judgment concerning a) the discount rate we use in calculating expected future cash flows, b) credit quality and c) expected maturity.

      We regularly monitor our investment portfolio to ensure that investments that may be other-than-temporarily impaired are identified in a timely fashion, properly valued, and any other-than-temporary impairments are charged against earnings in the proper period. Our methodology to identify potential impairments is further described in the Investments section below.

      The timely identification and valuation of potentially impaired securities involves many judgments. Inherently, there are risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as unforeseen events which affect our investments in one or more companies, political subdivisions, or industries could result in additional write-downs in future periods for impairments that are deemed to be other-than-temporary. See further discussion of the valuation of our investment portfolio under the Investment section below.

      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 capitalized as deferred policy acquisition costs (DAC). Amortization of such policy acquisition costs is charged to expense in proportion to premium recognized over the estimated policy life. We make judgments in the identification of deferrable acquisition costs and the determination of estimated policy life utilized in the amortization assumptions. See further discussion of DAC under the Financial Position section below.

Overview

      Through our subsidiaries, we provide mortgage guaranty insurance coverage to residential mortgage lenders and investors as a credit-enhancement vehicle, typically when individual borrowers have less than 20% equity in the property. Business originated by lenders and submitted to us on a loan-by-loan basis is referred to as flow business. Mortgage guaranty insurance facilitates the sale of individual low down payment loans in the secondary market and provides protection to lenders who choose to keep the loans in their own portfolios. Additionally, we provide mortgage insurance to lenders and investors who seek additional default protection, capital relief, and credit-enhancement on groups of loans that are sold in the secondary market. This business is referred to as structured bulk transactions.

      Our revenues principally consist of a) initial and renewal earned premiums from flow business (net of reinsurance premiums ceded as part of our risk management strategies), b) initial and renewal earned premiums from structured bulk transactions, and c) investment income on invested assets. We also realize investment gains, net of investment losses, periodically as a source of revenue when the opportunity presents itself within the context of our overall investment strategy.

      Our expenses essentially consist of a) amounts ultimately paid on claims submitted, b) increases in reserves for estimated future claim payments, c) general and administrative costs of acquiring new business and servicing existing policies, d) other general business expenses, and e) income taxes.

      Our profitability depends largely on a) the adequacy of our product pricing and underwriting discipline relative to the risks insured, b) persistency levels, c) operating efficiencies, and d) the level of investment yield, including realized gains and losses, on our investment portfolio. We define persistency as the percentage

of insurance in force remaining from twelve months prior. Cancellations of policies originated during the past twelve months are not considered in our calculation of persistency. This method of calculating persistency may vary from that of other mortgage insurers. We believe that our calculation presents an accurate measure of the percentage of insurance in force remaining from twelve months prior. Cancellations result primarily from the borrower refinancing or selling mortgaged residential properties and, to a lesser degree, from the borrower achieving prescribed equity levels at which the lender no longer requires mortgage guaranty insurance.

Consolidated Results of Operations

      Following is a summary of our results for the last three years (in thousands except per share information):

      A primary driver of our results is persistency, due to its impact on both renewal earned premiums and the amortization of DAC. Increased persistency means that more of our business is being retained and renewal earned premiums increase as a result. Further, amortization of DAC is based on assumed persistency levels. When actual persistency levels are lower than that assumed in our DAC models, we accelerate the amortization of DAC expense. Annual persistency levels increased throughout 2004 as refinanced activity slowed from levels experienced in 2003, which reduced DAC amortization expense in the current year from that of 2003.

      Two other important drivers of our results have been an increase in bulk production and the development of losses and loss adjustment expenses. We describe our results in greater detail in the discussions that follow. The information is presented in three categories in each of the year-to-year comparisons that follow: Production and In Force, Revenues, and Losses and Expenses.

2004 Compared to 2003

      Net income for 2004 increased 14.3% over 2003 driven by a 17.8% increase in earned premiums and a 21.3% decline in DAC amortization. Net loss and loss adjustment expense increased 50.5%, partially offsetting these favorable impacts. Net income per share on a diluted basis increased 13.1% over 2003. Net realized

investment gains, after taxes, contributed income of $0.02 per share on a diluted basis in 2004 compared to $0.13 per share for 2003. Diluted realized gains and losses per share is a non-GAAP measure. We believe this is relevant and useful information to investors because, except for write-downs on other-than-temporarily impaired securities, it shows the effect that our discretionary sales of investments had on earnings.

      Total insurance written in 2004 was $17.2 billion compared to $20.5 billion in 2003, a decrease of 16.1%. Total insurance written includes insurance written from flow production and structured bulk transactions.

      Flow insurance written for 2004 decreased 36.7% to $10.5 billion from $16.6 billion in 2003. We experienced record levels of production in 2003 due to the lower interest rate environment in that year that contributed to a very strong refinance market. Refinances comprised 29.9% of our flow insurance written in 2004 compared to 51.5% in 2003. Loan originations for the entire industry declined approximately 27% in 2004, primarily due to this drop in refinancing activity. The Mortgage Bankers Association anticipates an even smaller loan origination market for 2005 compared to 2004. This is due in part to the continued decline in refinancing activity, as borrowers have previously locked in lower rates and terms than are expected to be available in 2005. Further, the continued expansion of alternative credit enhancements such as 80/10/10 structures (a combination of an 80% first mortgage loan, a 10% second mortgage loan usually issued by the same lender, and a 10% down payment) continues to erode the mortgage insurance industry’s overall penetration into the mortgage marketplace. We believe that the increasing use of these alternative credit enhancements will moderate new flow business in 2005. However, should interest rates rise, these types of arrangements will become less attractive to borrowers.

      Insurance written in 2004 attributable to structured bulk transactions totaled $6.7 billion compared to $3.9 billion in 2003 as we continued our strategic commitment to that market. Insurance written attributed to structured bulk transactions is likely to vary significantly from period to period due to: a) the limited number of transactions (but with larger size) occurring in this market, b) the level of competition from other mortgage insurers, c) the relative attractiveness in the marketplace of mortgage insurance versus other forms of credit enhancement, and d) the changing loan composition and underwriting criteria of the market.

      Although terms vary, the structured bulk market can be broadly categorized into three different segments, or tiers, depending on the risk characteristics of the loans comprising a transaction. The loan characteristics of the three segments are a) predominantly high credit quality, low loan to value (LTV), fully underwritten loans that may have niche characteristics such as non-conforming loan balances and risk concentrations related to geography, transaction purpose, or occupancy type; b) loans that generally have high credit quality and low to moderate LTVs that have been underwritten with reduced, streamlined, or no documentation; and c) generally fully underwritten loans with credit impaired borrowers (FICO credit score less than 575). In general, we believe that structured bulk business originated in segments b) and c) will report a higher default rate than our flow business. However, we also believe that the lower LTVs associated with the structured bulk business originated in segments a) and b) will ultimately generate lower claim rates as a proportion of the reported defaults and lower levels of severity than flow business. We have entered into structured bulk transactions primarily in the first two segments mentioned above. At December 31, 2004, only approximately 1% of our insurance in force attributable to structured bulk transactions is categorized in segment c) above.

      The following table provides estimates of our national market share of net new primary insurance written based on information available from the industry association and other public sources:

      Our market share of flow business declined slightly in 2004 from 2003 due to the decline in production of a product driven primarily by the refinance segment. The increase in our structured bulk transactions market share shown above was the result of the greater availability of transactions that met our credit quality and pricing benchmarks on which we were able to successfully bid.

      Periodically we enter into structured bulk transactions involving loans that have insurance effective dates within the current reporting period but for which detailed loan information regarding the insured loans is not provided by the issuer of the transaction until later. When this situation occurs, we accrue premiums that are due but not yet paid based upon the estimated commitment amount of the transaction in the reporting period with respect to each loan’s insurance effective date. However, the policies are not reflected in our in force, insurance written, or related industry data totals until the loan level detail is reported to us. At December 31, 2004, we had approximately $0.7 billion of structured transactions with effective dates within the fourth quarter for which loan level detail had not been received and, therefore, are not included in our own data or industry totals. These amounts will be reported as new production and insurance in force totals in 2005 when the issuer of the transactions provides loan level detail to us. We have properly included in premium written and premium earned the respective estimated amounts due and earned during 2004 related to this insurance.

      Total direct insurance in force reached $36.8 billion at December 31, 2004, compared to $31.7 billion at December 31, 2003 as a result of continued production and an improvement in persistency. The following table shows our persistency rates for our flow and structured bulk business at December 31, 2004 and 2003:

      The increase in persistency rates over the 2003 levels was primarily due to the decline in refinance activity described above. If current interest rate levels persist or increase further, we anticipate continuing, although slowing, improvements in persistency in 2005. However, persistency will be adversely affected if rates decline significantly from current levels.

      Our direct insurance in force grew 16.1% from December 31, 2003 to December 31, 2004, and the credit quality of our in force portfolio has remained relatively consistent. As shown below, the credit quality of our structured bulk business at December 31, 2004 has improved over December 31, 2003 as we have focused our efforts on transactions consisting of higher quality loans. FICO credit scores are one of the major factors used in assessing credit risk. The following table presents the FICO credit score distribution of our risk in force for both flow and structured bulk business at December 31, 2004 and 2003.

      As the table shows, we insure some loans that have FICO credit scores below 575. We believe that these loans have a higher probability of loss than a loan with a FICO credit score of 575 or greater. We do not expect loans with FICO scores less than 575 to become a significant portion of our insurance in force.

      Total direct premiums written were $176.7 million for 2004, an increase of 14.7% compared to $154.0 million for 2003. This increase was driven by a $31.3 million increase in direct renewal premiums written, partially offset by a $8.6 million decline in direct initial premiums. As mentioned earlier, increased persistency was the primary factor that caused the increase in renewal premiums in 2004. Lower mortgage

originations for the industry caused by lower levels of refinancings and the increased popularity of the alternative credit enhancements described earlier caused the decline in direct initial premiums.

      Net premiums written increased 11.5% to $141.3 million in 2004 over $126.7 million in 2003. The difference between direct premiums written and net premiums written is ceded premium. Ceded premium is comprised of premiums written under excess of loss reinsurance treaties with captive as well as non-captive reinsurance companies. Driven by an increase in the amount of premium subject to captive reinsurance arrangements, ceded premiums written increased 29.5% to $35.4 million in 2004 from $27.3 million in 2003. The following table provides further data on ceded premiums for the years ended December 31, 2004 and 2003:

      During 2004, 55.8% of flow insurance written and 33.9% of total insurance written was subject to captive reinsurance arrangements, compared to 46.1% of flow insurance written and 37.3% of total insurance written in 2003. The increase in the percentage of flow insurance written subject to captive reinsurance arrangements is primarily a result of decreased production in our lender-paid mortgage insurance program that is generally not subject to captive reinsurance arrangements. Additionally, none of our insurance written in 2004 and 2003 attributable to structured bulk transactions was subject to captive reinsurance arrangements.

      At December 31, 2004, 56.6% of direct flow insurance in force and 43.3% of total direct insurance in force was subject to captive reinsurance arrangements, compared to 51.5% and 43.6% of total insurance in force at December 31, 2003. None of our insurance in force under structured bulk transactions is subject to captive reinsurance arrangements.

      We believe captive reinsurance arrangements are an effective risk management tool as selected lenders share in the risk under such arrangements. Additionally, captive reinsurance arrangements are structured so that Triad receives capital relief in certain risk-based capital models utilized by rating agencies. We remain committed to the concept of captive reinsurance arrangements, including deep ceded arrangements where the net premium cede rate is greater than 25%, on a lender-by-lender basis as we deem it to be prudent. We will continue to be an active participant with our lender partners in structures utilizing alternative attachment points, risk bands, cede rates, and ceding commissions.

      Earned premiums increased 17.8% to $141.0 million for 2004 from $119.7 million for 2003. The difference between net written premiums and earned premiums is the change in the unearned premium reserve. Our unearned premium liability increased $0.3 million from December 31, 2003 to December 31, 2004 compared to an increase of $7.1 million from December 31, 2002 to December 31, 2003. The growth in 2003 was the result of growth in sales of products with premiums paid on an annual basis during that year. Direct written premium from the annual premium product represented 15.5% of direct premium written in both 2004 and 2003.

      As mentioned earlier, assuming interest rates do not decline, we anticipate our persistency will continue to improve. This improvement should have a positive effect on renewal earned premiums and total earned premiums in 2005.

      Net investment income for 2004 grew 15.6% over 2003 primarily due to the growth in average invested assets, partially offset by a decline in portfolio yields. Average invested assets at cost or amortized cost grew by 17.7% in 2004 over 2003 as a result of the investment of cash flows from operations throughout the year. Our

investment portfolio tax-equivalent yield declined to 6.99% at December 31, 2004 from 7.13% at December 31, 2003.

      Net realized investment gains/(losses), except for write-downs on other-than-temporarily impaired securities, are the result of our discretionary dispositions of investment securities in the context of our overall portfolio management strategies and are likely to vary significantly from period to period. Write-downs on other-than-temporarily securities were approximately $0.5 million in 2004 compared to $0.8 million in 2003. See further discussion of impairment write-downs in the Realized Gains, Losses and Impairments section below.

      Net losses and loss adjustment expenses (net of reinsurance recoveries) increased 50.5% in 2004 over 2003. This increase was due to the growth in the number of delinquencies and paid losses and is reflective of our overall growth of insurance in force and the seasoning of our in force business. Net paid losses, excluding loss adjustment expenses, increased to $28.3 million for 2004 from $17.5 million for 2003, an increase of 61.7%. Average severity (direct paid losses divided by number of claims paid) for all loans combined was approximately $24,200 for 2004 compared to $24,100 for 2003. However, the average severity on structured bulk loans was $23,800 for 2004 compared to $21,100 for 2003. The following table provides detail on direct paid losses for our flow business and structured bulk business for the years ended December 31, 2004 and 2003 (in thousands):

      The increase in paid losses is consistent with our expectations as a greater amount of our insurance in force reaches its anticipated highest claim frequency years. Due to the growth of our inforce business, we believe direct paid losses for both flow and structured bulk business will continue to increase in 2005, although somewhat less than the 2004 growth rate.

      Net losses and loss adjustment expenses also includes the change in reserves for losses and loss adjustment expenses. The following table shows further detail about the Company’s loss reserves at December 31, 2004 and 2003 broken out by flow business and structured bulk business (in thousands):

      In 2004 and 2003, 81% and 60%, respectively, of our structured bulk production was structured with deductibles that put us in the second loss position, which we expect to moderate the loss development in the bulk portfolio. Prior to the fourth quarter of 2004, there was only a small amount of reported defaults on the

structured bulk production that included deductibles. Beginning in fourth quarter 2004 as the loss development pattern began to emerge on these books with deductibles, we began taking these deductibles into consideration when calculating our reserves and did not establish reserves for those claims on which we were in the second loss position.

      The following table shows our loss ratios (the ratio of incurred losses and loss adjustment expense to premiums earned) for our flow business and our structured bulk business for the years ended December 31, 2004 and 2003:

      The increase in the loss ratio for the flow business shown above is consistent with our expectations, again, as a greater amount of our insurance in force reaches its anticipated highest claim frequency years. For our structured bulk business, the deductible structures put in place over the past two years have caused the decline in the loss ratio.

      As of December 31, 2004 and 2003, approximately 91% and 92% of our insurance in force was originated in the previous 36 months. Based upon our experience and industry data, we believe that claims incidence for flow business is generally highest in the third through sixth years after loan origination. We believe that the period of highest claims incidence for structured bulk transactions is generally highest in the second through fourth years after loan origination. 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. The factors most significant to our loss development will continue to be the level of new delinquent loans and their subsequent cure performance. Because of the growth of our inforce business, we believe the number of loans in default for both flow and structured bulk business will increase, although moderating from the 2004 growth level. The following table indicates the growth of the number of loans in default at December 31:

      Amortization of DAC decreased by 21.3% in 2004 from 2003 and is reflective of the increase in persistency experienced in 2004. A full discussion of the impact of persistency on DAC amortization is included in the Deferred Policy Acquisition Costs section below.

      The increase in other operating expenses in 2004 over 2003 of 16.3% is relatively consistent with our growth in the insurance in force. Further, we experienced increased expenses in 2004 related to compliance with the Sarbanes-Oxley requirements and other compliance oriented expenses that we do not expect to repeat at the same level in 2005. We have made substantial investments in technology that allow for growth in both our flow and structured bulk business without proportional increases in operating expenses. The expense ratio (ratio of the amortization of deferred policy acquisition costs and other operating expenses to net premiums written) for 2004 was 28.8% compared to 32.3% for 2003. The improvement in the expense ratio for 2004 was due primarily to the decrease in DAC amortization expense mentioned above.

      Our effective tax rate was 28.7% for 2004 and 29.4% for 2003. The decrease in the effective tax rate is due primarily to an increase in tax-exempt interest resulting from a higher percentage of assets being invested in tax-preferred municipal securities. We expect our effective tax rate to remain near current levels or increase slightly as we expect earned premium to grow faster than tax-preferred income.

2003 Compared to 2002

      Net income for 2003 increased 13.3% over 2002 to $51.1 million. Net income per share on a diluted basis increased 11.9% to $3.52 for 2003 from $3.15 per share for 2002. This improvement in net income was driven by a 14.0% increase in earned premiums and a 6.1% increase in net investment income. Net income for 2003 included after-tax net realized investment gains of $2.0 million, while net income for 2002 included after tax net realized investment losses of $1.6 million.

      Total insurance written in 2003 was $20.5 billion compared to $13.4 billion in 2002, an increase of 52.5%. Flow insurance written for 2003 increased 36.0% to $16.6 billion from $12.2 billion in 2002. This increase was primarily the result of expanding relationships with national lenders, strong demand for risk-sharing arrangements and other product offerings, and a lower interest rate environment that contributed to a very strong refinance market. Insurance written in 2003 attributable to structured bulk transactions totaled $3.9 billion compared to $1.2 billion in 2002. The jump in structured bulk transactions written was driven by a robust growth in the overall bulk marketplace in 2003 coupled with our renewed strategic commitment to that market. As described above, insurance written attributed to structured bulk transactions is likely to vary significantly from period to period.

      The following table provides estimates of our national market share of net new primary insurance written based on information available from the industry association and other public sources:

      Total direct insurance in force reached $31.7 billion at December 31, 2003, compared to $25.4 billion at December 31, 2002. Significant refinance activity in 2003 and 2002 resulted in a high level of policy cancellations that substantially offset the impact that the high level of insurance written had on in force growth. As a result, insurance in force increased by only $6.3 billion in 2003, even though insurance written during 2003 was $20.5 billion. The following table shows our persistency rates for our flow and structured bulk business at December 31, 2003 and 2002:

      Refinance activity was 52.1% of insurance written in 2003 compared to 40.1% in 2002. The high level of refinance activity and the resulting decrease in persistency was reflective of the low interest rate environment that was in place during 2003.

      The following table presents the FICO credit score distribution of our risk in force for both flow and structured bulk business at December 31, 2003 and 2002.

      Total direct premiums written were $154.0 million for 2003, an increase of 24.0% compared to $124.2 million for 2002. Net premiums written increased by 19.7% to $126.7 million in 2003 from $105.9 million for 2002. Contributing to the increase in premiums written for 2003 were significant writings under our annual premium payment plan. During 2003, 34% of total insurance written was under the annual premium payment plan compared to 18% of total insurance written during 2002.

      Driven by an increase in the amount of premium subject to captive reinsurance arrangements, ceded premiums written increased 48.9% to $27.3 million in 2003 from $18.3 million in 2002. The following table provides further data on ceded premiums for the years ended December 31, 2003 and 2002:

      During 2003, 46.1% of flow insurance written and 37% of total insurance written was subject to captive reinsurance arrangements compared to 51% of flow insurance written and 46% of total insurance written in 2002. The decline in the percentage of flow insurance written subject to captive reinsurance arrangements from 2002 to 2003 was primarily a result of increased production in our lender-paid mortgage insurance program that was not subject to captive reinsurance arrangements.

      Approximately 54.2% of direct flow insurance in force (43.6% of total insurance in force) was subject to captive reinsurance arrangements at December 31, 2003, compared to 51.6% (45.7% of total insurance in force) at December 31, 2002. This increase was due primarily to the increased market penetration of our captive reinsurance arrangements and the high level of refinance activity in 2003, as policies that were previously not subject to captive reinsurance arrangements refinanced and new policies issued were subject to captive reinsurance arrangements.

      Earned premiums increased 14.0% to $119.7 million for 2003 from $105.1 million for 2002. The difference between net written premiums and earned premiums in 2003 was due to the significant writings of our annual premium product and the related increase in the unearned premium reserve. Our unearned premium liability increased to $15.6 million at December 31, 2003, from $8.5 million at December 31, 2002. Direct written premium from the annual premium product represented 15.5% of direct premium written in 2003 compared to 7.0% of direct premium written in 2002. The growth in written and earned premiums resulted from strong levels of new insurance written offset by the impact of a low level of persistency and by the increase in ceded premiums.

      Net investment income for 2003 was $17.1 million, a 6.1% increase over $16.1 million in 2002. Average invested assets at cost or amortized cost grew by $60 million to $364 million for the year ended December 31, 2003, an increase of 19.9% from $304 million for 2002. The increase in average invested assets was attributable

to the investment of funds derived from cash flows from operations in 2003. The percentage increase in net investment income was much lower than the percentage increase in invested assets primarily due to a decrease in investment yields.

      We reported $3.0 million of net realized investment gains during 2003 and $2.5 million of net realized investment losses during 2002. Net realized gains during 2003 included approximately $0.8 million of impairment writedowns. The writedowns primarily involved securities in the automotive, energy, and pharmaceutical sectors as well as a commercial mortgage-backed security.

      Net incurred losses and loss adjustment expenses (net of reinsurance recoveries) increased by 69.5% in 2003 to $23.8 million from $14.1 million in 2002. The increase in losses and loss adjustment expenses was reflective of our overall growth of insurance in force, relative growth of our participation in the bulk market, and the seasoning of our in force business. Net paid losses, excluding loss adjustment expenses, increased to $17.5 million during 2003 from $10.3 million during 2002, an increase of 70.3%. Average severity was approximately $24,100 for 2003 compared to $21,400 for 2002. The following table provides detail on direct paid losses from flow business and structured bulk business for the years ended December 31, 2003 and 2002 (in thousands):

      The following table showing further detail about the Company’s loss reserves at December 31, 2003 and 2002 broken out by flow business and structured bulk business (in thousands):

      The following table shows our loss ratios for our flow business and our structured bulk business for the years ended December 31, 2003 and 2002:

      The increases in the loss ratios shown above were consistent with the growth of our overall insurance in force, relative growth of our participation in the structured bulk market and the seasoning of our in force business.

      Amortization of DAC increased by 31.8% to $18.1 million in 2003 from $13.7 million for 2002. The increase reflects growth in DAC related to the expansion of our insurance in force and accelerated amortization due to higher cancellations from refinance activity in 2003. Low persistency levels during 2003 and 2002 resulted in additional amortization of deferred policy acquisition costs through dynamic adjustments totaling $5.5 million in 2003 and $2.6 million in 2002.

      Other operating expenses decreased 0.5% to $22.8 million for 2003 from $22.9 million for 2002. The expense ratio for 2003 was 32.3% compared to 34.6% for 2002. The expense ratio for 2003 improved because other operating expenses decreased and net written premium increased, offset somewhat by the accelerated amortization of DAC.

      Our effective tax rate was 29.4% for 2003 and 30.9% for 2002. The decrease in the effective tax rate was due primarily to an increase in tax-exempt interest resulting from a higher percentage of assets being invested in tax-preferred municipal securities.

Significant Customers

      Our objective is controlled, profitable growth in both the flow and bulk arenas while adhering to our risk management strategies. Our strategy is to continue our focus on national lenders while maintaining the productive relationships that we have built with regional lenders. Our ten largest customers were responsible for 71%, 74%, and 73% of flow insurance written during 2004, 2003, and 2002, respectively. Our two largest customers were responsible for 55%, 58%, and 53% of flow insurance written during 2004, 2003, and 2002, respectively. The loss of one or more of these significant customers could have an adverse effect on our business.

Financial Position

      Total assets increased to $672 million at December 31, 2004, a 17% growth over the same date in 2003, primarily the result of growth in invested assets. Total liabilities increased to $235 million at December 31, 2004, from $206 million in 2003, primarily driven by an increase in deferred tax liabilities. This section identifies several items on our balance sheet that are important in the overall understanding of our financial position. These items include deferred policy acquisition costs, prepaid federal income tax and related deferred income taxes, and loss and loss adjustment expense reserves. Our mortgage insurance operations and reserves are primarily supported by our investment portfolio. The majority of our assets are contained in the investment portfolio. A separate Investments section follows the Financial Position section and reviews our investment portfolio, key portfolio management strategies, and methodologies by which we manage credit risk.

      Costs expended to acquire new business are capitalized as DAC and recognized as expense over the anticipated premium paying life of the policy. We employ a dynamic model that calculates amortization of DAC separately for each book year of business. The model relies on assumptions that we make based upon historical industry experience and our own unique experience regarding the annual persistency development of each book year. Persistency is the most important assumption utilized in determining the timing of reported amortization expense reflected in the income statement and the carrying value of DAC on the balance sheet. A change in the assumed persistency can impact the current and future amortization expense as well as the carrying value on the balance sheet. Our model accelerates DAC amortization through a dynamic adjustment when actual persistency for a book year is lower than the estimated persistency originally utilized in the model. This dynamic adjustment is capped at the levels assumed in the models, and we do not decrease DAC amortization below the levels assumed in the model when persistency increases above those levels. The dynamic adjustment effectively adjusts the estimated policy life originally utilized in the model to a revised policy life based upon the current actual persistency.

      In 2003 as the amount of structured bulk transactions grew, we revised our DAC models to separate the costs capitalized and the amortization streams between transactions arising from structured bulk and the flow business. Generally, structured bulk transactions have significantly less acquisition costs associated with the production of the business and they also have a shorter original estimated policy life. We apply the dynamic adjustment utilizing the same methodology to the separate structured bulk DAC models. At December 31, 2004 and 2003, net unamortized DAC relating to structured bulk transactions amounted to 5.4% and 4.8% of the total DAC on the balance sheet.

      The following table shows the DAC asset for the previous three years and the effect of persistency on amortization (dollar amounts in thousands):

      Low persistency levels during the past three years have caused accelerated DAC amortization. If persistency continues to improve in 2005, we would expect the accelerated DAC amortization to continue to moderate, depending on the level of improvement. Otherwise, we will continue to experience increased DAC amortization through the dynamic adjustment. Differences in persistency in the flow and structured bulk portfolios will not have the same impact on their respective DAC amortization because of the lower balance and the shorter estimated policy life on structured bulk transactions. See further information on the accounting for DAC in Note 1 in the Notes to Consolidated Financial Statements.

      We purchase ten-year non-interest bearing United States Mortgage Guaranty Tax and Loss Bonds (“Tax and Loss Bonds”) in lieu of paying current federal income taxes to take advantage of a special contingency reserve deduction for mortgage guaranty companies. We record these bonds on our balance sheet as prepaid federal income taxes. Purchases of Tax and Loss Bonds are essentially a prepayment of federal income taxes that will become due in ten years when the contingency reserve is released, and the Tax and Loss Bonds mature. Prepaid income taxes were $119.1 million and $98.1 million at December 31, 2004 and 2003. The change from year to year approximates the change in deferred income tax liability for the year.

      Deferred income taxes are provided for the differences in reporting taxable income in the financial statements and on the tax return. These cumulative differences are enumerated in Note 6 in the Notes to Consolidated Financial Statements. The largest cumulative difference is the special contingency reserve deduction for mortgage insurers mentioned above. The remainder of the deferred tax liability has primarily arisen from book and tax reporting differences related to deferred policy acquisition costs and unrealized investment gains.

      We calculate our best estimate of reserves to provide for the estimated costs of settling claims on loans reported in default and loans in default that are in the process of being reported to us, utilizing various factors that have been developed and tested over time. With respect to loans reported in default, loss and loss adjustment expense reserves are established when notices of default are received. Consistent with industry practices, we do not establish loss reserves for future claims on insured loans that are not currently in default.

Our reserving methodology focuses on the determination of a loss severity factor and a projected claim rate (frequency factor) for each reported delinquent loan category at the valuation date.

      We analyze various components in determining the loss severity factor, including the baseline severity, policy year, geography and salvage recoverable. In determining the frequency factor, we focus our analysis on the policy year/policy age, the number of previous reported defaults to identify chronic late payers, and the number of months that the payment is past due. We utilize historical long-term performance in our reserving methodology and adjust our factors for current economic events when we believe the events will significantly impact the long-term loss development. For these reasons, there may be fluctuations in the reserve factors utilized from year to year. Further, we analyze individual defaults within structured bulk transactions to determine whether the business was written with a deductible that would put us in a second loss position. Until the projected loss reserve for the aggregate defaults within a transaction structured with a deductible exceed a pre-established threshold, no reserves are established. Because the estimate for loss reserves is sensitive to the estimates of claims frequency and severity, we perform analyses to test the reasonableness of the best estimate generated by the loss reserve process. Adjustments to reserve estimates are reflected in the financial statements in the periods in which the adjustments are made.

      Our loss and loss adjustment expense reserves increased to $34.0 million at December 31, 2004 from $27.2 million at December 31, 2003. Note 4 in the Notes to the Consolidated Financial Statements contains a roll forward of these amounts for the last three years showing the incurred losses and the actual payments for the current and prior years. During the fourth quarter of 2003, claim severity had increased, particularly on paid claims related to structured bulk transactions from the 2001 and 2002 book years. At that time, we concluded that these extremely limited amount of actual claim payments related to the 2001 and 2002 bulk book years did not constitute a long-term trend and we did not adjust the severity factors during 2003. During of the first half of 2004, we continued to experience adverse severity trends on claims paid, particularly on the 2001 and 2002 structured bulk book years. Additionally, during the first half of 2004, we settled some flow claims with extended delinquency periods at amounts that exceeded our expectations based upon the factors in place at the end of 2003.. As a result of these two factors reflecting both prior structured bulk and flow books, we increased our severity factors utilized in our reserve calculations in 2004. This action also contributed to the recognized deficiency in 2004. A redundancy in reserves is shown for 2003 and 2002. These redundancies resulted principally from settling case-basis reserves on default notices occurring in prior years for amounts less than expected. Over 81% of our insurance in force was written within the last two years.

      Experience indicates that years three through six have the highest incidence of defaults. Because of this fact, we expect loss reserves to continue to grow, reflecting the growth and aging of our insurance in force. However, we anticipate the increase in the loss reserves to be moderated somewhat as the number of structured bulk transactions with deductibles incorporated into the risk structure continues to increase. Based upon the current and reasonable estimates of future economic conditions, we expect cash flows from operations to be sufficient to cover the anticipated increase in expected claim payments.

      The following table shows default statistics as of December 31, 2004, and 2003.

      The number of loans in default reported above includes all reported delinquencies that are in excess of two payments in arrears at the reporting date and all reported delinquencies that were previously in excess of two payments in arrears and have not been brought current. The increase in the default rate for flow business is attributable primarily to the maturing of the flow portfolio for reasons consistent with the increase in reserves explained above. The default occurrences for both flow business and structured bulk business are consistent with management’s expectation.

Investment Portfolio

      We manage our investment portfolio to meet or exceed regulatory and rating agency requirements. We invest for the long term, and most of our investments are held until they mature. Our investment portfolio includes primarily fixed income securities, and the majority of these are tax-preferred state and municipal bonds. We have established a formal investment policy that describes our overall quality and diversification objectives and limits. Our investment policies and strategies are subject to change depending upon regulatory, economic, and market conditions as well as our existing financial condition and operating requirements, including our tax position. While we invest for the long term and most of our investments are held until they mature, we classify our entire investment portfolio as available for sale. This classification allows us the flexibility to dispose of securities in order to meet our investment strategies and operating requirements. All investments are carried on our balance sheet at fair value.

      The following schedule shows the growth and diversification of our investment portfolio (dollars in thousands).

      We seek to provide liquidity in our investment portfolio through cash equivalent investments and through diversification and investment in publicly traded securities. We attempt to maintain a level of liquidity and duration in our investment portfolio consistent with our business outlook and the expected timing, direction, and degree of changes in interest rates. See Note 2 in Notes to Consolidated Financial Statements that describes the scheduled maturity of our fixed maturity investments. The duration to maturity of the fixed maturity portfolio was 10.6 years at December 31, 2004 compared to 11.2 years at December 31, 2003.

      Another way that we manage risk and liquidity is to limit our exposure on individual securities. The following table shows the ten largest exposures to an individual creditor in our investment portfolio as of December 31, 2004 (dollars in thousands):

      As shown above, no investment in the securities of any single issuer exceeded 2% of our investment portfolio at December 31, 2004.

      The following table shows the results of our investment portfolio for the last three years (dollars in thousands).

      The drop in the effective pre-tax yield shown above reflects the decrease in new money rates available for investment coupled with our strategies to increase the overall credit quality of the portfolio and increase our investment in state and municipal bonds.

      The following table summarizes by category our unrealized gains and losses in our securities portfolio at December 31, 2004 (in thousands):

      These unrealized gains and losses do not necessarily represent future gains or losses that we will realize. Changing conditions related to specific securities, overall market interest rates, or credit spreads, as well as our decisions concerning the timing of a sale, may impact values we ultimately realize. We monitor unrealized losses through further analysis according to maturity date, credit quality, individual creditor exposure and the length of time the individual security has continuously been in an unrealized loss position. Of the gross unrealized losses on fixed maturity securities shown above, approximately $327,000 related to bonds with a maturity date in excess of ten years. The largest individual unrealized loss on any one security at December 31, 2004 was approximately $105,000 on a bond with an amortized cost of $2.0 million. Gross unrealized gains and losses at December 31, 2003 were $18.0 million and $(0.8) million, respectively.

      Credit risk is inherent in an investment portfolio. We manage this risk through a structured approach to internal investment quality guidelines and diversification while assessing the effects of the changing economic

landscape. One way we attempt to limit the inherent credit risk in the portfolio is to maintain investments with high ratings. The following table shows our investment portfolio by credit ratings (dollars in thousands).