Loss Reserves

We establish reserves to recognize the estimated liability for losses and loss adjustment expenses (“LAE”) related to defaults on insured mortgage loans. Loss reserves are established by estimating the number of loans in our inventory of delinquent loans that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity.

Estimation of losses is inherently judgmental. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment, and the current and future strength of local housing markets. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrower income and thus their ability to make mortgage payments, and a drop in housing values which may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Changes to our estimates could result in a material impact to our results of operations and capital position, even in a stable economic environment.

The following table provides a reconciliation of beginning and ending loss reserves for the nine months ended September 30, 2015 and 2014:



	Nine months ended September 30,
	2015			2014
	(In thousands)

Reserve at beginning of period	$	2,396,807		$	3,061,401
Less reinsurance recoverable	57,841			64,085
Net reserve at beginning of period	2,338,966			2,997,316

Losses incurred:
Losses and LAE incurred in respect of default notices related to:
Current year	338,611			454,390
Prior years (1)	(90,130		)	(75,387		)
Subtotal	248,481			379,003

Losses paid:
Losses and LAE paid in respect of default notices related to:
Current year	9,227			11,574
Prior years	652,465			895,061
Reinsurance terminations (2)	(15,440		)	—
Subtotal	646,252			906,635

Net reserve at end of period	1,941,195			2,469,684
Plus reinsurance recoverables	38,748			57,898

Reserve at end of period	$	1,979,943		$	2,527,582


(1)	A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves and a positive number for prior year losses incurred indicates a deficiency of prior year loss reserves.

(2)

In a termination or commutation, the reinsurance agreement is cancelled, with no future premium ceded and funds for any incurred but unpaid losses transferred to us. The transferred funds result in an increase in our investment portfolio (including cash and cash equivalents) and a decrease in net losses paid (reduction in losses incurred). In addition, there is an offsetting decrease in the reinsurance recoverable (increase in losses incurred), and thus there is no net impact to losses incurred.

The “Losses incurred” section of the table above shows losses incurred on default notices received in the current year and in prior years. The amount of losses incurred relating to default notices received in the current year represents the estimated amount to be ultimately paid on such default notices. The amount of losses incurred relating to default notices received in prior years represents the actual claim rate and severity associated with those default notices resolved in the current year differing from the estimated liability at the prior year-end, as well as a re-estimation of amounts to be ultimately paid on defaults remaining in inventory from the end of the prior year. This re-estimation of the estimated claim rate and estimated severity is the result of our review of current trends in the default inventory, such as percentages of defaults that have resulted in a claim, the amount of the claims, changes in the relative level of defaults by geography and changes in average loan exposure.

Losses incurred on default notices received in the current year decreased in the first nine months of 2015 compared to the same period in 2014, primarily due to a decrease in the number of new default notices received, net of related cures, as well as a decrease in the estimated claim rate on new delinquencies.

The prior year development of the reserves in the first nine months of 2015 and 2014 is reflected in the table below.



	Nine months ended September 30,
	2015			2014
	(In millions)
Decrease in estimated claim rate on primary defaults	$	(95	)	$	(38	)
Increase in estimated severity on primary defaults	12			(20		)
Change in estimates related to pool reserves, LAE reserves and reinsurance	(7		)	(17		)
Total prior year loss development (1)	$	(90	)	$	(75	)


(1)	A negative number for prior year loss development indicates a redundancy of prior year loss reserves, and a positive number indicates a deficiency of prior year loss reserves.

For the nine months ended September 30, 2015 and 2014 we experienced favorable prior year loss reserve development. This development was primarily due to a lower claim rate on the approximately 52% and 50% of prior year default inventory that was resolved during the nine months ended September 30, 2015 and 2014, respectively. In addition, during the first nine months of 2015, the claim rate development was favorably impacted by $21 million due to re-estimation of previously recorded reserves relating to disputes on our claims paying practices and adjustments to incurred but not reported losses (IBNR). This favorable development was offset, in part, by an increase in the claim rate and severity on prior year defaults remaining in the delinquent inventory.

The “Losses paid” section of the table above shows the breakdown between claims paid on default notices received in the current year and claims paid on default notices received in prior years. Until a few years ago, it took, on average, approximately twelve months for a default that is not cured to develop into a paid claim. Over the past several years, the average time it takes to receive a claim associated with a default has increased. This is, in part, due to new loss mitigation protocols established by servicers and to changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation processes. It is difficult to estimate how long it may take for current and future defaults that do not cure to develop into paid claims.

The liability associated with our estimate of premiums to be refunded on expected claim payments is accrued for separately at September 30, 2015 and December 31, 2014 and approximated $105 million and $115 million, respectively. Separate components of this liability are included in “Other liabilities” and, for December 31, 2014, “Premium deficiency reserve” on our consolidated balance sheet. Changes in the liability affect premiums written and earned and change in premium deficiency reserve.

A rollforward of our primary default inventory for the three and nine months ended September 30, 2015 and 2014 appears in the table below. The information concerning new notices and cures is compiled from monthly reports received from loan servicers. The level of new notice and cure activity reported in a particular month can be influenced by, among other things, the date on which a servicer generates its report, the number of business days in a month and transfers of servicing between loan servicers.



	Three months ended September 30,				Nine months ended September 30,
	2015		2014		2015		2014
Default inventory at beginning of period	66,357		85,416		79,901		103,328
New notices	19,509		22,927		55,856		67,451
Cures	(17,036	)	(19,582	)	(56,700	)	(68,082	)
Paids (including those charged to a deductible or captive)	(3,958	)	(5,288	)	(12,671	)	(18,420	)
Rescissions and denials	(230	)	(319	)	(623	)	(1,123	)
Items removed from inventory resulting from the Countrywide settlement on GSE loans	—		—		(1,121	)	—
Default inventory at end of period	64,642		83,154		64,642		83,154

Pool insurance notice inventory was 2,950 at September 30, 2015 and 4,525 at September 30, 2014.

The decrease in the primary default inventory experienced during 2015 and 2014 was generally across all markets and primarily in book years 2008 and prior. As of September 30, 2015 the percentage of loans in the inventory that have been in default for 12 or more consecutive months has declined compared with the prior year end and one year prior, as shown in the table below. Historically as a default ages it becomes more likely to result in a claim. The percentage of loans that have been in default for 12 or more consecutive months and the number of loans in our primary claims received inventory have been affected by our suspended rescissions and the resolution of certain of those rescissions discussed below and in Note 5 – “Litigation and Contingencies.”



	September 30, 2015			December 31, 2014			September 30, 2014
Consecutive months in default
3 months or less	13,991	22	%	15,319	19	%	16,209	19	%
4 - 11 months	14,703	23	%	19,710	25	%	18,890	23	%
12 months or more	35,948	55	%	44,872	56	%	48,055	58	%

Total primary default inventory	64,642	100	%	79,901	100	%	83,154	100	%

Primary claims received inventory included in ending default inventory (1)	2,982	5	%	4,746	6	%	5,194	6	%


(1)	Our claims received inventory includes suspended rescissions, as we have voluntarily suspended rescissions of coverage related to loans that we believed would be included in a potential resolution. As of September 30, 2015, rescissions of coverage on approximately 430 loans had been voluntarily suspended compared to 1,425 at December 31, 2014 and 1,575 at September 30, 2014.

The number of months a loan is in the default inventory can differ from the number of payments that the borrower has not made or is considered delinquent. These differences typically result from a borrower making monthly payments that do not result in the loan becoming fully current. The number of payments that a borrower is delinquent is shown in the table below.



	September 30, 2015			December 31, 2014			September 30, 2014
Number of payments delinquent
3 payments or less	20,637	32	%	23,253	29	%	23,769	28	%
4 - 11 payments	14,890	23	%	19,427	24	%	18,985	23	%
12 payments or more	29,115	45	%	37,221	47	%	40,400	49	%

Total primary default inventory	64,642	100	%	79,901	100	%	83,154	100	%

Claims paying practices

Our loss reserving methodology incorporates our estimates of future rescissions. A variance between ultimate actual rescission rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses.

The liability associated with our estimate of premiums to be refunded on expected future rescissions is accrued for separately. At September 30, 2015 and December 31, 2014 the estimate of this liability totaled $7 million and $28 million, respectively. Separate components of this liability are included in “Other liabilities” and, for December 31, 2014, “Premium deficiency reserve” on our consolidated balance sheets. Changes in the liability affect premiums written and earned and change in premium deficiency reserve.

For information about discussions and legal proceedings with customers with respect to our claims paying practices, including settlements that we believe are probable, as defined in ASC 450-20, see Note 5 – “Litigation and Contingencies.”