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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2003

OR

For the transition period from              to             

Commission file number 1-11356

RADIAN GROUP INC.

(Exact name of registrant as specified in its charter)

(215) 564-6600

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: YES x  NO ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of 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. ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

YES x  NO ¨

State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $3,423,094,000 as of June 30, 2003, 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).

(APPLICABLE ONLY TO CORPORATE REGISTRANTS)

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 94,331,880 shares of Common Stock, $.001 par value, outstanding on March 4, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424 (b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).

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Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information that are based on the Company’s beliefs, certain assumptions made by the Company, forecasts of future results and current expectations, estimates and projections about the markets and economy in which the Company and its various segments operate. The words “anticipate,” “intend,” “may,” “expect,” “believe,” “should,” “plan,” “will” and “estimate” and variations of such words and similar expressions are also used to identify forward-looking statements. The forward-looking statements are not guarantees of future performance and involve uncertainties and assumptions which are difficult to predict, many of which are beyond the Company’s control. Future events and actual outcomes may differ materially from those matters expressed or implied in such forward-looking statements. The following are some of the factors that could cause actual outcomes to differ materially from the matters expressed or implied in the Company’s forward-looking statements. Readers are also directed to risks discussed in other documents filed by the Company with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on the Company’s forward-looking statements, which speak only as of their respective dates.

All capitalized terms used but not defined below are defined in Part I, Item 1—“Business” of this report.

General economic factors may adversely affect the Company’s loss experience and the demand for mortgage insurance and financial guaranties.

The Company’s business, and the risks associated with the business, tend to be cyclical, and track general economic and market conditions. The Company’s loss experience on the mortgage and financial guaranty insurance it writes could be materially adversely affected by extended national or regional economic recessions, business failures, falling housing values, rising unemployment rates, interest rate changes or volatility, changes in investor perceptions regarding the strength of private mortgage insurers or financial guaranty providers and the policies or guaranties offered by such insurers, investor concern over the credit quality of municipalities and corporations, terrorist attacks, acts of war or combinations of such factors. These events could also materially decrease demand for housing or could reduce the demand for mortgage insurance or financial guaranty insurance. These factors could also cause claims and losses on the policies and guaranties that the Company has issued to increase beyond what the Company anticipates. In addition to exposure to general economic factors, financial guaranty insurance exposes the Company to the specific risks faced by the particular businesses, municipalities or pools of assets covered by the Company’s insurance.

Because the Company’s business is concentrated among relatively few major customers, its revenues could decline if the Company loses any significant customer.

The Company’s mortgage insurance and financial guaranty businesses are both dependent on a small number of customers. The Company’s top 10 mortgage insurance customers are generally responsible for approximately 50% of both its primary new insurance written in a given year and its direct primary risk in force, based on the aggregate principal amount of the mortgage loans insured by the Company multiplied by the coverage percentage. The concentration of business with the Company’s customers may increase as a result of mergers of those customers or other factors. The Company’s master policies and related lender agreements do not, and by law cannot, require the Company’s mortgage insurance customers to do business with the Company. In addition, in 2003, the Company’s financial guaranty subsidiaries, Radian Reinsurance and Radian Asset Assurance, together derived 30.9% of their annual gross premiums from four primary insurers, with one insurer accounting for 12.1% of their annual gross premiums. In addition, five trade credit reinsurers generated 10.5% of the financial guaranty business segment’s 2003 gross premiums.

If the Company were to lose the business of one of its major customers, its revenues would be materially adversely affected. As a result of the downgrade by S&P in October 2002, one of Radian Reinsurance’s primary insurance customers exercised its right to recapture substantially all of the financial guaranty reinsurance ceded

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to Radian Reinsurance. Radian Reinsurance has reached agreement with its other primary insurer clients, without additional cost to Radian Reinsurance, whereby such primary insurers have agreed not to exercise their rights with respect to the downgrade of Radian Reinsurance by S&P. None of the primary insurers has a similar right with respect to the downgrade by Fitch. See the paragraph below entitled “A downgrade of the ratings of any of the Company’s subsidiaries by any of the rating agencies could adversely affect the Company’s business,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Guaranty —Results of Operations” for additional information regarding the financial impact of the recapture of reinsurance by one of Radian Reinsurance’s primary insurance customers.

An increasing concentration of servicers in the mortgage lending industry makes the Company’s mortgage insurance business vulnerable to a rise in delinquencies in its insured portfolio.

A recent trend in the mortgage lending and mortgage loan servicing industry has been toward consolidation, particularly with respect to “specialized” servicing such as for manufactured housing loans. The Company depends in part on reliable, consistent servicing of loans that it insures. This reduction in the number of servicers could lead to disruptions in the servicing of mortgage loans covered by the Company’s insurance policies, which in turn could contribute to a rise in delinquencies among those loans.

Because the Company’s business is concentrated in a few states, its losses could increase materially or its revenues could decline as a result of regional economic factors.

In addition to the Company’s customer concentration, much of the Company’s business is concentrated in relatively few states, which increases its vulnerability to economic downturns in those states. The Company’s principal mortgage insurance subsidiary, Radian Guaranty, has approximately 60% of its primary insurance in force concentrated in 10 states (with the highest percentage in California). The Company also has a large percentage of the second mortgage insurance in force concentrated in California. The recent low mortgage interest rate environment has generated increased refinancing activity (the payoff of an existing mortgage loan combined with the establishment of a new mortgage loan). Because mortgage loans in areas experiencing property value appreciation are less likely to require mortgage insurance at the time of refinancing than are loans in areas experiencing limited or no property value appreciation, a low mortgage interest rate environment may have the effect of further concentrating the Company’s primary mortgage insurance in force in economically weaker areas. Radian Reinsurance and Radian Asset Assurance also have approximately 40% of their insurance in force concentrated in six of those same 10 states, and are potentially vulnerable to weakening economic conditions in those states. See “Item 1. Business—Risk Management—Geographic Dispersion.”

The Company faces the possibility of higher claims as its mortgage insurance policies age.

Historically, most claims under private mortgage insurance policies on prime loans occur during the third through fifth year after issuance of the policies, and on policies on non-prime loans during the second through fourth year after issuance of the policies. At December 31, 2003, approximately 83% of the Company’s primary mortgage insurance risk in force has not yet reached its anticipated highest claim frequency years. If the growth of the Company’s new business were to slow or decline, claims could grow as a percentage of the Company’s revenues, which would likely adversely affect its results of operations and financial condition.

Adverse selection by ceding companies may adversely affect the Company’s financial results.

A portion of the Company’s financial guaranty reinsurance business is written under treaties, which generally give the ceding company some ability to select the risks ceded to the Company as long as they are covered by the terms of the treaty. There is a risk under these treaties that the ceding companies will adversely select the risks ceded to the Company by ceding those exposures that have higher rating agency capital charges or that the ceding companies expect to be less profitable. The Company attempts to mitigate this risk in a number of ways, including requiring ceding companies to retain a minimum amount, which varies by treaty, of the ceded business. If the Company is unsuccessful in mitigating this risk, its financial results may be adversely affected.

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If the estimates the Company uses in establishing reserves for its mortgage insurance or financial guaranty business are incorrect, it may be required to take charges to income and its ratings may be reduced.

The Company establishes reserves in both its mortgage insurance and financial guaranty businesses to provide for the estimated costs of settling claims. In its mortgage insurance business segment, the Company generally does not establish reserves until it is notified that a borrower has failed to make at least two payments when due. Once a payment has been missed, the Company uses historical models based on a variety of loan characteristics, including the status of the loan as reported by the servicer of the loan, economic conditions, and the estimated foreclosure period in the area where a default exists, to help determine the amount of the loss reserve.

In the Company’s financial guaranty business segment, the process for establishing financial guaranty loss reserves is similar; however, the remote probability of losses and the dearth of historical losses in this business make it more difficult to estimate the appropriate loss reserve. Reserves are established for both specific and non-specific losses, and are monitored by the Company or the primary insurers over the life of the obligation. The financial guaranty business segment has a regular case reserve committee meeting where experts in the risk management and surveillance area provide input before any case reserves are determined, and the surveillance team actively monitors any problem deals and notifies the committee if a change in the loss reserve is necessary. The Company increases this reserve when (i) a primary insurer provides for or increases its reserve for losses and loss adjustment expenses, (ii) the transaction deteriorates to a point where the Company has determined a default is reasonably probable, based on all the facts and circumstances then known and estimable. In case (ii), the Company will establish a specific loss reserve that represents the present value of the amount of the claim the Company expects that will ultimately have to pay (including expenses associated with the settlement of the loss).

Setting the loss reserves in both business segments involves significant reliance upon estimates with regard to the likelihood, magnitude and timing of a loss. The models and estimates the Company uses to establish loss reserves may not prove to be accurate, especially during an extended economic downturn. There can be no assurance that the Company has correctly estimated the necessary amount of its reserves or that the reserves it establishes will be adequate to cover ultimate losses on incurred defaults.

If the Company’s estimates are inadequate, the Company may be forced by insurance and other regulators or rating agencies to increase its reserves. Unanticipated increases to the reserves would lead to a reduction in the Company’s earnings and could have ratings implications. A reduction of its ratings could have a significant negative impact on the Company’s ability to attract and retain business.

The Company’s net income may be subject to increased volatility because a portion of the credit risk the Company assumes is in the form of credit derivatives that are accounted for under FAS 133, which requires that these instruments be marked-to-market quarterly.

Any event causing credit spreads (i.e., the difference in interest rates between comparable securities having different credit risk) on an underlying security referenced in a credit derivative in the Company’s financial guaranty portfolio either to widen or to tighten will affect the fair value of the credit derivative, and may increase the volatility of the Company’s earnings. Credit derivatives are classified as derivatives under Statement of Financial Accounting Standards No. 133. The mark-to-market position on derivatives must be accounted for either as assets or liabilities on the balance sheet, and measured at fair market value. Although there is no cash flow effect from this “marking to market,” net changes in the fair market value of the derivative are reported in the Company’s Consolidated Statements of Income and therefore will affect the Company’s reported earnings. If the derivative is held to maturity and no loss is incurred, any gains or losses previously reported would be offset by corresponding gains or losses at maturity.

Common events that may cause credit spreads on an underlying security referenced in a credit derivative to fluctuate include changes in the state of national or regional economic conditions, industry cyclicality, changes to

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a company’s competitive position within an industry, management changes, changes in the ratings of the underlying security, movements in interest rates, default or failure to pay interest, or any other factor leading investors to revise expectations about the issuer’s ability to pay principal and interest on its debt obligations. Similarly, common events that may cause credit spreads on an underlying structured security referenced in a credit derivative to fluctuate may include the occurrence and severity of collateral defaults, changes in demographic trends and their impact on the levels of credit enhancement, rating changes, changes in interest rates or prepayment speeds, or any other factor leading investors to revise expectations about the risk of the collateral or the ability of the servicer to collect payments on the underlying assets sufficient to pay principal and interest.

Moreover, since Financial Guaranty currently only provides credit protection through its financial guaranty portfolio, and to date has not purchased protection due to regulatory limitations on a monoline financial guaranty insurance company to purchase credit protection, the Company may experience greater volatility in its earnings than other market participants that both purchase and provide credit protection in the same markets.

The Company’s estimated fair value amounts on its derivative financial guaranty contracts could vary significantly depending on the market assumptions and estimation methodologies used by the Company.

The gains and losses that the Company recognizes on its derivative financial guaranty contracts are derived from internally generated models, which may differ from other models derived internally and externally. The estimated fair value amounts have been determined by the Company using market information, to the extent available, and appropriate valuation methodologies. Significant differences may exist with respect to the available market information and assumptions used to determine gains and losses on derivative financial guaranty contracts. Considerable judgment is required to interpret available market data to develop the estimates of fair value. Accordingly, the estimates are not necessarily indicative of amounts the Company could realize in a current market exchange due to the lack of a liquid market or that other market participants may estimate. The use of different market assumptions and/or estimation methodologies may have an effect on the estimated fair value amounts.

Some of the Company’s products are riskier than traditional mortgage policies or financial guaranties of public finance obligations.

The Company generally provides its private mortgage insurance for high-risk mortgage products. A significant portion of the Company’s mortgage insurance in force consists of insurance on mortgage loans with loan-to-value ratios (“LTVs”) of more than 90% and on adjustable-rate mortgage loans. The LTV is the ratio of the original loan amount to the value of the property. Mortgage loans with LTVs greater than 90% are expected to have default incidence rates substantially higher than those with lower LTVs. Adjustable-rate mortgage loans generally have higher default rates than fixed-rate loans. In addition, if the Company is required to pay a claim on a higher LTV loan, it is generally more difficult to recover the Company’s costs from the underlying property, especially in areas with declining property values.

The Company also offers traditional pool mortgage insurance, which exposes it to different risks from primary mortgage insurance. The Company’s pool mortgage insurance products generally cover all losses in a pool of loans up to the Company’s aggregate exposure limit (generally between 1% and 10% of the initial aggregate loan balance of the entire pool of loans). Under pool insurance, the Company could be required to pay the full amount of every loan in the pool within its insured layer that is in default and upon which a claim is made until the aggregate limit is reached, rather than a percentage of that amount, as is the case in traditional primary mortgage insurance. As of December 31, 2003, $2.4 billion, or 7.9%, of the Company’s risk in force in its mortgage insurance business segment was attributable to pool insurance.

The Company insures non-prime loans, which are riskier than the Company’s general portfolio and which will likely require the Company to make a higher percentage of claims payouts. These are usually classified as “Alt-A”, “A minus” or “B/C” loans, and enable borrowers with less than normal documentation or with

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substandard credit histories to obtain mortgages and mortgage insurance. Although the Company has historically limited the insurance of these non-prime loans to those made by lenders with good results and servicing experience in this area, the Company believes that non-prime lending programs represent the largest area for future growth in the mortgage insurance industry, and it has increased and expects to continue to increase its insurance written in this area. During 2003, non-prime business accounted for $27.4 billion or 40.1% of the Company’s mortgage insurance businesses new primary insurance written (of which 73.0% was Alt-A) compared to $16.2 billion or 33.1% in 2002 (of which 72.8% was Alt-A). At December 31, 2003, non-prime insurance in force was $37.8 billion or 31.5% of total primary insurance in force as compared to $25.6 billion or 23.2% of primary insurance in force a year ago. Because of the lack of data regarding the performance of such loans, actual performance may differ significantly from expected performance which would lead to higher losses.

The Company’s subsidiaries, Radian Insurance and Amerin Guaranty, write credit insurance on non-traditional mortgage-related assets such as second mortgages, home equity loans and mortgages with LTVs above 100%, provide credit enhancement to mortgage-related capital market transactions, and have in the past written credit insurance on manufactured housing loans. These types of insurance could have higher claims payouts than traditional mortgage insurance products. The Company has less experience writing these types of insurance and less performance data on such business.

The Company’s subsidiaries also write guaranties involving structured finance transactions that expose the Company to a variety of market, credit and political risks beyond those that are specific to the mortgage insurance or public finance financial guaranty businesses. The Company issues guaranties connected with certain asset-backed transactions and securitizations secured by one or a few classes of assets, such as residential mortgages or other consumer assets, utility mortgage bonds and multi-family housing bonds and obligations under credit default swaps, both funded and synthetic. Financial Guaranty also provides trade credit reinsurance, which protects sellers of goods under certain circumstances against non-payment of the receivables they hold from buyers of those goods. These guaranties expose the Company to the risk of buyer nonpayment, which could be triggered by many factors, including the business failures of buyers. Such guaranties may cover receivables both where the buyer and seller are in the same country as well as cross-border receivables. In the case of cross-border transactions, the Company sometimes grants coverage extending to certain political risks, such as foreign currency controls and expropriation, which could interfere with the payment from the buyer.

If the Company is required to pay claims on its mortgage insurance or financial guaranty products beyond what it has anticipated, then its financial condition and results of operations could be materially and adversely affected.

The Company’s financial guaranty products may subject it to significant risks from individual or correlated credits.

The breadth of the Company’s business exposes it to potential losses in a variety of its products as a result of a credit problem at one company. For example, the Company could be exposed to an individual corporate credit risk if the credit is contained in multiple portfolios of collateralized debt obligations that the Company insures, or if it is the originator or servicer of loans or other assets backing structured securities that the Company has insured. While the Company tracks its aggregate exposure to single counterparties in its various lines of business and has established underwriting criteria to manage aggregate risk from a single counterparty, there can be no assurance that the Company’s ultimate exposure to a single counterparty will not exceed its underwriting guidelines, due to merger or otherwise, or that an event with respect to a single counterparty will not cause a significant loss. In addition, because the Company insures or reinsures municipal obligations, the Company can have significant exposures to single municipal risks. While the risk of a complete loss, where the Company pays the entire principal amount of a municipal obligation and interest thereon with no recovery, is generally lower than for corporate credits as most municipal bonds are backed by tax or other revenues, there can be no assurance that a single default by a municipality would not have a material adverse effect on the Company’s results of operations or financial condition.

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The Company’s delegated underwriting program may subject it to unanticipated claims.

In its mortgage insurance business, the Company permits many of its mortgage lender customers to commit Radian Guaranty to insure loans using pre-established underwriting guidelines. Once a lender is accepted for the Company’s delegated underwriting program, the Company generally insures a loan originated by that lender even if the lender has not followed the specified underwriting guidelines. Even if the Company terminates a lender’s underwriting authority, the Company remains at risk for any loans previously insured by the lender before such termination. A lender could possibly commit the Company to insure a material number of loans with unacceptable risk profiles before the Company were able to discover the problem and terminate that lender’s delegated underwriting authority. The performance of loans insured through programs of delegated underwriting has not been tested over a period of extended adverse economic conditions. If the specified underwriting guidelines are not properly applied by the Company’s lenders, or if the Company has not properly constructed the guidelines, the Company could be required to pay a higher number of claims than it expects.

The Company may face increased risks associated with its contract underwriting business.

In its mortgage insurance business, the Company underwrites some of its customers’ mortgage loans for secondary market compliance while at the same time assessing the loans for mortgage insurance. The Company’s customers sometimes require the Company to purchase, issue mortgage insurance on, or indemnify them against future loss associated with loans that the Company has underwritten for secondary market compliance on their behalf but on which the Company has made a material mistake. The Company, therefore, assumes some credit risk and interest rate risk if it makes an error. In a rising interest rate environment, the value of loans that the Company is required to repurchase could decrease, and consequently, the costs to the Company of such repurchases could increase. In 2003, loans underwritten via contract underwriting accounted for 25.8% of commitments for insurance and 22.6% of insurance certificates issued.

The Company’s revenues from mortgage insurance are dependent on the annual renewals of policies that may be terminated or not renewed by policyholders.

Most of the Company’s mortgage insurance premiums each month are derived from the renewal of policies that the Company has written in previous months. Consequently, a decrease in the length of time that the Company’s mortgage insurance policies remain in force would cause a decline in its revenues, unless the Company is able to write enough new business to replace the canceled policies. Recently, the rate of nonrenewal has been increasing. Factors that could cause an increase in nonrenewals of the Company’s mortgage insurance policies include falling mortgage interest rates (which leads to increased refinancings and associated cancellations of mortgage insurance), appreciating home values, and changes in the mortgage insurance cancellation requirements of mortgage lenders and investors.

The Company’s success depends on its ability to assess and manage its underwriting risks.

The Company’s success depends on its ability to accurately assess and manage the risks associated with the business it insures. The Company generally cannot cancel the mortgage insurance or financial guaranty insurance coverage it provides, and, because it generally fixes premium rates for the life of a policy when issued, it cannot adjust renewal premiums or otherwise adjust premiums over the life of a policy. If the risk underlying a particular mortgage insurance or financial guaranty coverage develops more adversely than anticipated, or if national and regional economies undergo unanticipated stress, the Company generally cannot increase premium rates on in-force business or cancel coverage to mitigate the effects of such adverse developments.

The Company’s mortgage insurance and financial guaranty premium rates may not adequately cover future losses. The Company’s mortgage insurance premiums are based upon its expected risk of claims on the insured loan, and take into account the loan’s LTV, loan type, mortgage term, occupancy status and coverage percentage, among other factors. Similarly, the Company’s financial guaranty premiums are based upon its expected risk of

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claim on the insured obligation, and take into account, among other factors, the rating and creditworthiness of the issuer of the insured obligations, the type of insured obligation, the policy term and the structure of the transaction being insured. In addition, the Company’s premium rates take into account expected cancellation rates, operating expenses and reinsurance costs, as well as profit and capital needs and the prices that the Company expects would be offered by its competitors. However, once issued, the Company cannot cancel the financial guaranty insurance coverage it provides. Since Financial Guaranty’s agreements to issue policies generally fix premium rates for the life of a policy when issued, the Company cannot adjust premiums over the life of the policy. If the risk underlying a particular policy develops more adversely than anticipated, or if national or regional economies undergo unanticipated stress, the Company generally cannot increase premium rates on in-force financial guaranty business or cancel coverage to mitigate the effects of such adverse developments. Despite the analytical methods employed, the Company’s premiums earned and the associated investment income on the premiums may ultimately prove to be inadequate to compensate for losses the Company may incur.

The Company’s success is dependent on its ability to manage its investment risks.

The Company’s income from its investment portfolio is one of its primary sources of cash flow to support its operations and claim payments. If the Company’s calculations with respect to its policy liabilities are incorrect, or if the Company improperly structures its investments to meet these liabilities, the Company could have unexpected losses, including losses resulting from forced liquidation of investments before their maturity. The Company’s investments and investment policies and those of its subsidiaries are subject to state insurance laws, and may change depending upon regulatory, economic and market conditions and the existing or anticipated financial condition and operating requirements, including the tax position, of the Company’s business segments.

There can be no assurance that the Company’s investment objectives will be achieved. The success of the Company’s investment activity is affected by general economic conditions, which may adversely affect the markets for interest-rate-sensitive securities, including the extent and timing of investor participation in such markets, the level and volatility of interest rates and, consequently, the value of such fixed-income securities. Volatility or illiquidity in the markets in which the Company directly or indirectly holds positions could adversely affect the Company.

If housing values fail to appreciate, the Company’s ability to recover amounts paid on defaulted mortgages may be reduced and its earnings may decrease.

Under the Company’s standard mortgage insurance policy, upon default the Company generally has the option of paying an entire loss amount and taking title to a mortgaged property or paying the Company’s coverage percentage in full satisfaction of its obligations under the policy. In recent years with a strong housing market, the Company has been able to take advantage of paying the entire loss amount on certain defaulted loans and selling properties quickly. If housing values fail to appreciate, the Company’s ability to recover amounts paid on defaulted mortgages may be reduced or delayed, which may decrease the Company’s earnings.

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A downgrade of the ratings of any of the Company’s subsidiaries by any of the rating agencies could adversely affect the Company’s business.

The insurance financial strength ratings assigned by S&P, Moody’s and Fitch to the Company’s subsidiaries may be downgraded by one or more of the rating agencies as a result of changes in the views of the rating agencies or adverse developments in the Company’s or its subsidiaries’ financial condition or results of operations due to underwriting or investment losses or otherwise. The Company’s subsidiaries have been assigned the following insurance financial strength ratings:

If the financial strength ratings of any of the Company’s mortgage insurance subsidiaries, Radian Guaranty, Radian Insurance or Amerin Guaranty, fall below “Aa3” from Moody’s or the “AA” level from S&P and Fitch, then 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 insured by them. If the insurance financial strength rating of Radian Asset Assurance falls below the “AA” level from S&P or Fitch, it could have a material adverse effect on its competitive position and its prospects for future financial guaranty insurance opportunities. If the insurance financial strength rating of Radian Reinsurance falls below “AA” from S&P or Fitch, or “Aa2” from Moody’s, the value of the reinsurance offered by Radian Reinsurance to its primary insurers could be reduced and may no longer be of sufficient economic value to its primary insurers for them to continue to cede insurance to Radian Reinsurance at economically viable rates.

Radian Reinsurance and Radian Asset Assurance are also parties to numerous reinsurance agreements with primary insurers that grant the primary insurers the right to recapture all of the business assumed by Radian Reinsurance or Radian Asset Assurance under these agreements if the insurance financial strength rating of Radian Reinsurance or Radian Asset Assurance, as the case may be, is downgraded below the rating levels from specified rating agencies established in the agreements, and, in some cases, the right to increase the commissions charged to Radian Reinsurance for cessions in order to compensate the primary insurers for the decrease in credit that the rating agencies allow the primary insurers for the reinsurance provided by the Company’s financial guaranty subsidiaries.

In October 2002, S&P announced that it had downgraded the insurance financial strength rating of Radian Reinsurance from “AAA” to “AA” (and on April 8, 2003, Fitch announced that it had downgraded the insurance financial strength rating of Radian Reinsurance from “AAA” to “AA” and removed it from “negative watch”). As a result of the downgrade by S&P, the primary insurers had the right, as described above, to recapture the financial guaranty reinsurance assumed by Radian Reinsurance, including substantially all of the unearned premium reserves of Radian Reinsurance. The primary insurers did not have a similar right with respect to the downgrade by Fitch. As described above, the primary insurers also had the right to increase commissions charged to Radian Reinsurance for cessions, including the right to a cash refund of a portion of the unearned premium reserves previously ceded to Radian Reinsurance reflecting the increased commissions. Radian Reinsurance reached agreement with three of the primary insurers whereby such primary insurers agreed not to exercise their rights with respect to the downgrade of Radian Reinsurance by S&P, without additional cost to Radian Reinsurance. The remaining primary insurer exercised its right to recapture substantially all of its business effective January 31, 2004. See Item 1 of this report, under the caption “Ratings”, for more information regarding the impact of the recapture by such primary insurer.

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Although Radian Reinsurance may be able to offset some of the effects of increased commissions or reduced reinsurance premiums by posting collateral for the benefit of the reinsurers, the S&P downgrade could have a material adverse effect on Radian Reinsurance’s competitive position and/or its prospects for future reinsurance opportunities. The Company cannot be certain that the rating agencies will not make further revisions to Radian Reinsurance’s or Radian Asset Assurance’s insurance financial strength ratings, which would again trigger these rights of the primary insurers.

For more information about the Company’s ratings, see “Item 1. Business—Risk Management—Ratings”.

An increase in the Company’s subsidiaries’ risk-to-capital ratio and/or leverage ratio may prevent them from writing new insurance.

Rating agencies and state insurance regulators impose capital requirements on the Company’s subsidiaries (Radian Guaranty, Amerin Guaranty, Radian Insurance, Radian Reinsurance and Radian Asset Assurance and their respective subsidiaries). These capital requirements include risk-to-capital ratios, leverage ratios and surplus requirements, and limit the amount of insurance that these subsidiaries may write. Moody’s and S&P have also entered into an agreement with Radian Guaranty that obligates Radian Guaranty to maintain at least $30 million of capital in Radian Insurance as a condition of the issuance and maintenance of Radian Insurance’s “Aa3” rating from Moody’s and “AA” rating from S&P. The Company’s subsidiaries have several alternatives available to control their risk-to-capital ratios and leverage ratios, including obtaining capital contributions from Radian Group Inc. as the parent holding company, purchasing reinsurance, or reducing the amount of new business written. To date, none of the Company’s subsidiaries has had any difficulty in maintaining appropriate risk-to-capital or leverage ratios or has been limited in its ability to write new insurance. However, a material reduction in the statutory capital and surplus of a subsidiary, whether resulting from underwriting or investment losses or otherwise, or a disproportionate increase in risk in force, could increase a subsidiary’s risk-to-capital ratio or leverage ratio. This in turn could limit that subsidiary’s ability to write new business or require that subsidiary to obtain reinsurance for existing business, which then could materially adversely affect the Company’s results of operations and financial condition.

The private mortgage insurance industry is highly competitive and the Company’s revenues could decline as a result of competition.

The United States private mortgage insurance industry is highly dynamic and intensely competitive. The Company’s competitors include:

In addition, there are an increasing number of alternatives to traditional private mortgage insurance, which could reduce the demand for the Company’s insurance products. These include:

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Many factors affect the relative competitive positions of the private mortgage insurance industry and the Company’s competitors, including price, underwriting criteria, legislative and regulatory initiatives that affect the FHA’s competitive position and the capital adequacy of, and alternative business opportunities for, lending institutions.

If the Company is unsuccessful at meeting the competition in its industry, its revenues may decline.

Because many of the mortgage loans that the Company insures are sold to Fannie Mae and Freddie Mac, changes in their business practices could significantly reduce the Company’s revenues.

Because the beneficiaries of the majority of the Company’s mortgage insurance policies are Fannie Mae and Freddie Mac, their business practices have a significant influence on the Company as well as on the mortgage insurance industry in general. Changes in their practices could reduce the number of policies they purchase that are insured by the Company and consequently reduce the Company’s revenues. Subject to certain minimum requirements, some of their programs require less insurance coverage than they historically have required. Fannie Mae and Freddie Mac have the ability to further reduce coverage requirements, which could cause a reduction in the demand for mortgage insurance and cause the Company’s premium revenues to decline.

Additionally, Fannie Mae and Freddie Mac could decide to differentiate between mortgage insurance companies rated “AAA” rather than “AA.” Such a decision could impair the ability of the Company’s subsidiaries, Radian Guaranty and Amerin Guaranty, which are both rated “AA,” to compete with “AAA”-rated companies. Currently, there is one “AAA”-rated mortgage insurance company. If Fannie Mae and Freddie Mac choose to purchase mortgage insurance from “AAA”-rated companies instead of the Company, the Company’s revenues would decline.

The Company faces significant competition in the financial guaranty industry and its revenues could decline as a result of competition.

The financial guaranty industry is also highly competitive. The principal sources of direct and indirect competition are:

The rating agencies allow credit to a ceding company’s capital requirements and single risk limits for reinsurance ceded in an amount that is in part determined by the financial strength rating of the reinsurer. Some of the Company’s competitors have greater financial resources and are better capitalized than the Company and/or have been assigned higher ratings by one or more of the major rating agencies. Competition in the financial guaranty reinsurance business is based on many factors, including overall financial strength, pricing, service and evaluation by the rating agencies of financial strength.

Legislation and regulatory changes and interpretations could harm the Company’s business.

Changes in laws and regulations affecting the municipal, asset-backed and trade credit debt markets, as well as other governmental regulations, may subject the Company to additional legal liability or affect the demand for financial guaranty insurance and the demand for the primary insurance and reinsurance that the Company provides.

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Increases in the maximum loan amount that the FHA can insure can reduce the demand for private mortgage insurance. This maximum amount has, in general, been increased annually, indexed to Fannie Mae and Freddie Mac limits. In addition, the FHA has streamlined its down-payment formula and reduced the premiums it charges for FHA insurance, making it more competitive with private mortgage insurance in areas with higher home prices. These and other legislative and regulatory changes have caused, and may cause in the future, demand for private mortgage insurance to decrease.

The U.S. Department of Housing and Urban Development (“HUD”) proposed a rule under the Real Estate Settlement Procedures Act (“RESPA”) to create an exemption from the provisions of RESPA that prohibit the giving of any fee, kickback or thing of value under any agreement or understanding that real estate settlement services will be referred. The proposed rule would have made the exemption available to lenders that, at the time a borrower submits a loan application, give the borrower a firm, guaranteed price for all the settlement services associated with the loan. In 2003, HUD withdrew the proposed rule and submitted another rule to the Office of Management and Budget. The contents of the new rule have not yet been made public, although most commentators are assuming that the new rule is similar to the old rule. If the new rule is implemented, the premiums charged for mortgage insurance could be negatively affected.

The Company’s business and its legal liabilities may also be affected by federal or state consumer, lending and insurance laws and regulations. In recent years the Company has also been subject to consumer lawsuits alleging violations of RESPA. If litigation or changes with respect to these laws and regulations are resolved in a way that is unfavorable to the Company, the Company’s revenues could decline.

Changes in tax laws could reduce the demand or profitability of financial guaranty insurance, which could harm the Company’s business.

Any material change in the U.S. tax treatment of municipal securities, or the imposition of a “flat tax” or a national sales tax in lieu of the current federal income tax structure in the United States, and changes in the treatment of dividends could adversely affect the market for municipal obligations and, consequently, reduce the demand for financial guaranty insurance and reinsurance of such obligations.

The Jobs and Growth Tax Relief Reconciliation Act of 2003, enacted in May 2003, significantly reduces the federal income tax rate for individuals on dividends and long-term capital gains. This tax change may adversely affect the market for municipal obligations and, consequently, reduce the demand for financial guaranty insurance and reinsurance of these obligations, which could reduce the Company’s revenue and profitability from the writing of such insurance and reinsurance. Future potential changes in U.S. tax laws, including current efforts by certain members of Congress and the Bush administration to eliminate the federal income tax on dividends, might also affect demand for municipal securities and for financial guaranty insurance and reinsurance of those obligations.

The Company’s growth may be restricted if its insurance subsidiaries were unable to obtain reinsurance or other forms of capital.

The Company’s financial guaranty insurance subsidiaries’ ability to maintain reinsurance capacity or other forms of capital is important to its growth strategy for its financial guaranty business. In order to comply with regulatory, rating agency and internal capital and single risk retention limits as the Company’s business grows, these subsidiaries may need access to sufficient reinsurance or other capital capacity to underwrite transactions. The market for reinsurance has recently become more concentrated, as several participants have exited the industry. If the Company were to become unable to obtain sufficient reinsurance or other forms of capital, this could have an adverse impact on the Company’s ability to issue new policies and grow its business. However, one of the benefits to the Company of the recapture of a portion of Radian Reinsurance’s business by a primary financial guaranty insurer is the availability of capital to support Financial Guaranty’s growth. In addition, if the Company were to consummate a currently contemplated merger between Radian Asset Assurance and Radian Reinsurance, Financial Guaranty would be able to utilize the capital of both its insurance companies to support the growth of its businesses.

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The performance of the Company’s strategic investments could harm its financial results.

At December 31, 2003, the Company had investments in affiliates of $328.5 million. The performance of the Company’s strategic investments in affiliates could be harmed by:

In addition, the Company’s ability to engage in additional strategic investments is subject to the availability of capital and maintenance of its insurance financial strength ratings by rating agencies.

The Company may not be able to effectively manage its growth.

The Company seeks to expand its business internationally and into new markets. Its expansion into new markets presents it with different risks and management challenges. The Company may not be able to effectively manage new operations or successfully integrate them into its existing operations.

If the potential merger of Radian Asset Assurance and Radian Reinsurance were to occur, the combined Financial Guaranty insurance company would face additional risks.

The Company is currently contemplating a merger of Radian Reinsurance into Radian Asset Assurance. If the merger were to occur, the rating agencies would review the transaction and its potential effects on the Company, and such review could result in a change in Radian Asset Assurance’s or the Company’s rating (either positive or negative). While the Company does not currently anticipate that the merger would have a material adverse effect on its or Radian Asset Assurance’s ratings by any of the rating agencies that rate them, and any determination by any of the rating agencies to lower any of its ratings of the Company or Radian Asset Assurance could affect a decision whether or not to proceed with the merger, the Company cannot provide assurance that were the merger to be consummated, it would not result in a reduction in any such rating, or that the potential for a reduction in any such rating would result in the merger not being consummated. A reduction in any such ratings could have a material adverse effect on the Company and its businesses.

If the merger were to occur, the Company’s reinsurance customers may view the combined entity as more of a competitor and a threat to their business and prospects, since Radian Asset Assurance would be a larger entity that not only reinsures their obligations, but also could directly insure larger obligations in competition with them. Even if Radian Asset Assurance’s ratings were not changed as a result of the merger, any of the Company’s reinsurance customers could: (i) Compete with the Company more vigorously than they do now on the direct financial guaranty transactions or other transactions the Company insures, (ii) materially reduce or eliminate the reinsurance currently ceded by such customer to the Company, (iii) if such customer does not consent to the merger and its reinsurance agreements with the Company do not permit Radian Reinsurance to merge with another entity, exercise any right to recapture all of the business ceded to Radian Reinsurance under such agreements, or (iv) become more reluctant to partner with the Company on transactions. Consequently, the Company may: (i) experience a reduction in the number of transactions entered into, the premium received and/or the premium rate relative to the insurance exposure on future transactions, (ii) have a material reduction in future reinsurance premiums written and earned, and/or (iii) be required to return unearned premium previously

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received by Radian Reinsurance. A reduction in direct insurance or reinsurance premiums received or the premium rates received, or the requirement to return unearned premium to the ceding company could have a material adverse effect on Financial Guaranty’s business. Since Financial Guaranty has a relatively small number of reinsurance clients, if any of these customers were to reduce or eliminate the reinsurance ceded to Financial Guaranty, or require the return of unearned premium, it could have a material adverse effect on Financial Guaranty.

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Part I

Item 1.    Business

General

Radian Group Inc. (the “Company”) provides, through its subsidiaries and affiliates, insurance and financial services to financial institutions in the United States of America and globally. The principal business segments of the Company are mortgage insurance, financial guaranty and financial services. The following table shows the percentage contributions to total revenues and net income of these businesses for 2003:

For selected financial information about each segment, see Note 2 of the Notes to Consolidated Financial Statements under the caption “Segment Reporting” included in Part II, Item 8 of this report.

The Company’s strategic objective is to be a diversified global credit enhancement and financial services company focused on returns on allocated equity. The key components of this strategy are to:

The Company began conducting business as an independent company upon its spin-off from Commonwealth Land Title Insurance Company and initial public offering on November 6, 1992, as CMAC Investment Corporation. On June 9, 1999, the Company merged with Amerin Corporation and was renamed Radian Group Inc. As further described below, on February 28, 2001, the Company acquired Enhance Financial Services Group Inc., a provider of financial guaranty insurance and reinsurance. The Company is incorporated in Delaware.

Mortgage Insurance Business

The Company provides, through its wholly owned subsidiaries, Radian Guaranty Inc., Amerin Guaranty Corporation and Radian Insurance Inc. (individually referred to as “Radian Guaranty”, “Amerin Guaranty” and “Radian Insurance” and together referred to as “Mortgage Insurance”), private mortgage insurance and risk management services to mortgage lending institutions located throughout the United States. Private mortgage insurance protects mortgage lenders from default-related losses on residential first mortgage loans made primarily to home buyers who make down payments of less than 20% of the home’s purchase price. Private mortgage insurance also facilitates the sale of such mortgage loans in the secondary mortgage market, principally to Freddie Mac and Fannie Mae (Government Sponsored Enterprises, “GSEs”). Radian Guaranty is restricted to providing insurance on residential first mortgage loans only. Beginning October 1, 2001, Amerin Guaranty was licensed to write second mortgage insurance. Mortgage Insurance offers two principal types of private mortgage insurance coverage, primary and pool. At December 31, 2003, primary insurance made up 88.7% of Mortgage Insurance’s total risk in force and pool insurance made up 7.9% of Mortgage Insurance’s total risk in force on first lien mortgages. During the third quarter of 2000, the Company commenced operations in Radian Insurance, a subsidiary of Radian Guaranty that writes credit insurance on non-traditional mortgage-related assets, such as second mortgages and manufactured housing loans, and provides credit enhancement to mortgage-related capital market transactions. The risk in force in Radian Insurance and Amerin Guaranty was $1.1 billion at December 31, 2003, which represented 3.4% of the mortgage insurance risk in force.

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Premium rates in the mortgage insurance business are determined on a risk adjusted basis that includes borrower, loan, and property characteristics. Radian uses models to project the premiums, losses and expenses, as well as the capital necessary to be held in support of the risk. Pricing is established in an amount that Radian expects will allow a reasonable return on allocated capital. Flow business (loans insured on an individual basis) is generally priced based on rates that have been filed with the various state insurance departments. Structured mortgage insurance business is generally priced based on the specific characteristics of the insured portfolio and can vary significantly from portfolio to portfolio depending on a variety of factors including the quality of the underlying loans, the credit history of the borrowers, the amount of coverage required, and the amount, if any, of credit protection below Radian’s risk position.

Primary Insurance

Primary insurance provides mortgage default protection on individual loans up to a specified coverage percentage. This coverage percentage is applied to the unpaid loan principal, plus past due interest and certain expenses associated with the default (collectively, the “claim amount”). Upon receipt of a valid claim the Company’s maximum liability is determined by applying the appropriate coverage percentage to the claim amount.

A portion of the Company’s current business is written with 30% coverage on loans with a loan-to-value ratio (“LTV”) between 90.01% and 95% (“95s”) and 25% coverage on loans with an LTV between 85.01% and 90% (“90s”). In January 1999, Fannie Mae announced a program that allows for lower levels of required mortgage insurance for certain low down payment loans approved through its “Desktop Underwriter” automated underwriting system.

The insured lender is required to obtain title to the property in order to submit a claim. Upon receipt of a valid claim, the Company generally has three options to settle the claim. The decision to select a settlement option is based on the value of the property. The claim settlement options are as follows:

In 2003, the Company paid the maximum liability for approximately 73% of total valid claims received. Approved sales resulted in approximately 26% of the valid claims being settled for an amount less than the maximum liability. The value of the property supported the Company paying the full claim amount and acquiring title to the property in approximately 1% of filed claims. Strong property values over the past few years have ultimately resulted in increased loss mitigation opportunities for the Company.

Pool Insurance

Pool insurance differs from primary insurance in that the maximum liability to the Company is not limited to a specific coverage percentage on each individual loan in the pool. There is an aggregate exposure limit (“stop loss”) on a “pool” of loans that is generally between 1% and 10% of the initial aggregate loan balance. Because of the lack of exposure limits on individual loans and the generally lower premium rates associated with pool insurance, the rating agency capital requirements for this product are more restrictive than primary insurance. Modified pool insurance has the stop loss-like feature of pool insurance and exposure limits on each individual loan.

The Company offers pool insurance on a selective basis. Generally, pool insurance is a credit enhancement on mortgage loans included in mortgage-backed securities or in whole loan sales, as well as certain other structured transactions. This pool insurance has a very low stop loss, generally 1.0% to 1.5%. The insured pools

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contain loans with and without primary mortgage insurance. Loans without primary insurance generally have an LTV of 80% or below. Premium rates on this business are significantly lower than primary mortgage insurance rates. Therefore, anticipated profitability on this business is lower than that of primary insurance. During 2003, the Company had pool risk written of $933 million (5.2% of the Company’s total mortgage insurance risk written) compared to $174 million in 2002 and $255 million in 2001. An increasing number of structured transactions have both primary and pool components. The Company expects to write a similar amount of pool insurance in 2004 as it did in 2003, with the continued writing of other forms of pool or modified pool insurance as opportunities arise.

Structured Transactions

The Company engages in structured transactions that may include primary insurance, pool insurance or some combination thereof. A structured transaction generally involves insuring a large group of seasoned or unseasoned loans or issuing a commitment to insure new loan originations under negotiated terms. Some structured transactions contain a risk-sharing component under which the insured or a third party assumes a first-loss position or shares in losses in some other manner. Opportunities for structured transactions have increased during the last three years and this trend is expected to continue, but the Company competes with other mortgage insurers as well as capital market executions such as senior/subordinated security structures to obtain such business. Most structured transactions involve non-traditional mortgage or mortgage-related assets such as higher loan balance “jumbo,” Alternative A (“Alt-A”) and A minus mortgages. Alt-A and A minus mortgages are included in the Company’s “non-prime” business. Competition for this business is generally based upon price and is also based on the percentage of a given pool of loans that the Company is willing to insure. In 2003, the Company wrote $18.9 billion of primary insurance in structured transactions consisting of approximately 41% prime loans and 59% non-prime loans, which represented 27.6% of primary new insurance written.

Risk/Revenue Sharing Products

The Company offers financial products to its customers that are designed to allow the customers to participate in the risks and rewards of the mortgage insurance business. The most common product is captive reinsurance, in which a lender sets up a reinsurance company that assumes part of the risk associated with that lender’s insured book of business. In most cases, the risk assumed by the reinsurer is an excess layer of aggregate losses that would be penetrated only in a situation of adverse loss development. The Company has experienced a trend toward increased use of these risk/revenue sharing products at increased percentage levels. The Company continues to evaluate the level of revenue sharing against the risk sharing on a customer-by-customer basis. The Company had approximately 45 active captive reinsurance agreements in place at December 31, 2003 and could enter into several new agreements or modify existing agreements in 2004, some with large national lenders. Premiums ceded to captive reinsurance companies in 2003 were $73.6 million, representing 10% of total direct mortgage insurance premiums earned, as compared to $57.1 million, or 8.3% of total premiums earned in 2002. Primary insurance written in 2003 that had captive reinsurance associated with it was $21.9 billion, or 32.1% of the Company’s total primary insurance written as compared to $17.0 billion or 34.8% in 2002. During 2000, Freddie Mac issued standards for captive reinsurance through its mortgage insurance eligibility requirements.

In addition to captive reinsurance, the Company has entered into risk/revenue sharing arrangements with the GSEs whereby the primary insurance coverage amount on certain loans is recast and the overall risk to the Company is reduced in return for a payment made to the GSEs. Premiums ceded under such programs in 2003 were not significant.

Radian Insurance Inc.

Radian Insurance was reorganized and rated in September 2000 to write credit insurance on mortgage-related assets that are not permitted to be insured by monoline mortgage guaranty insurers. Such assets include second mortgages, manufactured housing loans, home equity loans and mortgages with LTVs above 100%.

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Radian Insurance also provides credit enhancement to mortgage-related capital market transactions. The Company believes that there are many opportunities to take advantage of its expertise in credit underwriting and evaluation of asset performance to write business that it is precluded from writing in its monoline mortgage guaranty companies, Radian Guaranty and Amerin Guaranty. Radian Insurance holds a “AA” rating from Standard & Poor’s Insurance Rating Service (“S&P”) and Fitch Ratings (“Fitch”), and a “Aa3” rating from Moody’s Investors Service (“Moody’s”), based on a prudent business plan and a Net Worth and Liquidity Maintenance Agreement with Radian Guaranty, which obligates Radian Guaranty to maintain at least $30 million of capital in Radian Insurance. The insurance structures typically used in Radian Insurance are pool insurance or modified pool insurance that can have a reserve or first loss position in front of Radian Insurance’s layer of risk. In addition to the Net Worth and Liquidity Maintenance Agreement, the Company capitalizes Radian Insurance in an amount that supports the existing risk in force. In October 2001, Radian Insurance entered into a reinsurance agreement with one of its affiliates, Radian Asset Assurance Inc. (“Radian Asset Assurance”), for a substantial part of its business at that time. In 2002, most of the credit insurance on mortgage and mortgage-related assets was written in Radian Asset Assurance. Some of this business was reinsured by Radian Insurance. During 2003, this business was written by both Radian Asset Assurance and Radian Insurance. The Company expects that future business will also be written by both Radian Insurance and Radian Asset Assurance, but the risk will remain with the Company originating the business.

Financial Guaranty Business

On February 28, 2001, the Company acquired the financial guaranty and other businesses of Enhance Financial Services Group Inc. (“EFSG”), a New York-based insurance holding company that primarily insures and reinsures credit-based risks, at a purchase price of approximately $581.5 million. The Company has retained EFSG as its financial guaranty insurance holding company, and conducts the financial guaranty business primarily through two insurance subsidiaries, Radian Asset Assurance Inc. (“Radian Asset Assurance”, formerly Asset Guaranty Insurance Company) and Radian Reinsurance Inc. (“Radian Reinsurance”, formerly Enhance Reinsurance Company). Radian Asset Assurance and Radian Reinsurance are collectively referred to in this report as “Financial Guaranty.” In addition, as part of the acquisition, the Company acquired an interest in two active credit-based asset businesses: Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) and Sherman Financial Services Group LLC (“Sherman”). Several smaller businesses acquired with EFSG are either in run-off or have been terminated.

In August 2003, the Financial Services Authority of the United Kingdom granted permission under Part IV of the Financial Services & Markets Act 2000 for Radian Asset Assurance Limited (“RAAL”), a subsidiary of Radian Asset Assurance, to conduct an insurance business in the United Kingdom. RAAL is authorized to conduct the following businesses: suretyship, credit, miscellaneous financial loss and legal expenses. As a result of this additional authority, the Company believes that, through RAAL, it will have additional opportunities to write financial guaranty insurance in the United Kingdom and, subject to compliance with the European passporting rules, in seven countries of the European Union. Although there can be no assurance as to the amount of such financial guaranty insurance RAAL will be able to write, if RAAL is successful it could significantly increase Financial Guaranty’s net premiums written (on a consolidated basis) in the future, and subsequently increase its net premiums earned (on a consolidated basis), as such premium written becomes earned over the life of the obligations insured.

Financial guaranty insurance provides an unconditional and irrevocable guaranty to the holder of a financial obligation of full and timely payment of principal and interest when due. In some circumstances, primarily in the mortgage-backed securities business, financial guaranty insurance may also pay principal, but only to the extent the outstanding principal balance on the financial obligation exceeds the value of the collateral insuring the financial obligation. Generally, in the event of a default under a financial guaranty obligation, payments under the insurance policy may not be accelerated by the holder of the insured obligation, without the approval of the insurer. The holder continues to receive payments of principal and interest on schedule, as if no default had occurred, and each subsequent purchaser of the obligation generally receives the benefit of such guaranty. The

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insurer retains the option to pay the obligation in full at any time. Also, the insurer often has recourse against the issuer and/or any related collateral for amounts paid under the terms of the policy.

The issuer of any obligation generally pays the premium for financial guaranty insurance either in full at the inception of the policy or, in the case of most structured finance transactions, in monthly, quarterly, semi-annual or annual installments from the cash flow of the related collateral. For public finance transactions, premium rates are typically stated as a percentage of total principal and interest. For asset-backed and structured finance transactions, premium rates are typically stated as a percentage of the total principal. The establishment of a premium rate for a transaction reflects some or all of the following factors:

Premiums are almost always non-refundable and are invested upon receipt. Premiums paid in full at inception are recorded as revenue (“earned”) over the life of the obligation (or the coverage period if shorter). The portion of the premium recorded as revenue in a specific quarter or year is proportional to the amortization of insured principal during that quarter or year. Premiums paid in installments are generally recorded as revenue in the accounting period in which coverage is provided. This long and relatively predictable premium earnings pattern is characteristic of the financial guaranty insurance industry and provides a relatively predictable source of future revenues to Financial Guaranty.

The financial guaranty insurance market that Financial Guaranty participates in consists of the following lines of business:

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The following table summarizes the net premiums written and earned for the indicated financial guaranty lines of business for 2003, 2002 and 2001 (for 2001, from the date of acquisition of EFSG by the Company):

Included in net premiums written and earned on structured products for 2003 were $54.1 million and $42.0 million, respectively, of credit enhancement fees on derivative financial guaranty contracts, compared to $40.4 million and $19.8 million, respectively, of credit enhancement fees on derivative financial guaranty contracts in 2002, and $5.3 million for both net premiums written and earned in 2001. Credit derivatives are classified as derivatives under Statement of Financial Accounting Standards No. 133. The mark-to-market position on derivatives must be accounted for as either assets or liabilities on the Consolidated Balance Sheets, and measured at fair value. Although there is no cash flow from “marking-to-market,” net changes in the fair value of the derivative are reported in the Consolidated Statements of Income.

Public Finance

Financial guaranty of public finance obligations provides credit enhancement of bonds, notes and other evidences of indebtedness issued by states and their political subdivisions (for example, counties, cities, or towns), utility districts, public and private non-profit universities and hospitals, public housing and transportation authorities, and other public and quasi-public entities. Municipal bonds are supported by the issuer’s taxing power in the case of general obligation or special tax-supported bonds, or by its ability to impose and collect fees and charges for public services or specific projects in the case of most revenue bonds. Insurance provided to the public finance market has been and continues to be a major source of revenue for the financial guaranty insurance industry.

Structured Finance

Asset-backed securitizations constitute a form of structured financing that is distinguished from unsecured debt issues by being secured by a specific pool of assets held by the issuing entity, rather than relying on the general unsecured creditworthiness of the issuer of the obligation. While most asset-backed debt obligations represent interests in pools of funded assets, such as residential and commercial mortgages and credit card or auto loan receivables, financial guarantors have also insured asset-backed debt obligations secured by a few assets, such as utility mortgage bonds and multi-family housing bonds. Other asset-backed classes of debt include pools of synthetic assets, which involve a guaranty of credit risk without the removal of the subject assets from the insured’s balance sheet. The transfer of this type of credit risk is referred to as a synthetic credit default swap. The asset-backed securities market, including both synthetic and funded collateralized debt obligations,

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has grown significantly in recent years, although there is no marketplace consensus on the portion of this market that is insured. Financial Guaranty increased its participation as an insurer of such transactions on a global basis during 2002 and 2003. The Company anticipates that Financial Guaranty will continue its participation in these transactions during 2004 and in subsequent years. Financial Guaranty’s structured finance business includes certain transactions that provide an unconditional and irrevocable guaranty of a counterparty’s obligations under a credit default swap. Through these transactions, Financial Guaranty generally assumes credit risk on defined portfolios of corporate credits, although these portfolios may also consist of asset-backed securities (including mortgage-backed securities and other consumer asset-backed securities). Such transactions may require short-term settlement of a credit event and are accounted for as derivatives per Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and therefore they may be required to post collateral even if there is no actual or anticipated loss on the transaction.

Since December 2000, Financial Guaranty has provided credit protection for pools of synthetic corporate obligations, synthetic mortgage-backed obligations and other asset-backed securities by insuring the obligations of sellers of protection under credit default swaps (such obligations being referred to herein as “Synthetic Obligations”). Financial Guaranty typically bases its credit protection for corporate obligations upon the occurrence of certain defined events for senior unsubordinated debt obligations contained within investment grade pools (as determined by S&P or Moody’s). Such pools have ranged from 49 to 479 obligors. Typically, Financial Guaranty provides protection up to a specified exposure amount per obligor (generally $10 or $15 million, but it may vary on a transaction-by-transaction basis), and aggregate exposure of $20.0 million to $380.7 million per pool of obligors. Financial Guaranty’s requirements to participate in these transactions generally include sufficient subordination and other protections such that Financial Guaranty’s risk attachment point and risk layer are set no lower than at an internally determined minimum tranche rating, which is generally at a “AA” or “AAA” attachment point as defined by at least one of the major rating agencies. In order to estimate this level, Financial Guaranty uses several internal and publicly available tools to model the risk associated with the transaction, including, without limitation, rating agency models such as S&P’s CDO Evaluator Model. Still, Financial Guaranty seeks a rating from the relevant rating agency on each transaction. Financial Guaranty further evaluates each deal by analyzing the individual obligors in the pool, including the concentration of industries in which they operate, the number of the obligors on credit watch for downgrade, if any, and a comparison of spreads on the debt obligations of these obligors to the market norm for similar companies. Financial Guaranty has set internal limits as to aggregate risk per obligor, industry sector and tranche size, and has developed a methodology for aggregating risk across its insured pools. At December 31, 2003 and 2002, Financial Guaranty had, on a direct basis, $7.2 billion and $4.9 billion, respectively, of such notional exposure consisting of 46 and 38 deals, respectively, as of such dates.

Because the same obligor may exist in a number of transactions, the 10 largest gross nominal exposures by Financial Guaranty to an individual corporate obligor in Financial Guaranty’s direct written book as of December 31, 2003 ranged from $313.0 million to $390.5 million, compared to a range of $264.6 million to $342.4 million in 2002. However, since each transaction in which a corporate obligor is covered has a distinct subordination requirement, meaning that prior credit events must occur with respect to other obligors in the pool in order for Financial Guaranty to have an obligation to pay in respect of a specific obligor, the Company believes that Financial Guaranty’s actual exposure to each corporate obligor is significantly less than such nominal exposure. Initial subordination before Financial Guaranty is obligated to pay ranges from 2.0% to 30.7% of the initial total pool size. As of December 31, 2003, the initial subordination for Financial Guaranty’s directly written protection ranged from $25.0 million to $460.0 million, and the subordination remaining for such transactions ranged from $9.6 million to $460.0 million. Financial Guaranty monitors not only the nominal exposure for each obligor for which it provides protection, but also risk-adjusted measures, taking into account, among other factors, current assessments of the relative risk that would be represented by direct exposure to the particular obligor and the remaining subordination in the transactions in which Financial Guaranty has exposure to a particular obligor.

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The gross par originated on both a direct and reinsurance basis in the structured finance area for 2003, 2002 and 2001 is as follows:

Financial Guaranty Reinsurance

Reinsurance is the commitment by one insurance company, the “reinsurer”, to reimburse another insurance company, the “ceding company,” for a specified portion of the insurance risks underwritten by the ceding company. Because the insured party contracts for coverage solely with the ceding company, the failure of the reinsurer to perform does not relieve the ceding company of its obligation to the insured party under the terms of the insurance contract. Similarly, the failure of the ceding company to perform does not relieve the reinsurer’s obligations under the reinsurance contract to the ceding company.

One of the more important of the various benefits provided by reinsurance to a ceding company is the ability it gives to write greater single risks and greater aggregate risks while remaining in compliance with the risk limits and capital requirements of applicable state insurance laws and rating agency guidelines. State insurance regulators allow ceding companies to reduce the liabilities appearing on their balance sheets to the extent of reinsurance coverage obtained from licensed reinsurers or from unlicensed reinsurers meeting certain solvency and other financial criteria. Similarly, the rating agencies permit a reduction in both exposures and liabilities ceded under reinsurance agreements, with the amount of credit permitted dependent on the financial strength rating of the reinsurer.

The principal forms of reinsurance are treaty and facultative. Under a treaty arrangement, the ceding company is obligated to cede, and the reinsurer is obligated to assume, a specified portion of all risks, within ranges, of transactions deemed eligible for cession by the terms of the treaty. Such limitations typically focus on size, security and ratings of the insured obligation. Each treaty is entered into for a defined term, generally one year, with renewals upon mutual consent and rights to early termination under certain circumstances (although the reinsurance risk thereafter extends for the life of the respective underlying obligations). In treaty reinsurance, there is a risk that the ceding company may select weaker credits or proportionally larger amounts to cede to reinsurers. However, Financial Guaranty mitigates this risk by requiring the ceding company to retain a sizable minimum portion of each ceded risk and include limitations on individual deals and sectors of risk. Under a facultative agreement, the ceding company has the option to offer, and the reinsurer has the option to accept, a portion of specific risks, usually in connection with particular obligations. In addition, under a facultative agreement, the reinsurer often performs its own underwriting and credit analysis to determine whether to accept the particular risk, while in a treaty agreement, the reinsurer generally relies on the ceding company’s credit analysis.

Reinsurance is typically written on either a proportional or non-proportional basis. Proportional relationships are those in which the ceding company and the reinsurer share a proportionate amount of the premiums and the losses of the risk group subject to reinsurance. In addition, the reinsurer generally pays the ceding company a commission, which is typically related to the ceding company’s underwriting and other expenses in connection with obtaining the business being reinsured. Non-proportional reinsurance can be done on an excess-of-loss or first-loss basis. An excess-of-loss reinsurance agreement provides coverage to a ceding company up to a specified dollar limit for losses, if any, incurred by the ceding company in excess of a specified threshold amount. A first-loss reinsurance agreement provides coverage to the ceding company on the first dollar of loss. This is a form of structural credit enhancement.

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Reinsurers may also, in turn, purchase reinsurance under retrocessional agreements to cover all or a portion of their own exposure for reasons similar to those that cause ceding companies to purchase reinsurance.

Potential Merger of Radian Asset Assurance and Radian Reinsurance

There have been internal discussions regarding, and management has taken steps toward, the merger of the financial guaranty reinsurance business of Radian Reinsurance into Radian Asset Assurance (the “Potential Merger”). If the Potential Merger were to occur, the financial guaranty reinsurance business currently conducted by Radian Reinsurance and the direct financial guaranty business conducted by Radian Asset Assurance would be conducted by Radian Asset Assurance as part of one company, and Radian Asset Assurance would have greater assets, liabilities and shareholder’s equity than it currently has on a stand-alone basis. However, the Potential Merger has not been fully approved by either Radian Asset Assurance’s or Radian Reinsurance’s respective boards of directors and shareholder. In addition, if such a merger were to occur, the transaction and its potential effects on Radian Asset Assurance and Radian Reinsurance would have to be approved by applicable regulatory bodies, including the New York Insurance Department and relevant rating agencies. Financial Guaranty has received preliminary regulatory approval from the New York and California Insurance Departments to the Potential Merger, subject to the satisfaction of certain conditions. However, there can be no assurance that the Potential Merger will occur.

If the Potential Merger were to occur, the Statutory (“STAT”) capital available to Radian Asset Assurance to write direct insurance would increase in an amount equal to the STAT capital of Radian Reinsurance. Consequently, Radian Asset Assurance’s regulatory and rating agency single risk exposure limits would increase to permit Radian Asset Assurance to insure and retain net exposure to larger risks than Radian Asset Assurance would be able to without the Potential Merger, without the need to find ample reinsurance capacity, whether from Radian Reinsurance or an unaffiliated third party. Similarly, the combined entity with larger regulatory and rating agency single risk exposure limits would be able to reinsure and retain net exposure to larger risks than Radian Reinsurance would be able to write without the Potential Merger, without the need to retrocede its risk to Radian Asset Assurance or an unaffiliated third party. Radian Asset Assurance also anticipates that its internally established criteria for single risk exposure should also permit it to retain exposure to larger risks. There can be no assurance, however, that Radian Asset Assurance would be able to insure or reinsure larger risks on terms and conditions acceptable to Radian Asset Assurance.

The Company believes that the Potential Merger could have the effect of making the rating of the larger combined Financial Guaranty company from the major rating agencies more stable, and could decrease the risk of a downgrade of Radian Asset Assurance by such agencies. However, the rating agencies are reviewing the Potential Merger and its potential effects on Financial Guaranty, and such review could result in a change in the rating (either positive or negative) of a combined Financial Guaranty company. Any determination by any of the rating agencies to lower any of its ratings for the combined Financial Guaranty company from those currently in effect for either Radian Asset Assurance or Radian Reinsurance could affect a decision whether or not to proceed with the Potential Merger, and if the Potential Merger were consummated notwithstanding a lowering of the combined Financial Guaranty company rating, it could have a materially adverse effect on Financial Guaranty’s business and would permit its largest financial guaranty primary insurance customers to terminate their current reinsurance relationships with Radian Reinsurance and recapture the reinsurance business ceded to Radian Reinsurance. See “Ratings” in this Item 1 for a description of the rights of certain of Radian Reinsurance’s customers upon a downgrade of the rating of Radian Reinsurance.

In addition, if the Potential Merger were to occur, the Company believes that its current and potential customers would view the combined entity more favorably since Radian Asset Assurance would have materially greater STAT capital. The customers’ credit exposure limits to Radian Asset Assurance should increase as a result of Radian Asset Assurance’s greater capital that could result in the ability of Radian Asset Assurance’s customers to enter into a greater number of and larger-sized transactions with Radian Asset Assurance, especially in its structured finance business, than they would without the Potential Merger. There can be no assurance,

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however, as to the effect the Potential Merger would have on the number and size of transactions that customers would enter into with Radian Asset Assurance.

However, Financial Guaranty’s reinsurance customers may view the combined Financial Guaranty company as more of a competitor and a threat to their business and prospects, since the combined Financial Guaranty company would be a larger entity that not only reinsures their obligations, but also could directly insure larger obligations in competition with them. Even if the combined Financial Guaranty company ratings were not changed or reduced as a result of the Potential Merger, any of Financial Guaranty’s customers could: (i) compete with Radian Asset Assurance more vigorously than they do now on the direct financial guaranty company transactions Radian Asset Assurance insures, (ii) materially reduce or eliminate the reinsurance currently ceded by such customer to Radian Reinsurance, (iii) if such customer does not consent to the Potential Merger and its reinsurance agreements with Radian Reinsurance do not permit Radian Reinsurance to merge with another entity, exercise any right to recapture all of the business ceded to Radian Reinsurance under such agreements, or (iv) become more reluctant to partner with Financial Guaranty on transactions. Consequently, Financial Guaranty would: (i) experience a reduction in the number of transactions entered into, the premium received and/or the premium rate relative to the insurance exposure on future direct financial guaranty insurance transactions, (ii) have a material reduction in future reinsurance premiums written and earned, and/or (iii) be required to return unearned premiums previously received by Radian Reinsurance. A reduction in direct insurance or reinsurance premiums received or the premium rates received, or the requirement to return unearned premium to the ceding company could have a material adverse effect on Financial Guaranty’s business. Since Radian Reinsurance has a relatively small number of customers, primarily consisting of most of the largest financial guaranty primary insurers, if any of these customers were to reduce or eliminate the reinsurance ceded to Financial Guaranty, or to require the return of unearned premium, it could have a material adverse effect on Financial Guaranty.

Other Financial Guaranty Businesses

Financial Guaranty provides reinsurance to many of the major primary insurers of trade credit exposures. Trade credit insurance protects sellers of goods under certain circumstances against non-payment of the receivables they hold from buyers of those goods. This reinsurance covers receivables where the buyer and seller are in the same country, as well as cross-border receivables. Sometimes in the latter instance, the coverage extends to certain political risks (foreign currency controls, expropriation, etc.) that could potentially interfere with the payment from the buyer. Since April 30, 2003, Radian Reinsurance, rather than Radian Asset Assurance, has provided this reinsurance to the trade credit primary insurers. As a condition for its approval of the Potential Merger, the California Insurance Department has requested that Radian Reinsurance novate its trade credit reinsurance risk off of Radian Reinsurance’s books. Financial Guaranty is in the process of obtaining consents from its trade credit primary insurers to novate these risks to RAAL.

In addition, the Company, through EFSG, owns a 36.0% interest in EIC Corporation Ltd., an insurance holding company (“EIC”) that, through its wholly owned insurance subsidiary licensed in Bermuda (“Exporters”), insures primarily foreign trade receivables for multinational companies, representing a 0.5% decrease in the Company’s ownership in Exporters as a result of certain members of Exporter’s management exercising their rights to acquire additional equity in EIC. Financial Guaranty has provided significant reinsurance capacity to this joint venture on a quota-share, surplus-share and excess-of-loss basis, which risk will be transferred to its affiliate Radian Reinsurance (Bermuda) Limited if the Potential Merger is consummated. The amount of this reinsurance exposure to Exporters at December 31, 2003 is $317.9 million. The Company has reserves of $14.5 million for this exposure, which the Company believes is adequate to cover any losses.

In very limited circumstances, Radian Reinsurance has provided a direct financial guaranty to customers in order to provide them with either (i) financial guaranty from an insurer rated by Moody’s and/or (ii) additional coverage beyond coverage being provided by Radian Asset Assurance. While a few of these financial guaranties had been provided on a stand-alone basis, most of these direct financial guaranties provided by Radian Reinsurance are given in conjunction with a financial guaranty provided by Radian Asset Assurance and include

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an additional condition to coverage that Radian Asset Assurance shall have failed to pay under its financial guaranty with respect to the same obligation. Financial Guaranty anticipates issuing a very limited number of these policies, none of which on a stand-alone basis, in 2004 and thereafter.

Radian Reinsurance has provided credit protection in respect of synthetic obligations, some of which are directly insured by Radian Asset Assurance. Radian Reinsurance had $10.5 billion and $7.3 billion of reinsurance notional exposure on synthetic obligations at December 31, 2003 and 2002, respectively.

Primus

The Company owns an approximate 12% interest in Primus Guaranty, Ltd., a Bermuda holding company and parent to Primus Financial Products, LLC. (“Primus”), a company that provides credit risk protection to derivatives dealers and credit portfolio managers on individual investment-grade entities.

Financial Services

RadianExpress.com

On November 9, 2000, the Company acquired RadianExpress.com Inc. (“RadianExpress,” formerly ExpressClose.com Inc.), an Internet-based settlement company that provides real estate information products and services to the first and second mortgage industry, for approximately $8.0 million consisting of cash, the Company’s common stock and stock options and other consideration. The transaction allowed the Company to expand further into the mortgage financial service business, which it considered an important adjunct to both the primary mortgage insurance business and the second mortgage activities of the Company. In December 2003, the Company announced that it would cease operations at RadianExpress, in a phased shutdown that is expected to be completed on or about March 31, 2004. The Company’s decision followed its receipt of an order from the California Superior Court denying the Company’s appeal from a decision by the California Commissioner of Insurance sustaining a California cease and desist order applicable to the Company’s offering of its Radian Lien Protection product. The California Superior Court’s denial is on appeal, but the decision significantly reduced the potential for increased revenues at RadianExpress, which was the Radian entity through which Radian Lien Protection sales would have been processed. The cessation of operations at RadianExpress resulted in a pre-tax charge of approximately $13.0 million related to the write-off of the investment and provisions for severance, leasehold commitments and other charges. Any income or expense from operations in 2004 will be recorded during that period, and is expected to be immaterial. RadianExpress had $19.8 million of revenues and $38.7 million of operating expenses for 2003, as compared to $17.4 million of revenues and $23.2 million of operating expenses for 2002. RadianExpress processed approximately 271,000 applications during 2003 and 341,000 applications during 2002 with approximately 28,000 and 36,000, respectively, of the transactions related to net funding services, whereby RadianExpress received and disbursed mortgages funded on behalf of its customers.

Asset-Based Businesses

The Company is engaged, through its affiliates, in certain consumer asset-based businesses, including the purchase, servicing and/or securitization of special assets, such as sub-performing/non-performing and seller-financed residential mortgages, real estate and subordinated residential mortgage-based securities, and the purchase and servicing of delinquent, primarily unsecured consumer assets, which utilizes the Company’s expertise in performing sophisticated analysis of complex, credit-based risks.

The most significant of the asset-based businesses is the Company’s 46% interest in C-BASS, a mortgage investment and servicing firm specializing in credit-sensitive, single-family residential mortgage assets and residential mortgage-backed securities. C-BASS invests in whole loans, single-family residential properties that have been, or are being, foreclosed, subordinated securities, known as “B pieces,” collateralized by residential

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loans and seller-financed notes. By using sophisticated analytics, C-BASS essentially seeks to take advantage of what it believes to be the mispricing of credit risk for certain of these assets in the marketplace. In addition, its residential mortgage servicing company, Litton Loan Servicing LP (“Litton”), which specializes in loss mitigation, default collection, collection of insurance claims and guaranty collections under government-sponsored mortgage programs, services whole loans and real estate. Litton’s subsidiaries service seller-financed loans and buy and sell seller-financed loans. As part of its investment strategy, C-BASS holds some assets on its books, securitizes certain assets and sells other assets directly into the secondary market.

The Company also engages C-BASS in the management of the acquisition and sale of certain residential mortgage-backed securities. These securities are included in other invested assets on the consolidated balance sheets.

As of December 31, 2003, the Company also owned a 41.5% interest in Sherman, a consumer asset and servicing firm specializing in purchases of and services related to charged-off and bankruptcy plan consumer assets and charged-off high loan-to-value mortgage receivables from national financial institutions and major retail corporations. The consumer assets and mortgage receivables are purchased at deep discounts to their original face value. Effective January 1, 2003, Sherman’s management exercised its right to acquire additional ownership of Sherman, reducing the Company’s ownership interest from 45.5% to 41.5%.

The Company has provided to Sherman a $100 million financial guaranty policy in connection with a structured financing of a pool of receivables previously acquired by Sherman.

The Company is seeking to sell or otherwise dispose of the remaining assets and operations of Singer Asset Finance Company L.L.C. (“Singer”), an entity acquired in connection with the purchase of EFSG. Singer, which had been engaged in the purchase, servicing and securitization of assets including state lottery awards and structured settlement payments, is currently operating on a run-off basis. Its operations consist of servicing and/or disposing of Singer’s previously originated assets and servicing of Singer’s non-consolidated special purpose vehicles.

In August 2002, the Company sold substantially all of the assets of another subsidiary of EFSG, Enhance Consumer Services LLC (“ECS”), which had been engaged in the purchase, servicing and securitization of viatical settlements, to an independent third party for an aggregate purchase price of $8.4 million, which approximated the carrying value.

Customers

Mortgage originators, such as mortgage bankers, mortgage brokers, commercial banks and savings institutions, are the principal customers of the Company’s mortgage insurance business, although individual mortgage borrowers generally incur the cost of primary insurance coverage. The Company does offer lender-paid mortgage insurance whereby mortgage insurance premiums are charged to the mortgage lender or loan servicer; the interest rate to the borrower is usually higher to compensate for the mortgage insurance premium that the lender is paying. In 2003, approximately 50% of the Company’s primary mortgage insurance was originated on a lender-paid basis, much of which consisted of structured transactions. This lender-paid business is highly concentrated among a few large mortgage lending customers.

To obtain primary mortgage insurance from the Company, a mortgage lender must first apply for and receive a master policy from the Company. The Company’s approval of a lender as a master policyholder is based, among other factors, upon an evaluation of the lender’s financial position and its management’s demonstrated adherence to sound loan origination practices. The Company’s quality control function then monitors the master policyholder based on a number of criteria.

The number of primary individual mortgage insurance policies the Company had in force was 889,403 at December 31, 2003, 881,620 at December 31, 2002, and 891,693 at December 31, 2001.

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The top 10 mortgage insurance customers were responsible for 53.3% of the Company’s primary new insurance written in 2003 compared to 46.5% in 2002 and 45.0% in 2001. The largest single mortgage insurance customer (including branches and affiliates of such customer), measured by primary new insurance written, accounted for 10.4% of primary new insurance written during 2003 compared to 8.1% in 2002 and 12.6% in 2001.

The Company’s direct financial guaranty insurance customers consist of many of the major global financial institutions that structure, underwrite or trade securities issued in public finance and structured finance transactions. These institutions are typically large commercial or investment banks and are targeted to implement the Company’s strategy of focusing on high quality deals in the public finance and structured finance markets. Although Financial Guaranty writes financial guaranty insurance for obligations issued by or on behalf of many public finance and structured finance entities, these issuers are not Financial Guaranty’s primary customers, as the financial guaranty insurance for such transactions is generally solicited by the financial institutions underwriting or placing their securities.

The Company’s financial guaranty reinsurance customers consist primarily of the largest primary insurance companies licensed to write financial guaranty insurance, including MBIA Insurance Corporation (“MBIA”); Ambac Assurance Corporation (“Ambac”); Financial Guaranty Insurance Company (“FGIC”); and Financial Security Assurance Inc. (“FSAI”), although primary trade credit insurers and Radian Asset Assurance also provide a significant portion of Radian Reinsurance’s premiums. These primary insurers were responsible for 61.6% of Radian Reinsurance’s gross premiums written in 2003, compared to 69.0% in 2002 and 80.7% in 2001. This trend reflects both Radian Reinsurance’s growing interdependence with Radian Asset Assurance and the Company’s strategy of becoming a large direct writer of “AA” financial guaranties through Radian Asset Assurance and other of its subsidiaries. As a result of the downgrade by S&P of Radian Reinsurance, described under “Ratings” in this Item 1, one of the primary insurers has exercised its right to recapture financial guaranty business ceded to Radian Reinsurance. Although the Company retained some facultative reinsurance business from such primary insurer, future business generated by such primary insurer will be limited. The Company anticipates redeploying the capital supporting this business into other opportunities in the near future. In addition, as a condition of its approval of the Potential Merger, the California Insurance Department has required that Radian Reinsurance novate its trade credit reinsurance risk off of Radian Reinsurance’s books, which Financial Guaranty is in the process of transferring to two of Radian’s Reinsurance’s affiliates.

The primary insurers were responsible for 30.9% of Financial Guaranty’s gross premiums written in 2003, compared to 26.7% in 2002 and 42.0% in 2001. In recent years, Financial Guaranty has increased the amount of direct business it writes, thereby reducing its dependence on the largest financial guaranty primary insurers. The largest single customer of Financial Guaranty, measured by gross premiums written, accounted for 12.1% of gross premiums written during 2003 compared to 10.4% in 2002 and 18.8% in 2001. This customer concentration results from the small number of primary insurance companies that are licensed to write financial guaranty insurance. Five trade credit primary insurers were responsible for 10.5% of gross premiums written during 2003.

Financial Guaranty has maintained close and long-standing relationships with all of the largest of the primary financial guaranty insurers, dating from either Financial Guaranty’s or the given primary insurer’s inception. The Company believes that these long-term relationships provide Financial Guaranty with a comprehensive understanding of the market, and the financial guaranty insurers’ underwriting procedures and reinsurance requirements. This allows Financial Guaranty’s clients to use their underwriting expertise effectively, thus improving the service they receive. Financial Guaranty’s long-standing commitment to the financial guaranty reinsurance market is also deemed a strength by the ceding companies, as they rely on the financial strength rating and ability to meet obligations over the life of the reinsured transaction. However, the termination in 2003 of the quota-share treaty agreement with one of these primary insurers and its decision to recapture financial guaranty business ceded to Radian Reinsurance may adversely affect Radian Reinsurance’s relationship with such primary insurer.

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EFSG is a party to reinsurance agreements with its financial guaranty primary insurance customers. EFSG’s reinsurance agreements are generally subject to termination (i) upon written notice (ranging from 90 to 120 days) prior to the specified deadline for renewal, (ii) at the option of the ceding company if EFSG fails to maintain certain financial, regulatory and rating agency criteria which are equivalent to or more stringent than those EFSG’s operating subsidiaries are otherwise required to maintain for their own compliance with the New York insurance law and to maintain a specified financial strength rating for the particular insurance subsidiary or (iii) upon certain changes of control. The Company obtained a waiver of these provisions for the merger transaction between the Company and EFSG. Upon termination under the conditions set forth in (ii) and (iii) above, the Company may be required (under some of the reinsurance agreements) to return to the ceding company all unearned premiums, less commissions, attributable to reinsurance ceded pursuant to such agreements. Upon the occurrence of the conditions set forth in (ii) above, whether or not an agreement is terminated, the Company may be required to obtain a letter of credit or alternative form of security to collateralize its obligation to perform under that agreement or it may be obligated to increase the level of commission paid. These and other matters associated with a downgrade in the ratings of the Company’s subsidiaries are discussed in further detail in the “Ratings” section of this Item 1 below.

Sales, Marketing and Competition

Sales and Marketing

The Company employs a mortgage insurance field sales force of approximately 76 persons, organized into two regions, providing local sales representation throughout the United States. Each of the two regions is supervised by a divisional sales manager (“DSM”) who is directly responsible for several regional sales managers (“RSMs”) and several service centers where underwriting and application processing are performed. The DSMs are responsible for managing the profitability of business in their regions including premiums, losses and expenses. The RSMs are responsible for managing a small sales force in different areas within the region. Key account managers manage specific accounts within a region that are not national accounts but that need more targeted oversight and attention. In addition to securing business from small and mid-size regional customers, the mortgage insurance business regions provide support to the national account effort in the field.

In recognition of the increased consolidation in the mortgage lending business and the large proportional amount of mortgage business done by large national accounts, the Company has a focused national accounts team consisting of eight national account managers (“NAMs”) and a dedicated “A Team” that is directly and solely responsible for supporting national accounts. Each NAM is responsible for a select group of dedicated accounts and is compensated based on the results for those accounts as well as the results of the Company. There has been a trend among national accounts to move to a more centralized decision about mortgage insurance based on risk/revenue- sharing products and other value-added services provided by the mortgage insurance companies. The Company also has a dedicated NAM who is primarily responsible for relationships with and programs implemented with Fannie Mae and Freddie Mac. National accounts business represented approximately 52% of the Company’s primary new insurance written in 2003 and is expected to provide a similar percentage in 2004.

Mortgage insurance sales personnel are compensated by salary, commissions on new insurance written and a production incentive based on the achievement of various goals. During 2003, these goals were related to volume and market share and this is generally expected to be similar in 2004, although there is a new component of sales compensation for 2004 that depends on the growth of insurance in force from flow mortgage insurance business.

The financial guaranty business is derived from relationships Financial Guaranty has established and maintains with many global financial institutions and primary insurance companies. These relationships provide business for Financial Guaranty in the following major areas: (1) deal flow on public finance transactions, asset-backed securities, collateralized debt obligations and other structured products; (2) reinsurance for public finance bonds and asset-backed securities (in which area one or both of Radian Reinsurance and Radian Asset Assurance

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currently has either treaty or facultative agreements with all of the largest financial guaranty primary insurers); (3) trade credit reinsurance; and (4) reinsurance for affiliated companies (including Exporters).

Financial Guaranty develops its public finance business primarily through relationships with those investment banks, commercial banks and financial advisors who provide financial and debt management services to and intermediate transactions with public finance borrowers. A dedicated public financial business development team, which reports directly to the head of Financial Guaranty’s public finance group, markets directly to these intermediaries, who are not paid or otherwise reimbursed for their services by Financial Guaranty. Financial Guaranty originates its structured finance transaction flow principally by developing and maintaining strong relationships with the financial institutions, both in the United States and abroad, that are actively involved in the structured finance market. Financial Guaranty develops its structured finance business through two primary business development units, one for asset-backed securities and the other for credit default swaps and other financial guaranties of structured finance transactions. In addition, Financial Guaranty has a London-based team of three structured finance professionals responsible for sales and marketing for European structured finance transactions.

In the reinsurance business, Financial Guaranty markets directly to the monoline insurers and their subsidiaries writing credit enhancement business. Trade credit reinsurance opportunities, on the other hand, are usually presented to Financial Guaranty by specialist reinsurance intermediaries that specialize in this product line, most of whom are located in London. Working either directly or through intermediaries, Financial Guaranty’s goal is to meet the needs of the primary insurers subject to internal underwriting and risk management requirements. Intermediaries are typically compensated by the reinsurer based on a percentage of premium assumed, which varies from agreement to agreement.

Competition

The Company competes directly with six other private mortgage insurers and with various federal government agencies, principally the Federal Housing Administration (“FHA”). In addition, the Company and other private mortgage insurers face competition from state-supported mortgage insurance funds. The private mortgage insurance industry consists of the Company and six other active mortgage insurance companies: GE Mortgage Insurance Corporation, Mortgage Guaranty Insurance Corporation, PMI Mortgage Insurance Co., Republic Mortgage Insurance Company, Triad Guaranty Insurance Corporation and United Guaranty Corporation.

The Company faces competition in the form of alternatives to traditional private mortgage insurance. These include (i) mortgage lenders structuring mortgage originations as a first mortgage with an 80% LTV coupled with a second mortgage with a 10% LTV, known as “80-10-10” loans, and (ii) investors using other credit enhancements in conjunction with reduced levels of private mortgage insurance. The Company believes that market conditions in 2003 accounted for the growth and prevalence of 80-10-10 loans in the market, and further improvement in conditions for second mortgages could diminish the percentage of business for the mortgage insurance industry.

The Company is subject to competition from companies that specialize in financial guaranty insurance or reinsurance, including MBIA, Ambac, FGIC, FSAI, ACE Guaranty Corp., CDC IXIS Financial Guaranty, XL Capital Assurance Inc., XL Financial Assurance Ltd. and RAM Reinsurance Co. Ltd. Another competitor, Axa Re Finance, S.A., discontinued its financial guaranty reinsurance business in 2002 and is currently in runoff. In the late 1990s, several multiline insurers increased their participation in financial guaranty reinsurance. However, the Company believes that the participation of multiline insurers in the financial guaranty insurance and reinsurance businesses should decrease dramatically due to the downgrade of certain of these multiline participants. Certain of these multiline insurers have formed strategic alliances with some of the U.S. primary financial guaranty insurers. Competition in the financial guaranty reinsurance business is based upon many factors, including overall financial strength, pricing, service and evaluation by the rating agencies of financial

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strength. The rating agencies allow credit to a ceding company’s capital requirements and single risk limits for reinsurance ceded in an amount that is a function of the financial strength rating of the reinsurer. The Company believes that competition from multiline reinsurers and new monoline financial guaranty insurers will continue to be limited due to (a) the lack of consistent dedication to the business from multiline insurers with the required financial strength and (b) the barriers to entry for new reinsurers posed by state insurance law and rating agency criteria governing minimum capitalization. However, one of the primary financial guaranty insurers made a capital contribution to an existing reinsurance company during 2003. In addition, the same primary company, along with other investors, established a new “AAA”-rated insurance entity. Another form of competition may also be developed through capital markets execution.

A majority of the insured public finance and structured finance transactions are guaranteed by the “AAA”-rated monoline financial guaranty insurers. As a “AA”-rated company, Radian Asset Assurance targets certain distinct markets. Additionally, in certain markets, issuers and other counterparties receive no additional credit between the “AA” or “AAA” enhancement levels. Since there is generally a higher interest cost to the issuer by using “AA” credit enhancement compared to similar bonds with “AAA” credit enhancement, many issuers may prefer “AAA” credit enhancement when available. However, “AA” insurance provides significant value over uninsured executions in select markets, and at times the additional cost to the issuer of “AAA” credit enhancement over “AA’” credit enhancement exceeds the higher interest costs an issuer may incur with “AA” enhancement. When there is no additional credit between “AA” and “AAA” enhancement levels or at other times, Radian Asset Assurance may compete with the “AAA”-rated financial guarantors on certain transactions.

Financial guaranty insurance also competes with other forms of credit enhancement, including letters of credit, guaranties and credit default swaps provided primarily by foreign banks and other financial institutions, some of which are governmental entities or have been assigned the highest credit ratings awarded by one or more of the major rating agencies. However, these credit enhancements serve to provide ceding companies with increased insurance capacity only for rating agency purposes. They do not qualify as capital for state regulatory purposes, nor do they constitute credit against specific liabilities that would allow the ceding company greater single risk capacity.

The Company believes that Financial Guaranty has a number of direct competitors in its other insurance businesses, some of which have greater financial and other resources than Financial Guaranty. As a primary insurer, Financial Guaranty writes insurance on those types of public finance obligations with respect to which such primary insurers have sometimes declined to participate because of the size or complexity of such bond issuances relative to the anticipated premium flow and returns. Financial Guaranty also serves as a reinsurer for certain specialty primary insurers that are not monoline financial guaranty insurers. These specialty primary insurers are themselves subject to competition from other primary insurers, many of which have greater financial and other resources. The recently completed sale of one of the primary financial guaranty insurers to one of the Company’s mortgage insurance competitors and the desire by that company to increase their writings in public finance and structured finance transactions establishes a more formidable competitor for the Company.

Risk Management

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 and quality control are all important elements of the Company’s risk management process. The Company also has begun to use Enterprise Risk Management (“ERM”) in evaluating its risk. This involves reviewing its consolidated and interdependent credit risk, market or funding risk, currency risk, interest rate risk, operational risk, and legal risk across all of its businesses, and the development of risk-adjusted return on capital models where the measure of capital is based on economic stress capital.

During 2003, the Company began implementing a redesigned, enterprise-wide credit committee structure, whereby an Enterprise Credit Committee consisting primarily of members of company-wide senior management

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oversees individual credit committees organized by product line and including representatives of the product line, risk management, finance and legal. The Company expects that this redesigned credit committee structure will allow it to more efficiently utilize company-wide and specific product expertise for the evaluation of risk and the determination of risk acceptance. Mortgage Insurance and Financial Guaranty participate in this revised structure. The Company believes that this redesigned credit committee structure will enable it to more fully utilize the intelligence, knowledge, experience and skills available throughout the Company to evaluate the risk in each subsidiary’s insurance in force and in proposed transactions, to complement each subsidiary’s intelligence, knowledge, experience and skills in underwriting and surveying the risk in proposed transactions and each subsidiary’s insured portfolio.

Mortgage Insurance Business

Risk Management Personnel

The mortgage insurance business has a comprehensive Risk Management/Risk Analytics/Credit Policy department in the Company’s Philadelphia headquarters, responsible for overall portfolio monitoring/management, policy setting, policy/guidelines communication and comprehensive analytics. In addition to the centralized Risk staff, the mortgage insurance business maintains a staff of Risk Managers throughout its geographic territories who partner both with its lenders and its field service center offices. The Risk Managers work with individual customers in evaluating loan programs, processes particular to risk and specific lender book of business performance. The National Field Risk Manager partners directly with its Field Service Center/Operations management in risk policies, procedures and philosophy. This effort is conducted along with the Risk Portfolio Quality Assurance department to ensure that guidelines, policies and procedures are adhered to on a regular basis. The mortgage insurance business employs an underwriting and support staff of approximately 80 persons who are located in Mortgage Insurance’s 15 service centers. There is also a specific Risk Manager who has direct contact and oversight for the risk taken by its agency operations in the states of Alaska and Hawaii.

Underwriting Process

The Company has generally accepted applications for primary mortgage insurance (other than in connection with structured transactions) under three basic programs: the traditional fully documented program, a limited documentation program and the delegated underwriting program. Programs that involve less than fully documented file submissions have become more prevalent in recent years.

Delegated Underwriting

The Company has a delegated underwriting program with a significant number of its customers. The Company’s delegated underwriting program currently involves only lenders that are approved by the Company’s Risk Management department. The delegated underwriting program allows the lender’s underwriters to commit the Company to insure loans based on agreed upon underwriting guidelines. Delegated loans are submitted to the Company in various ways—fax, electronic data interchange (“EDI”) and through the Internet. The Company routinely audits loans submitted under this program. As of December 31, 2003, approximately 27% of the risk in force on the Company’s books was originated on a delegated basis and during 2003 and 2002, respectively, 41% and 40% of the primary loans insured by the Company during such years were originated on a delegated basis.

Mortgage Scoring Models

During the last few years, the use of scoring mechanisms to predict loan performance has become prevalent in the marketplace, especially with the GSEs’ advocacy of the use of credit scores in the mortgage loan underwriting process. The use of credit scores was pioneered by Fair Isaac and Company (“FICO”) and became popular in the mid-1980s. The FICO model calculates a score based on a borrower’s credit history among other factors. This credit score-based scorecard is used to estimate the future performance of a loan over a one- or two-

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year time horizon. The higher the credit score the lower the likelihood that a borrower will default on a loan. The Company’s proprietary Prophet Score^® model begins with a FICO score, then adds specific additional data regarding the borrower, the loan and the property such as LTV, loan type, loan amount, property type, occupancy status and borrower employment. The Company believes that it is this additional mortgage data that expands the integrity of the Company’s Prophet Score^® model over the entire life of the loan. Beginning in October 1996, the Prophet Score^® has appeared on each insurance commitment that the Company issued. In addition, the Company uses a similar model called SubProphet^SM to evaluate subprime borrowers.

Alternative Products

An increasingly popular form of mortgage lending is in the area of non-prime loans. Subsets of this category in which the Company has become involved are Alt-A, A minus and B/C loans. The Company has continued to limit its participation in these non-prime markets to mostly Alt-A and A minus loans rather than B/C loans and has targeted the business insured to specific lenders with proven good results and servicing experience in this area. The Company believes, however, that non-prime lending programs represent the largest area for future growth in the mortgage insurance industry, and has increased and expects to continue to increase its insurance written in this area. During 2003, non-prime business accounted for $27.4 billion or 40.1% of Mortgage Insurance’s new primary insurance written (73.0% of which was Alt-A) compared to $16.2 billion or 33.1% in 2002 (72.8% of which was Alt-A). At December 31, 2003, non-prime insurance in force was $37.8 billion or 31.5% of total primary insurance in force as compared to $25.6 billion or 23.2% of primary insurance in force a year ago.

Alt-A Loans

Alt-A loans are composed of insured loans where the borrowers FICO score is 620 or higher and where the loan documentation has been reduced. While the Company believes the Alt-A loans present a slightly higher risk than its normal business, the Company believes the premium surcharge compensates the Company for this additional risk. Alt-A loans represented 19.4% of total primary risk in force at the end of 2003 and Alt-A products made up 29.3% of the Company’s primary new insurance written in 2003 as compared to 24.1% in 2002. The default rate on the Alt-A business was 5.3% at December 31, 2003 compared to 5.2% at December 31, 2002. Claims paid on Alt-A loans were $56.2 million and $27.3 million in 2003 and 2002, respectively.

A Minus Loans

The A minus program includes insured loans where the borrower has a FICO score of 570–619. This product comes to the Company primarily through primary structured transactions and the insurance is typically lender-paid. The Company also receives a significantly higher premium for insuring this product that is commensurate with the increased default risk and which is normally a variable rate based on the Prophet Score^®. The Company also classifies certain Fannie Mae Desktop Underwriter and Freddie Mac Loan Prospector automated underwriting system loan-level responses as A minus, regardless of the FICO score. The pricing is tiered into four levels, based on the FICO score of the A minus loan with increased premium at each descending tier of FICO score. A minus loans represented 10.2% of total primary risk in force at the end of 2003 and made up 9.7% of the Company’s primary new insurance written in 2003 as compared to 7.1% of primary new insurance written in 2002. The default rate on the A minus loans was 9.6% at December 31, 2003 compared to 9.7% at December 31, 2002. Claims paid on A minus loans were $47.3 million and $19.8 million in 2003 and 2002, respectively.

B/C Loans

The Company has no approved programs to insure loans that are defined as B/C risk grades. However, some pools of loans submitted for insurance as primary structured transactions might contain a limited number of these

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loans. The pricing of these structured transactions reflects a higher premium on these loans due to the increased default risk associated with these types of loans. B/C loans represented 2.4% of total primary mortgage risk in force at the end of 2003 and made up approximately 1.1% of total primary new insurance written during 2003 compared to 1.9% of total primary new insurance written during 2002. This decrease is primarily the result of a business decision to not insure these loans. The default rate on the B/C loans was 17.8% at December 31, 2003 compared to 15.1% at December 31, 2002. Claims paid on B/C loans were $24.4 million and $12.3 million in 2003 and 2002, respectively.

Contract Underwriting

The Company utilizes its underwriting skills to provide an outsourced underwriting service to its customers, known as contract underwriting. For a fee, the Company underwrites fully documented loan files for secondary market compliance, while concurrently assessing the file for mortgage insurance if applicable. Contract underwriting continues to be a popular service to mortgage insurance customers. During 2003, loans underwritten via contract underwriting accounted for 26.8% of applications, 25.8% of commitments for insurance and 22.6% of insurance certificates issued. The Company gives recourse to its customers on loans it underwrites for compliance. If the Company makes a material error in underwriting a loan, the Company agrees to provide a remedy of either placing mortgage insurance coverage on the loan or purchasing the loan. During 2003, the Company processed requests for remedies on fewer than 1% of the loans underwritten and sold a number of loans previously acquired as part of the remedy process. The Company had total losses from sales and remedies in 2003 of approximately $5.5 million. Providing these remedies means the Company assumes some credit risk and interest rate risk if an error is found during the limited remedy period in the agreements governing the Company’s provision of contract underwriting services. Rising mortgage interest rates or an economic downturn may expose the mortgage insurance business to higher losses. During 2003, the financial impact of these remedies was insignificant although there is no assurance that such results will continue in 2004 and beyond.

Portfolio Quality Assurance

As part of the Company’s system of internal control, the Risk Management department maintains a Portfolio Quality Assurance (“PQA”) function. Among its other activities, the PQA function is responsible for ensuring that operational risks that impact the quality of the Company’s portfolio of insured product and quality of loans underwritten by the Company or its delegated lenders are identified, investigated and communicated in order to minimize the Company’s exposure to controllable risk. The PQA function accomplishes this objective primarily by performing contract underwriting audits, delegated lender audits, third-party originator audits and mortgage fraud investigations.

Contract Underwriting Audits

The PQA function routinely audits the performance of the Company’s contract underwriters. In order to ensure the most effective use and allocation of audit resources, a risk assessment model has been developed which identifies high-, medium- and low-risk contract underwriters based upon five weighted risk factors applied to each underwriter. The models are continually updated with current information. Audit rotation is more frequent for high-risk underwriters and less frequent for those classified as low-risk. Audit results are communicated to management and influence whether additional targeted training is necessary or whether termination of the underwriter’s services is appropriate.

Contract underwriting audits help to ensure that customers receive quality underwriting services. The audits also protect the Company in that they facilitate the Company’s efforts to improve quality control.

Delegated Lender Audits

Through the use of borrower credit scoring and analysis of lender loan performance, the Company is able to monitor the credit quality of loans submitted for insurance. The Company, through its PQA function, also

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conducts a periodic, on-site review of selected delegated lenders’ insured delegated underwriting business. Delegated lenders with significant risk concerns, as identified in past reviews and through the Company’s regular risk reporting and analysis of the business, or lenders with a relatively high volume of business with the Company, may be reviewed more frequently.

Loans are selected for review on a random sample basis, and this sample may be augmented by a targeted sample based upon specific risk factors or trends identified through the monitoring process described above. The size of the random sample is determined using statistical techniques. The objectives of the loan review are to identify errors in the loan data transmitted to the Company, to determine lender compliance with the Company’s underwriting guidelines and eligible loan criteria, to assess the quality of a lender’s underwriting decisions, and to rate the risk of the individual loans insured. The Company has developed a proprietary data collection and risk analysis application to facilitate these reviews. Audits are graded based upon the risk ratings of the loans reviewed, lender compliance and data integrity. The results of each audit are summarized in a report to the lender and to Company management. The audit results are used as a means to improve the quality of the business the lender submits to the Company for insurance. Issues raised in the reports that are not resolved in a manner and within a time period acceptable to the Company may result in restriction or termination of the lender’s delegated underwriting authority.

Third-Party Originator Audits

PQA is responsible for coordinating and conducting third-party originator audits, also known as broker audits. This combination of loan-level audits of broker-originated files and overall broker surveillance helps ensure that the Company’s exposure to brokers who originate poor quality loans, or loans containing some form of misrepresentation, is minimized.

Mortgage Fraud Investigations

The PQA function includes a separate group of investigators known as the Special Investigations Unit (“SIU”). The SIU is responsible for identification and investigation of primarily insured loans involving non-compliance with the terms of the Company’s master policy of insurance (or commitment letter for structured transactions) in order to ensure that claims are ultimately paid for agreed upon, valid and insurable risks. Much of the SIU’s efforts involve the identification, investigation and reporting of mortgage fraud schemes which impact the Company. The SIU often coordinates its activities with legal counsel, law enforcement, and fraud prevention organizations, and works to promote mortgage fraud awareness, prevention and detection among the Company’s personnel and client lenders.

Due Diligence of Structured Transactions

The Credit Desk function, in conjunction with other members of the Risk Management department, performs due diligence of structured transactions. These due diligence reviews may be precipitated either by a desire to develop an ongoing relationship with selected lenders, or by the submission of a proposed transaction by a given lender. Due diligence can take two forms: business-level and loan-level.

Business-Level Due Diligence

The Company believes that a key component of understanding the risks posed by a potential business deal is understanding the business partner. The Company’s objective is to understand the lender’s business model in sufficient depth to determine whether the Company should have confidence in the lender as a potential long-term business partner and customer. Business-level due diligence may be performed on any prospective lender with whom a structured deal is contemplated and with whom the Company has had no prior business experience. Business-level due diligence includes a review of the lender’s company structure, management, business philosophy, financial health, credit management processes, quality control processes, and servicing relations.

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Loan-Level Due Diligence

Loan level due diligence is conducted on pending structured transactions in order to determine whether appropriate underwriting guidelines have been adhered to, whether loans conform to Company guidelines, to evaluate data integrity and to detect any fraudulent loans. Loans are selected for audit on a sample basis, and audit results are communicated to the Company’s management. The results of loan-level due diligence assist management in determining whether the pending deal should be consummated, and if so, provides data that can be used to determine appropriate pricing. It also provides management with a database of information on the quality of a particular lender’s underwriting practices for future reference.

The results of these due diligence reviews are summarized in reports to the Company’s management. Letter grades are assigned to each section of the business- and loan-level reviews. Weights are then assigned to each section of the review (e.g., corporate, credit, quality control, servicing) that vary based upon the product under review (e.g., prime first liens, A minus first liens, prime second liens, etc.), which results in an overall letter grade assigned to the lender. The grade conveys to the Company’s management the opinion of the Risk Management department as to the overall risk profile presented by a lender and therefore the relative appeal of a potential relationship with that lender.

Financial Guaranty Business

Underwriting

The Company believes its financial guaranty underwriting discipline is critical to the profitability and growth of the financial guaranty business. The Company has a structured underwriting process to determine the characteristics and creditworthiness of risks that the Company directly insures or reinsures. Financial Guaranty conducts periodic reviews of its insured parties to determine the credit quality and performance of the book of business. This review includes an examination of the financial results, compliance and other factors that may be useful or necessary to consider. The underwriting process is performed at a transaction level for direct insurance transactions, and all transactions are subject to formal approval. To ensure quality control, emphasis is placed on extensive credit analysis and stringent legal structuring. Insurability is determined both on an individual and portfolio basis. As a result, a transaction is analyzed as to the credit characteristics of the specific transaction as well as how the credit fits into the overall portfolio, including sector and geographic concentrations. Each transaction has support from the legal department (or from outside counsel supervised by the legal department) from the underwriting phase through the closing phase.

The size of the direct insurance transactions underwritten and insured by Financial Guaranty is subject to single risk exposure limitations. These limitations are derived from state insurance regulation, rating agency guidelines and internally established criteria. The primary factor in determining single risk capacity is the class or sector of business being underwritten. For public finance credits, Financial Guaranty has self-imposed single risk guidelines which vary depending upon the perceived probability and severity of default of the public finance obligation insured or reinsured. For asset-backed transactions, the single risk guidelines generally follow the lower of state insurance regulation limitations, and internally derived single risk, rating agency guidelines and cumulative servicer-related risk. On individual underwritings, Financial Guaranty’s credit committees may limit insurance or reinsurance participation to an amount below that allowed by the single risk guidelines noted above. Moreover, Financial Guaranty relies on ongoing oversight by its credit committees with input from the Risk Management department to avoid undue exposure concentration in any given sector, obligor (or affiliates thereof), type of obligation or geographic area.

Notwithstanding Financial Guaranty’s reviews of its insured parties in the reinsurance transactions, the entire underwriting responsibility rests with the primary insurer. As a result, primary insurers participate more actively in the structuring of the transaction and conduct more detailed reviews of the parties than would a reinsurer. Financial Guaranty’s underwriting supplements the underwriting procedures of the ceding companies. Rather than relying entirely upon the underwriting performed by the ceding companies, Financial Guaranty and

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the rating agencies conduct extensive reviews of the ceding companies. Moreover, the ceding company is typically required to retain at least 25% of the exposure on any single risk assumed. Financial Guaranty carefully evaluates the risk underwriting and management of treaty customers, monitors the insured portfolio performance and conducts an underwriting review of the facultative reinsurance it writes. Facultative reinsurance underwriting, like direct underwriting, is performed at a transaction level.

The Company believes that the reinsurance of public finance guaranties provides a relatively stable source of premium income. Most premiums received are credited as deferred premium revenue and are earned over the contract period or over the period that coverage is provided, thereby providing a relatively stable, predictable source of earned premiums.

The Company conducts periodic reviews of its financial guaranty primary insurer customers and other carriers with which it does treaty or facultative business. That review entails an examination of the ceding company’s operating, underwriting and surveillance procedures, personnel, organization and existing book of business, as well as the ceding company’s underwriting of a sample of business assumed under the treaty. Facultative transactions are reviewed individually under procedures adopted by Financial Guaranty’s credit committees. Any underwriting issues are discussed internally by the credit committee and with the ceding company’s personnel.

Financial Guaranty’s surveillance procedures include reviews of those exposures assumed as a reinsurer as to which it may have concerns. The Company also maintains regular communication with the surveillance departments of the ceding companies.

Ratings

The Company has its financial strength rated by S&P, Moody’s and Fitch. The rating criteria used by the rating agencies focus on the following factors: Capital resources; financial strength; commitment of management to, and alignment of shareholder interests with, the insurance business; demonstrated management expertise in the insurance business conducted by the Company; credit analysis; systems development; marketing; capital markets and investment operations, including the ability to raise additional capital; and a minimum policyholders’ surplus comparable to primary company requirements, with initial capital sufficient to meet projected growth as well as access to such additional capital as may be necessary to continue to meet standards for capital adequacy. As part of their rating process, S&P, Moody’s and Fitch test the Company’s insurance subsidiaries by subjecting them to a “worst-case depression scenario.” Expected losses over a depression period are established by applying capital charges to the existing and projected insurance portfolio.

The financial strength rating assigned by the rating agencies to an insurance or reinsurance company is based upon factors relevant to policyholders and is not directed toward the protection of such company’s securityholders. Such a rating is neither a rating of securities nor a recommendation to buy, hold or sell any security. The financial strength rating assigned to the insurance subsidiaries should not be viewed as indicative of or relevant to any ratings which may be assigned to the Company’s outstanding debt securities by any rating agency and should not be considered an evaluation of the likelihood of the timely payment of principal or interest under such securities. However, these ratings are an indication to an insurer’s customers of the insurer’s present financial strength and its capacity to honor its future claims payment obligations. Therefore, ratings are generally considered critical to an insurer’s ability to compete for new insurance business.

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The Company has been assigned a senior debt rating of “A+” by Fitch, “A” by S&P and “A2” by Moody’s. The Company’s principal subsidiaries have been assigned the following financial strength ratings:

On October 4, 2002, S&P announced that it had downgraded the Insurer Financial Strength rating of Radian Reinsurance from “AAA” to “AA”. On April 8, 2003, Fitch downgraded the Insurer Financial Strength rating of Radian Reinsurance from “AAA” to “AA” and removed it from “negative watch.” Radian Reinsurance and Radian Asset Assurance are parties to numerous reinsurance agreements with primary insurers which grant the primary insurers the right to recapture all of the business ceded to Radian Reinsurance or Radian Asset Assurance under these agreements if the financial strength rating of Radian Reinsurance or Radian Asset Assurance, as the case may be, is downgraded below the rating levels established in the agreements, and, in some cases, to increase the commissions in order to compensate the primary insurers for the decrease in credit the rating agencies give the primary insurers for the reinsurance provided by Radian Reinsurance and Radian Asset Assurance.

As a result of this downgrade by S&P, one of the primary insurers exercised its right to recapture the financial guaranty reinsurance ceded to Radian Reinsurance. None of the primary insurers has a similar right with respect to the downgrade by Fitch. Radian Reinsurance has now reached agreement with the remaining primary insurers whereby such primary insurers have agreed not to exercise their rights with respect to the downgrade of Radian Reinsurance by S&P, at no additional cost to Radian Reinsurance.

With respect to the primary insurer that has exercised its rights, effective January 31, 2004, approximately $16.4 billion of par in force reinsurance ceded to Radian Reinsurance was recaptured. Radian Reinsurance was required to return approximately $96.4 million of STAT unearned premium reserves for which the carrying value under accounting principles generally accepted in the United States of America (“GAAP”) was approximately $71.5 million. In addition, Radian Reinsurance was reimbursed for policy acquisition costs of approximately $31.0 million for which the carrying value under GAAP was $21.3 million. Radian Reinsurance also reimbursed the primary insurer for case reserves recorded under GAAP for approximately $11.5 million. Finally, Radian Reinsurance took a charge of $0.8 million for mark-to-market adjustments related to certain insurance policies associated with the recapture. The sum of the above adjustments related to this recapture resulted in an estimated initial reduction of pre-tax income of $15.9 million and is summarized as follows:

The Company estimates that the amount of capital it is holding to support this recaptured insurance business approximates $170.0 million. Such capital could potentially be redeployed for additional reinsurance, including reinsurance of obligations primarily insured by Radian Asset Assurance, or other opportunities with possibly higher returns to the Company than the reinsurance business recaptured by the primary insurer. Since the

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acquisition of Radian Reinsurance by the Company in February 2001, reinsurance assumed from this primary insurer resulted in $25.1 million of written premium and $20.6 million of earned premium in 2001, $30.8 million of written premium and $32.0 million of earned premium in 2002 and $33.1 million of written premium and $37.0 million of earned premium for 2003.

In December 2003, Moody’s placed the Aa2 Insurance Financial Strength rating of Radian Reinsurance on review for possible downgrade. In January 2004, S&P revised its outlook for Radian Group, Radian Asset Assurance and Radian Reinsurance to “negative” from “stable” while reaffirming their respective ratings of “A”, “AA” and “AA”.

Future downgrades could trigger the primary financial guaranty insurers to recapture additional financial guaranty business that was assumed by Radian Reinsurance. The estimated impact of potential downgrades, excluding the impact of the business that has already been recaptured, is as follows:

Reinsurance Ceded

Amerin Guaranty and Radian Guaranty currently use reinsurance from affiliated companies in order to remain in compliance with the insurance regulations of certain states that require that a mortgage insurer limit its coverage percentage of any single risk to 25%. Amerin Guaranty and Radian Guaranty currently intend to use such reinsurance primarily for purposes of such compliance. Radian Reinsurance and Radian Asset Assurance also use reinsurance from affiliated companies in order to remain in compliance with applicable insurance regulations, including single risk limitations. Radian Reinsurance and Radian Asset Assurance currently intend to use such reinsurance from affiliated companies primarily for the purpose of such compliance. In addition, the Company has made use of facultative reinsurance on a selected basis to limit its single risk on individual transactions or to limit the aggregate amount of risk in a particular area.

Pursuant to a policy that is currently in a six-year run-off, Radian Guaranty reinsures all direct insurance in force under an excess of loss reinsurance program that it considers to be an effective catastrophic reinsurance coverage. Under this program, the reinsurer is responsible for 100% of covered losses in excess of Radian Guaranty’s retention. This policy was canceled by the reinsurer in November 2001; however, the reinsurer must provide six years of run-off coverage beginning with the date of cancellation. There is an overall aggregate limit of liability applicable to any run-off period equal to four times the annual limit in effect for the calendar year of such nonrenewal. For 2004, this aggregate limit is estimated to be $560 million. The annual retention is determined by a formula that contains variable components. The estimated 2004 retention is approximately $735 million of loss, which represents 120% of expected premiums earned by Radian Guaranty. The reinsurer’s aggregate annual limit of liability is also determined by a formula with variable components and is currently estimated to be $140 million. In addition, in 1999, a limit was set on the amount of annual pool insurance losses that can be counted in the reinsurance recoverable calculation. For 2004, this limit is $90 million. The excess of loss reinsurance program also provided restrictions and limitations on the payment of dividends by Radian Guaranty, investments, mergers or acquisitions involving other private mortgage insurance companies and reinsurance of exposure retained by Radian Guaranty.

In addition, Radian Guaranty entered into a variable quota-share (“VQS”) treaty for primary risk in the 1994 to 1997 origination years and a portion of the pool risk written in 1997. Under this treaty, quota-share loss relief is provided at varying levels ranging from 7.5% to 15.0% based upon the loss ratio on the reinsured book. The higher the loss ratio, the greater the potential reinsurance relief, which protects Radian Guaranty in adverse loss situations. A commission is paid by the reinsurer to Radian Guaranty and the agreement is noncancelable for 10 years by either party. As of December 31, 2003, the risk in force covered by the VQS treaty was approximately $1.0 billion, or approximately 3.9% of Mortgage Insurance’s total primary risk in force and $64.1 million, or

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approximately 2.6% of Mortgage Insurance’s total pool risk in force. The Company has not reinsured any additional business pursuant to the VQS treaty since 1998.

As of December 31, 2003, Radian Asset Assurance reinsured approximately 17.5% of its direct insurance exposure to Radian Reinsurance and other highly rated insurers and reinsurers. Most of this exposure has been reinsured by Radian Reinsurance, principally in order to comply with applicable regulatory single risk limitations. Radian Asset Assurance has also reinsured a small portion of its direct insurance exposure to third parties in order to comply with applicable regulatory single risk limitations. Radian Asset Assurance has also reinsured a significant portion of its direct insurance exposure in transactions with one of its largest reinsurance customers pursuant to which the availability of such reinsurance was a condition for Radian Asset Assurance accepting the direct insurance exposure. Radian Reinsurance has historically retroceded relatively little of its financial guaranty reinsurance exposure for risk management reasons. In its specialty insurance businesses, Financial Guaranty in recent years has reinsured a portion of its direct insurance exposure, principally in order to comply with applicable regulatory single risk limitations.

In November 2001, Radian Reinsurance entered into a credit agreement with a group of highly rated European banks, which was amended in January 2004, under which Radian Reinsurance is entitled, upon reaching the greater of 8.5% of average annual debt service or $210 million of covered losses and subject to certain conditions, to draw from such banks up to $95 million under certain circumstances. The recourse to Radian Reinsurance under this credit agreement is limited to recoveries on the covered losses. The agreement has an initial term of seven years and may be extended annually for additional one-year periods.

Cross-Guaranty Agreement

A Cross-Guaranty Agreement was entered into on August 11, 1999 by Radian Guaranty and Amerin Guaranty. The agreement provides that in the event Radian Guaranty fails to make a payment to any of its policyholders, Amerin Guaranty will make the payment; in the event Amerin Guaranty fails to make a payment to any of its policyholders, then Radian Guaranty will make the payment. Under the terms of the agreement, the obligations of both parties are unconditional and irrevocable; however, no payments will be made without prior approval by the insurance department of the payor’s state of domicile.

Defaults and Claims

Defaults

The default and claim cycle in the mortgage insurance business begins with the Company’s receipt of a default notice from the insured. Generally, the Master Policy of Insurance requires the insured to notify the Company of a default within 15 days after the loan has become 60 days past due. The insured must notify the Company within 45 days if the borrower fails to remit his or her first payment. Defaults occur due to a variety of factors, including but not limited to a reduction in the borrower’s income, unemployment, divorce, illness and marital problems.

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The following table shows the number of primary and pool loans insured, related loans in default and the percentage of loans in default (default rate) as of the dates indicated:

Regions of the United States may experience different default rates due to varying economic conditions. The following table shows the primary mortgage insurance default rates by the Company’s defined regions as of the dates indicated, including prime and non-prime loans.

As of December 31, 2003, primary mortgage insurance default rates for the Company’s two largest states measured by risk in force, California and Florida, were 2.4% and 4.5% respectively, compared to 2.3% and 4.2% respectively, at December 31, 2002.

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Claims

As discussed above, mortgage insurance claim volume is related to the circumstances surrounding the default. Claim volume is also affected by local housing prices and supply, interest rates and unemployment levels.

Claim activity in the mortgage insurance business is not evenly spread through the coverage period of a book of business. Historically, most claims under mortgage insurance policies on prime loans occur during the third through fifth year after issuance of the policies, and on policies on non-prime loans during the second through fourth year after issuance of the policies. Thereafter, the number of claims received has historically declined at a gradual rate, although the rate of decline can be affected by conditions in the economy. Approximately 82.9% of the primary risk in force, including most of the Company’s risk in force on alternative products, and approximately 40.7% of the pool risk in force at December 31, 2003 had not yet reached its anticipated highest claim frequency years.

The following table shows claims paid information for primary mortgage insurance for the periods indicated:

The disproportionately higher incidence of claims in Georgia and Utah is directly related to a significant amount of defaulted loans with questionable property values in those states. The Company’s Risk Management department identified these issues several years ago and has put into place several property valuation checks and balances to prevent these issues from recurring. Further, these same techniques are being applied to all mortgage insurance transactions. The Company expects this higher incidence of claims in Georgia and Utah to continue until loans originated in Georgia and Utah prior to the implementation of these preventive measures become sufficiently seasoned. The higher level of claim incidence in Texas partly resulted from unemployment levels which were higher than the national average and lower home price appreciation. The Company believes that claims in the Midwest and Southeast have been rising and will continue to rise due to the weakening of the industrial sector of the economy.

In the direct financial guaranty business and certain of the mortgage-backed securities insured by Radian Insurance, the Company is typically obligated to pay amounts equal to defaulted payments on insured obligations on their respective due dates, although in certain transactions insuring mortgage-backed securities the Company is also obligated to pay principal when and if, but only to the extent, the outstanding principal balance exceeds the value of the collateral insuring the bonds at the end of a reporting period (either monthly or quarterly). In the

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financial guaranty reinsurance business, the Company is typically obligated to pay amounts equal to defaulted payments on insured obligations either (i) on a periodic basis (typically monthly) in arrears based on claims made on policies of the applicable ceding companies covered by an applicable reinsurance treaty or agreement, net of premiums due Financial Guaranty and recoveries made in respect of claims paid, or (ii) in certain circumstances on their respective due dates. For public finance, asset-backed and other structured products, the Company underwrites to a remote-expected loss standard. A remote-expected loss standard means that in a normal economic and operating environment, the assets underlying the financial guaranty perform within the range anticipated at origination and the transaction matures with no loss paid. However, in a stressed or unexpectedly negative economic or operating environment, well beyond conditions that were reasonably anticipated at origination of the risk, some losses may occur. As such, the patterns of claim payments tend to fluctuate and may be low in frequency and high in severity. For trade credit protection reinsurance, the Company underwrites and prices to encompass historical loss patterns experienced by the Company and by ceding companies in similar businesses. The claim payments in trade credit tend to follow a more historical loss pattern that is reflective of overall global economic conditions.

Loss Mitigation

The Mortgage Insurance Claims department staff consists of 23 full time employees dedicated to avoiding or minimizing losses. These experienced specialists pursue opportunities to mitigate loss before and after the claim is received.

For pre-claim default situations, specialists focus on the following activities to reduce loss:

For post-claim default situations, specialists strive to minimize the claim payment by:

In the Company’s financial guaranty business, the risk management group is responsible for detecting any deterioration in credit quality or changes in the economic or political environment that could affect the timely payment of debt service on an insured issue. Once a problem is detected, the group then works with the appropriate parties in order to avoid a default. Claims are generally mitigated by restructuring the obligation, enforcing in a timely fashion any security arrangements, and working with the issuer to solve management or potential political problems. Issuers are typically under no obligation to restructure insured issues in order to prevent losses. The Company believes that early detection and continued involvement by the surveillance group has reduced claims. In December 2003, during its year-end review, the Company decided it was necessary to establish additional reserves for a manufactured housing transaction. The Company provided an additional $96 million of reserves. When added to the $15 million of reserves already established, the total reserve for this transaction is $111 million, which represents the total par exposure on this transaction. This amount is expected to be paid out over the next several years.

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Financial Guaranty’s surveillance procedures include periodic review of all its exposures, focusing on those exposures with which the Company may have concerns. While the specific procedures vary depending on whether the risk is public finance or structured finance, direct or reinsurance, the general procedures followed for surveillance of risks include:

Financial Guaranty conducts periodic reviews, in most cases in its direct business, at least annually, of its insured parties and issues to determine the credit quality and performance of Financial Guaranty’s book of business. This review includes an examination of the financial results, compliance and other factors that may be useful or necessary to consider. However, in its reinsurance insurance, the primary obligation for the determination and mitigation of claims rests with the primary insurer. As a result, primary insurers conduct more detailed reviews of the parties than would a reinsurer and are responsible for loss determination and mitigation. Financial Guaranty and the rating agencies conduct extensive reviews of the ceding companies. Moreover, the ceding company is typically required to retain at least 25% of the exposure on any single risk assumed. As a part of its surveillance for reinsurance transactions, Financial Guaranty periodically reevaluates the risk underwriting and management of treaty customers and monitors the reinsured portfolio performance.

Homeownership Counseling

Mortgage Insurance has a Homeownership Counseling Center (the “Center”) to work with borrowers receiving insured loans under Community Homebuyer, 97% LTV (“97s”) or other “affordable housing” programs. The Company considers this counseling to be very important to the future success of those particular borrowers with regard to sustaining their mortgage payments. In addition, the Center counsels such borrowers early in the default process in an attempt to help cure loan defaults and assist the borrowers in meeting their mortgage obligation.

Loss Reserves – General

The Company has determined that the establishment of loss reserves in its businesses constitutes a critical accounting policy. As such, more detailed descriptions of the Company’s policies are set forth in the Notes to the Consolidated Financial Statements included in Part I, Item 8 of this report and in the “Management’s Discussion and Analysis of Results of Operations and Financial Condition” included in Part II, Item 7 of this report.

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Loss Reserves – Mortgage Insurance

The mortgage insurance reserve for losses and loss adjustment expenses (“LAE”) consists of the estimated cost of settling claims on defaults (or delinquencies) reported and defaults that have occurred but have not been reported. SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the reserve for losses. Consistent with GAAP and industry accounting practices, the Company does not establish loss reserves for future claims on insured loans that are not currently in default. In determining the liability for unpaid losses related to reported outstanding defaults, the Company establishes loss reserves on a case-by-case basis. The amount reserved for any particular loan is dependent upon the characteristics of the loan, the status of the loan as reported by the servicer of the insured loan as well as the economic conditions and estimated foreclosure period in the area in which the default exists. As the default progresses closer to foreclosure, the amount of loss reserve for that particular loan is increased, in stages, to approximately 100% of the Company’s exposure and that adjustment is included in current operations. With respect to delinquent loans that are in the early stage of delinquency, considerable judgment is exercised as to the adequacy of reserve levels. The Company relies on its historical models and makes adjustments to its estimates based on current economic conditions and recent trend information. These adjustments in estimates for delinquent loans in the early stage of delinquency are more judgmental in nature than for loans that are in the later stage of delinquency. If the default cures, the reserve for that loan is removed from the reserve for losses and LAE. The curing process causes an appearance of a reduction in reserves from prior years. The Company also reserves for defaults that have occurred but have not been reported using historical information on defaults not reported on a timely basis by lending institutions. The estimates are continually reviewed and, as adjustments to these liabilities become necessary, such adjustments are reflected in current operations.

The following table presents information relating to Mortgage Insurance’s liability for unpaid claims and related expenses (in millions):

Loss Reserves – Financial Guaranty

Reserves for losses and LAE in the financial guaranty business are established based on the Company’s estimate of specific and non-specific losses, including expenses associated with settlement of such losses on its insured and reinsured obligations. The Company’s estimation of total reserves considers known defaults, reports and individual loss estimates reported by ceding companies and annual increases in the total net par amount outstanding of the Company’s insured obligations. The Company records a specific provision for losses and related LAE when reported by primary insurers or when, in the Company’s opinion, an insured risk is in default or default is probable and the amount of the loss is reasonably estimable. In the case of obligations with fixed periodic payments, the provision for losses and LAE represents the present value of the Company’s ultimate expected losses, adjusted for estimated recoveries under salvage or subrogation rights. The non-specific reserves represent the Company’s estimate of total reserves, less provisions for specific reserves. Generally, when a case-

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basis reserve is established or adjusted, an offsetting adjustment is made to the non-specific reserve. The Company discounts certain financial guaranty liabilities arising from defaults over the life of the claim payment at annual rates, which correspond to the financial guaranty insurance subsidiaries’ investment yields ranging from 4.05% to 4.75% in 2003 and 4.10% to 5.25% in 2002. Discounted liabilities at December 31, 2003 were $17.5 million, net of discounts of $3.2 million compared to discounted liabilities of $18.5 million at December 31, 2002, net of discounts of $7.3 million.

Reserves for losses and LAE for Financial Guaranty’s other lines of business, primarily trade credit reinsurance, are based on reports and individual loss estimates received from ceding companies, net of anticipated estimated recoveries under salvage and subrogation rights. In addition, a reserve is included for losses and LAE incurred but not reported on trade credit reinsurance.

The Company’s non-specific loss reserve for the financial guaranty business, as of December 31, 2003 is $163.7 million, compared to $48.0 million as of December 31, 2002. Included in non-specific reserves for 2003 is $111 million related to a single transaction with Conseco Finance Corp. The Company believes that the reserves for losses and LAE, including case and unallocated or non-specific reserves, are adequate to cover the ultimate net cost of claims. However, the reserves are necessarily based on estimates, and there can be no assurance that the ultimate liability will not exceed such estimates.

As anticipated, Financial Guaranty experienced relatively higher loss levels in certain of its other insurance businesses, such as trade credit reinsurance, than it experienced in its financial guaranty reinsurance business. The Company believes that the higher premiums it receives in these businesses adequately compensates it for the risks involved.

At December 31, 2003, Financial Guaranty had established $276.9 million in net reserves for losses and loss adjustment expenses (of which $189.0 million represented incurred but not reported and non-specific reserves). The following table sets forth certain information regarding Financial Guaranty’s loss experience for the years indicated (in millions):

In 2003, 2002 and 2001, Financial Guaranty recorded losses of $38.7 million, $36.3 million and $24.9 million, respectively, in connection with its trade credit and surety businesses.

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Analysis of Primary Risk in Force

The Company’s mortgage insurance business strategy is to assume risks that have known patterns of performance. The Company analyzes its portfolio in a number of ways to identify any concentrations or imbalances in risk dispersion. The Company believes the performance of its insurance portfolio is affected significantly by:

Financial Guaranty seeks to maintain a diversified insurance portfolio designed to spread its risk based on insurer, type of debt obligation insured, and geographic concentration.

Primary Risk in Force by Policy Year

The following table sets forth the percentage of the Company’s primary mortgage insurance risk in force by policy origination year as of December 31:

Geographic Dispersion

The following tables reflect the percentage of direct primary mortgage insurance risk in force on the Company’s book of business (by location of property) for the top 10 states and top 15 metropolitan statistical areas (“MSAs”) as of December 31, 2003 and 2002:

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The following table sets forth the distribution by state of the Company’s financial guaranty insurance in force as of December 31, 2003 and 2002:

For the years ended December 31, 2003, 2002 and 2001, the Company’s revenue attributable to foreign countries was approximately 6%, 6% and 3%, respectively. In addition, long-lived assets located in foreign countries were immaterial for the 2003, 2002 and 2001 fiscal years.

Lender and Product Characteristics

While geographic dispersion is an important component of overall risk dispersion and it has been a strategy of the Company to limit its exposure in the top 10 states and top 15 MSAs, the Company believes the quality of the risk in force should be considered in conjunction with other elements of risk dispersion, such as product distribution, as well as the Company’s risk management and underwriting practices.

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The following table reflects the percentage of the Company’s direct mortgage insurance risk in force (as determined on the basis of information available on the date of mortgage origination) by the categories indicated as of December 31, 2003 and 2002:

Direct Mortgage Insurance Risk in Force