Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - Essent Group Ltd.a33118ex321.htm
EX-31.2 - EXHIBIT 31.2 - Essent Group Ltd.a33118ex312.htm
EX-31.1 - EXHIBIT 31.1 - Essent Group Ltd.a33118ex311.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 
 
FORM 10-Q
 
 
 
 
(Mark One)
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the period ended March 31, 2018
 
o      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
 
Commission file number 001-36157 
 
  
ESSENT GROUP LTD.
(Exact name of registrant as specified in its charter)
 
  
Bermuda
 
Not Applicable
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
Clarendon House
2 Church Street
Hamilton HM11, Bermuda
(Address of principal executive offices and zip code)
 
(441) 297-9901
(Registrant’s telephone number, including area code)
 
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 ý  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232-405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
 
 
 
Smaller reporting company
o
 
 
 
Emerging growth company
o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
The number of the registrant’s common shares outstanding as of May 1, 2018 was 98,105,419.



Essent Group Ltd. and Subsidiaries
 
Form 10-Q
 
Index
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i


Unless the context otherwise indicates or requires, the terms “we,” “our,” “us,” “Essent,” and the “Company,” as used in this Quarterly Report on Form 10-Q, refer to Essent Group Ltd. and its directly and indirectly owned subsidiaries, including our primary operating subsidiaries, Essent Guaranty, Inc. and Essent Reinsurance Ltd., as a combined entity, except where otherwise stated or where it is clear that the terms mean only Essent Group Ltd. exclusive of its subsidiaries.
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q, or Quarterly Report, includes forward-looking statements pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts or present facts or conditions, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the introduction of new products and services, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or the negative of these terms or other comparable terminology.
 
The forward-looking statements contained in this Quarterly Report reflect our views as of the date of this Quarterly Report about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance or achievements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described below, in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report, and in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission. These factors include, without limitation, the following:
 
changes in or to Fannie Mae and Freddie Mac, which we refer to collectively as the GSEs, whether through Federal legislation, restructurings or a shift in business practices;

failure to continue to meet the mortgage insurer eligibility requirements of the GSEs;

competition for our customers or the loss of a significant customer;
 
lenders or investors seeking alternatives to private mortgage insurance;

increase in the number of loans insured through Federal government mortgage insurance programs, including those offered by the Federal Housing Administration;

decline in the volume of low down payment mortgage originations;

uncertainty of loss reserve estimates;

decrease in the length of time our insurance policies are in force;

deteriorating economic conditions;

the scope of recently enacted U.S. Federal tax reform and its impact on us, our shareholders and our operations;

the definition of “Qualified Mortgage” reducing the size of the mortgage origination market or creating incentives to use government mortgage insurance programs;

the definition of “Qualified Residential Mortgage” reducing the number of low down payment loans or lenders and investors seeking alternatives to private mortgage insurance;

the implementation of the Basel III Capital Accord, which may discourage the use of private mortgage insurance;

management of risk in our investment portfolio;

fluctuations in interest rates;

ii



inadequacy of the premiums we charge to compensate for our losses incurred;

dependence on management team and qualified personnel;

disturbance to our information technology systems;

change in our customers’ capital requirements discouraging the use of mortgage insurance;

declines in the value of borrowers’ homes;

limited availability of capital;

unanticipated claims arise under and risks associated with our contract underwriting program;

industry practice that loss reserves are established only upon a loan default;

disruption in mortgage loan servicing;

risk of future legal proceedings;

customers’ technological demands;

our non-U.S. operations becoming subject to U.S. Federal income taxation;

becoming considered a passive foreign investment company for U.S. Federal income tax purposes; and

potential inability of our insurance subsidiaries to pay dividends.
 
Readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on these forward-looking statements. All of the forward-looking statements we have included in this Quarterly Report are based on information available to us on the date of this Quarterly Report. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as otherwise required by law.
 


iii


PART I — FINANCIAL INFORMATION
 
Item 1.   Financial Statements (Unaudited)
 
Essent Group Ltd. and Subsidiaries

Condensed Consolidated Balance Sheets (Unaudited)
 
 
 
March 31,
 
December 31,
(In thousands, except per share amounts)
 
2018
 
2017
Assets
 
 

 
 

Investments available for sale, at fair value
 
 

 
 

Fixed maturities (amortized cost: 2018 — $2,116,143; 2017 — $1,994,200)
 
$
2,080,365

 
$
1,992,371

Short-term investments (amortized cost: 2018 — $380,776; 2017 — $312,714)
 
380,762

 
312,694

Total investments
 
2,461,127

 
2,305,065

Cash
 
32,958

 
43,524

Accrued investment income
 
14,383

 
12,807

Accounts receivable
 
45,953

 
29,752

Deferred policy acquisition costs
 
15,563

 
15,354

Property and equipment (at cost, less accumulated depreciation of $51,363 in 2018 and $50,466 in 2017)
 
6,590

 
6,979

Prepaid federal income tax
 
151,294

 
252,157

Other assets
 
13,349

 
8,730

Total assets
 
$
2,741,217

 
$
2,674,368

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
 

 
 

Liabilities
 
 

 
 

Reserve for losses and LAE
 
$
49,966

 
$
46,850

Unearned premium reserve
 
272,339

 
259,672

Net deferred tax liability
 
132,325

 
127,636

Credit facility borrowings (at carrying value, less unamortized deferred costs of $1,303 in 2018 and $1,409 in 2017)
 
263,697

 
248,591

Securities purchases payable
 
6,201

 
14,999

Other accrued liabilities
 
21,399

 
36,184

Total liabilities
 
745,927

 
733,932

Commitments and contingencies (see Note 7)
 


 


Stockholders’ Equity
 
 

 
 

Common shares, $0.015 par value:
 
 

 
 

Authorized - 233,333; issued and outstanding - 98,102 shares in 2018 and 98,434 shares in 2017
 
1,472

 
1,476

Additional paid-in capital
 
1,099,676

 
1,127,137

Accumulated other comprehensive loss
 
(32,002
)
 
(3,252
)
Retained earnings
 
926,144

 
815,075

Total stockholders’ equity
 
1,995,290

 
1,940,436

Total liabilities and stockholders’ equity
 
$
2,741,217

 
$
2,674,368

 
See accompanying notes to condensed consolidated financial statements.


1


Essent Group Ltd. and Subsidiaries
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
 
 
 
Three Months Ended March 31,
(In thousands, except per share amounts)
 
2018
 
2017
Revenues:
 
 

 
 

Net premiums written
 
$
165,225

 
$
119,297

Increase in unearned premiums
 
(12,667
)
 
(1,646
)
Net premiums earned
 
152,558

 
117,651

Net investment income
 
13,714

 
8,435

Realized investment gains, net
 
197

 
655

Other income
 
994

 
851

Total revenues
 
167,463

 
127,592

 
 
 
 
 
Losses and expenses:
 
 

 
 

Provision for losses and LAE
 
5,309

 
3,693

Other underwriting and operating expenses
 
38,124

 
36,332

Interest expense
 
2,450

 
716

Total losses and expenses
 
45,883

 
40,741

 
 
 
 
 
Income before income taxes
 
121,580

 
86,851

Income tax expense
 
10,511

 
20,253

Net income
 
$
111,069

 
$
66,598

 
 
 
 
 
Earnings per share:
 
 

 
 

Basic
 
$
1.14

 
$
0.73

Diluted
 
1.13

 
0.72

 
 
 
 
 
Weighted average shares outstanding:
 
 

 
 

Basic
 
97,298

 
91,258

Diluted
 
97,951

 
93,023

 
 
 
 
 
Net income
 
$
111,069

 
$
66,598

 
 
 
 
 
Other comprehensive income (loss):
 
 

 
 

Change in unrealized (depreciation) appreciation of investments, net of tax (benefit) expense of ($5,193) in 2018 and $2,061 in 2017
 
(28,750
)
 
4,850

Total other comprehensive (loss) income
 
(28,750
)
 
4,850

Comprehensive income
 
$
82,319

 
$
71,448

 
See accompanying notes to condensed consolidated financial statements.


2


Essent Group Ltd. and Subsidiaries
 
Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
 
(In thousands)
 
Common
Shares
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
 
Treasury
Stock
 
Total
Stockholders’
Equity
Balance at January 1, 2017
 
$
1,397

 
$
918,296

 
$
(12,255
)
 
$
436,335

 
$

 
$
1,343,773

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 

 
 

 
 

 
379,747

 
 

 
379,747

Other comprehensive income
 
 

 
 

 
8,068

 
 

 
 

 
8,068

Issuance of common shares, net of issuance cost of $1,802
 
75

 
197,623

 
 
 
 
 
 
 
197,698

Issuance of management incentive shares
 
8

 
(8
)
 
 

 
 

 
 

 

Stock-based compensation expense
 
 

 
18,688

 
 

 
 

 
 

 
18,688

Cumulative effect of ASU 2016-09 adoption
 
 
 
111

 
 
 
(72
)
 
 
 
39

Treasury stock acquired
 
 

 
 

 
 

 
 

 
(7,577
)
 
(7,577
)
Cancellation of treasury stock
 
(4
)
 
(7,573
)
 
 

 
 

 
7,577

 

Reclassification of certain income tax effects resulting from tax reform
 
 
 
 
 
935

 
(935
)
 
 
 

Balance at December 31, 2017
 
$
1,476

 
$
1,127,137

 
$
(3,252
)
 
$
815,075

 
$

 
$
1,940,436

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 

 
 

 
 

 
111,069

 
 

 
111,069

Other comprehensive loss
 
 

 
 

 
(28,750
)
 
 

 
 

 
(28,750
)
Issuance of management incentive shares
 
6

 
(6
)
 
 

 
 

 
 

 

Stock-based compensation expense
 
 

 
3,605

 
 

 
 

 
 

 
3,605

Treasury stock acquired
 
 

 
 

 
 

 
 

 
(31,070
)
 
(31,070
)
Cancellation of treasury stock
 
(10
)
 
(31,060
)
 
 

 
 

 
31,070

 

Balance at March 31, 2018
 
$
1,472

 
$
1,099,676

 
$
(32,002
)
 
$
926,144

 
$

 
$
1,995,290

 
See accompanying notes to condensed consolidated financial statements.


3


Essent Group Ltd. and Subsidiaries
 
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
 
 
Three Months Ended March 31,
(In thousands)
 
2018
 
2017
Operating Activities
 
 

 
 

Net income
 
$
111,069

 
$
66,598

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Gain on the sale of investments, net
 
(197
)
 
(655
)
Depreciation and amortization
 
897

 
1,001

Stock-based compensation expense
 
3,605

 
4,619

Amortization of premium on investment securities
 
3,287

 
2,983

Deferred income tax provision
 
9,882

 
18,042

Change in:
 
 

 
 

Accrued investment income
 
(1,576
)
 
(703
)
Accounts receivable
 
(2,238
)
 
(1,887
)
Deferred policy acquisition costs
 
(209
)
 
(93
)
Prepaid federal income tax
 
100,863

 
615

Other assets
 
(4,619
)
 
(975
)
Reserve for losses and LAE
 
3,116

 
1,326

Unearned premium reserve
 
12,667

 
1,646

Other accrued liabilities
 
(14,679
)
 
(14,629
)
Net cash provided by operating activities
 
221,868

 
77,888

 
 
 
 
 
Investing Activities
 
 

 
 

Net change in short-term investments
 
(68,068
)
 
19,968

Purchase of investments available for sale
 
(266,847
)
 
(200,795
)
Proceeds from maturity of investments available for sale
 
16,601

 
18,206

Proceeds from sales of investments available for sale
 
102,458

 
60,129

Purchase of property and equipment
 
(508
)
 
(1,087
)
Net cash used in investing activities
 
(216,364
)
 
(103,579
)
 
 
 
 
 
Financing Activities
 
 

 
 

Credit facility borrowings
 
15,000

 
25,000

Treasury stock acquired
 
(31,070
)
 
(7,127
)
Net cash (used in) provided by financing activities
 
(16,070
)
 
17,873

 
 
 
 
 
Net decrease in cash
 
(10,566
)
 
(7,818
)
Cash at beginning of year
 
43,524

 
27,531

Cash at end of period
 
$
32,958

 
$
19,713

 
 
 
 
 
Supplemental Disclosure of Cash Flow Information
 
 
 
 
Income tax payments
 
$

 
$
(1,200
)
Interest payments
 
(2,324
)
 
(701
)
 
See accompanying notes to condensed consolidated financial statements.

4


Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
In these notes to condensed consolidated financial statements, “Essent”, “Company”, “we”, “us”, and “our” refer to Essent Group Ltd. and its subsidiaries, unless the context otherwise requires.
 
Note 1. Nature of Operations and Basis of Presentation
 
Essent Group Ltd. (“Essent Group”) is a Bermuda-based holding company, which, through its wholly-owned subsidiaries, offers private mortgage insurance and reinsurance for mortgages secured by residential properties located in the United States. Mortgage insurance facilitates the sale of low down payment (generally less than 20%) mortgage loans into the secondary mortgage market, primarily to two government-sponsored enterprises (“GSEs”), Fannie Mae and Freddie Mac.

The primary mortgage insurance operations are conducted through Essent Guaranty, Inc. (“Essent Guaranty”), a wholly-owned subsidiary approved as a qualified mortgage insurer by the GSEs and is licensed to write mortgage insurance in all 50 states and the District of Columbia. Essent Guaranty reinsures 25% of GSE-eligible new insurance written to Essent Reinsurance Ltd. (“Essent Re”), an affiliated Bermuda domiciled Class 3A Insurer licensed pursuant to Section 4 of the Bermuda Insurance Act 1978 that provides insurance and reinsurance coverage of mortgage credit risk. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae. In 2016, Essent Re formed Essent Agency (Bermuda) Ltd., a wholly-owned subsidiary, which provides underwriting services to third-party reinsurers. In accordance with certain state law requirements, Essent Guaranty also reinsures that portion of the risk that is in excess of 25% of the mortgage balance with respect to any loan insured, after consideration of other reinsurance, to Essent Guaranty of PA, Inc. (“Essent PA”), an affiliate.
 
In addition to offering mortgage insurance, we provide contract underwriting services on a limited basis through CUW Solutions, LLC ("CUW Solutions"), a Delaware limited liability company, that provides, among other things, mortgage contract underwriting services to lenders and mortgage insurance underwriting services to affiliates.

We have prepared the condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) pursuant to such rules and regulations. In the opinion of management, the statements include all adjustments (which include normal recurring adjustments) required for a fair statement of financial position, results of operations and cash flows for the interim periods presented. These statements should be read in conjunction with the consolidated financial statements and notes thereto, including Note 1 and Note 2 to the consolidated financial statements, included in our Annual Report on Form 10-K for the year ended December 31, 2017, which discloses the principles of consolidation and a summary of significant accounting policies. The results of operations for the interim periods are not necessarily indicative of the results for the full year. We evaluated the need to recognize or disclose events that occurred subsequent to March 31, 2018 prior to the issuance of these condensed consolidated financial statements.
 
Note 2. Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This update is intended to provide a consistent approach in recognizing revenue. In accordance with the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In December 2016, the FASB clarified that all contracts that are within the scope of Topic 944, Financial Services-Insurance, are excluded from the scope of ASU 2014-09. The Company adopted this ASU effective January 1, 2018. The adoption of this ASU did not have a material effect on the Company's consolidated operating results or financial position.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This update requires certain equity investments (except those accounted for under the equity method of accounting or result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. A qualitative assessment for impairment is

5

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


required for equity investments without readily determinable fair values. This update also requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. In addition, an entity is required to evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale investment securities in combination with the entity’s other deferred tax assets. The Company adopted this ASU effective January 1, 2018. The adoption of this ASU did not have a material effect on the Company's consolidated operating results or financial position.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This update will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The new guidance will also require additional disclosures about the amount, timing and uncertainty of cash flows arising from leases. The provisions of this update are effective for annual and interim periods beginning after December 15, 2018. The Company expects a gross-up of its consolidated balance sheets as a result of recognizing lease liabilities and right of use assets. The Company is still evaluating the impact the adoption of this ASU will have on the consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326). This update is intended to provide financial statement users with more information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of an allowance for credit losses. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance rather than as a write-down of the amortized cost of the securities. The provisions of this update are effective for annual and interim periods beginning after December 15, 2019. While the Company is still evaluating this ASU, we do not expect it to impact our accounting for insurance losses and loss adjustment expenses ("LAE") as these items are not within the scope of this ASU.


6

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 3. Investments Available for Sale
 
Investments available for sale consist of the following:
 
March 31, 2018 (In thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
 
$
211,888

 
$

 
$
(7,332
)
 
$
204,556

U.S. agency securities
 
33,663

 

 
(842
)
 
32,821

U.S. agency mortgage-backed securities
 
492,150

 
29

 
(15,959
)
 
476,220

Municipal debt securities(1)
 
480,371

 
3,615

 
(5,053
)
 
478,933

Corporate debt securities(2)
 
637,012

 
712

 
(10,781
)
 
626,943

Residential and commercial mortgage securities
 
86,605

 
591

 
(766
)
 
86,430

Asset-backed securities
 
183,444

 
429

 
(424
)
 
183,449

Money market funds
 
371,786

 

 
(11
)
 
371,775

Total investments available for sale
 
$
2,496,919

 
$
5,376

 
$
(41,168
)
 
$
2,461,127


December 31, 2017 (In thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
 
$
231,905

 
$
2

 
$
(4,102
)
 
$
227,805

U.S. agency securities
 
33,669

 

 
(555
)
 
33,114

U.S. agency mortgage-backed securities
 
462,986

 
567

 
(7,516
)
 
456,037

Municipal debt securities(1)
 
457,418

 
9,098

 
(1,261
)
 
465,255

Corporate debt securities(2)
 
610,516

 
4,249

 
(3,037
)
 
611,728

Residential and commercial mortgage securities
 
78,974

 
791

 
(358
)
 
79,407

Asset-backed securities
 
167,638

 
467

 
(183
)
 
167,922

Money market funds
 
263,808

 

 
(11
)
 
263,797

Total investments available for sale
 
$
2,306,914

 
$
15,174

 
$
(17,023
)
 
$
2,305,065

 
 
 
March 31,
 
December 31,
(1) The following table summarizes municipal debt securities as of :
 
2018
 
2017
Special revenue bonds
 
63.4
%
 
63.6
%
General obligation bonds
 
31.2

 
30.7

Certificate of participation bonds
 
4.1

 
4.4

Tax allocation bonds
 
0.8

 
0.8

Special tax bonds
 
0.5

 
0.5

Total
 
100.0
%
 
100.0
%
 
 
March 31,
 
December 31,
(2) The following table summarizes corporate debt securities as of :
 
2018
 
2017
Financial
 
41.9
%
 
45.9
%
Consumer, non-cyclical
 
17.7

 
16.2

Communications
 
10.9

 
7.3

Energy
 
7.8

 
7.8

Utilities
 
5.2

 
5.3

Industrial
 
5.1

 
6.3

Consumer, cyclical
 
4.8

 
5.3

Technology
 
3.9

 
3.9

Basic materials
 
2.7

 
2.0

Total
 
100.0
%
 
100.0
%

7

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)



The amortized cost and fair value of investments available for sale at March 31, 2018, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Because most U.S. agency mortgage-backed securities, residential and commercial mortgage securities and asset-backed securities provide for periodic payments throughout their lives, they are listed below in separate categories.
 
(In thousands)
 
Amortized
Cost
 
Fair
Value
U.S. Treasury securities:
 
 

 
 

Due in 1 year
 
$
12,815

 
$
12,809

Due after 1 but within 5 years
 
93,015

 
91,492

Due after 5 but within 10 years
 
76,197

 
71,833

Due after 10 years
 
29,861

 
28,422

Subtotal
 
211,888

 
204,556

U.S. agency securities:
 
 

 
 

Due in 1 year
 

 

Due after 1 but within 5 years
 
33,663

 
32,821

Subtotal
 
33,663

 
32,821

Municipal debt securities:
 
 

 
 

Due in 1 year
 
40,259

 
40,197

Due after 1 but within 5 years
 
82,714

 
82,215

Due after 5 but within 10 years
 
198,553

 
198,335

Due after 10 years
 
158,845

 
158,186

Subtotal
 
480,371

 
478,933

Corporate debt securities:
 
 

 
 

Due in 1 year
 
72,533

 
72,250

Due after 1 but within 5 years
 
344,859

 
339,707

Due after 5 but within 10 years
 
200,838

 
196,224

Due after 10 years
 
18,782

 
18,762

Subtotal
 
637,012

 
626,943

U.S. agency mortgage-backed securities
 
492,150

 
476,220

Residential and commercial mortgage securities
 
86,605

 
86,430

Asset-backed securities
 
183,444

 
183,449

Money market funds
 
371,786

 
371,775

Total investments available for sale
 
$
2,496,919

 
$
2,461,127


Gross gains and losses realized on the sale of investments available for sale were as follows:
 
 
 
Three Months Ended March 31,
(In thousands)
 
2018
 
2017
Realized gross gains
 
$
791

 
$
681

Realized gross losses
 
594

 
26

 

8

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


The fair value of investments in an unrealized loss position and the related unrealized losses were as follows:
 
 
 
Less than 12 months
 
12 months or more
 
Total
March 31, 2018 (In thousands)
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
U.S. Treasury securities
 
$
139,221

 
$
(3,121
)
 
$
62,347

 
$
(4,211
)
 
$
201,568

 
$
(7,332
)
U.S. agency securities
 
17,144

 
(363
)
 
15,677

 
(479
)
 
32,821

 
(842
)
U.S. agency mortgage-backed securities
 
264,058

 
(5,594
)
 
206,819

 
(10,365
)
 
470,877

 
(15,959
)
Municipal debt securities
 
260,852

 
(4,253
)
 
22,839

 
(800
)
 
283,691

 
(5,053
)
Corporate debt securities
 
472,587

 
(7,635
)
 
87,942

 
(3,146
)
 
560,529

 
(10,781
)
Residential and commercial mortgage securities
 
38,097

 
(458
)
 
5,626

 
(308
)
 
43,723

 
(766
)
Asset-backed securities
 
94,019

 
(376
)
 
5,730

 
(48
)
 
99,749

 
(424
)
Money market funds
 
57,473

 
(11
)
 

 

 
57,473

 
(11
)
Total
 
$
1,343,451

 
$
(21,811
)
 
$
406,980

 
$
(19,357
)
 
$
1,750,431

 
$
(41,168
)
 
 
 
Less than 12 months
 
12 months or more
 
Total
December 31, 2017 (In thousands)
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
U.S. Treasury securities
 
$
151,119

 
$
(1,240
)
 
$
69,454

 
$
(2,862
)
 
$
220,573

 
$
(4,102
)
U.S. agency securities
 
17,320

 
(190
)
 
15,794

 
(365
)
 
33,114

 
(555
)
U.S. agency mortgage-backed securities
 
180,443

 
(1,394
)
 
217,944

 
(6,122
)
 
398,387

 
(7,516
)
Municipal debt securities
 
124,171

 
(817
)
 
23,492

 
(444
)
 
147,663

 
(1,261
)
Corporate debt securities
 
214,371

 
(1,213
)
 
94,261

 
(1,824
)
 
308,632

 
(3,037
)
Residential and commercial mortgage securities
 
29,842

 
(179
)
 
5,988

 
(179
)
 
35,830

 
(358
)
Asset-backed securities
 
58,798

 
(133
)
 
5,828

 
(50
)
 
64,626

 
(183
)
Money market funds
 
59,489

 
(11
)
 

 

 
59,489

 
(11
)
Total
 
$
835,553

 
$
(5,177
)
 
$
432,761

 
$
(11,846
)
 
$
1,268,314

 
$
(17,023
)
 
The gross unrealized losses on these investment securities are principally associated with the changes in market interest rates and credit spreads subsequent to their purchase. Each issuer is current on its scheduled interest and principal payments. We assess our intent to sell these securities and whether we will be required to sell these securities before the recovery of their amortized cost basis when determining whether an impairment is other-than-temporary. There were no other-than-temporary impairments in each of the three months ended March 31, 2018 and 2017.
 
The fair value of investments deposited with insurance regulatory authorities to meet statutory requirements was $8.6 million as of March 31, 2018 and December 31, 2017. In connection with its insurance and reinsurance activities, Essent Re is required to maintain assets in trusts for the benefit of its contractual counterparties. The fair value of the investments on deposit in these trusts was $676.9 million at March 31, 2018 and $615.8 million at December 31, 2017. In March 2018, Essent Guaranty entered into an excess-of-loss reinsurance agreement. See Note 4. In connection with this agreement, Essent Guaranty is required to maintain assets on deposit for the benefit of the reinsurer. The fair value of the assets on deposit was $3.3 million at March 31, 2018.


9

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Net investment income consists of: 
 
 
Three Months Ended March 31,
(In thousands)
 
2018
 
2017
Fixed maturities
 
$
13,643

 
$
9,019

Short-term investments
 
751

 
59

Gross investment income
 
14,394

 
9,078

Investment expenses
 
(680
)
 
(643
)
Net investment income
 
$
13,714

 
$
8,435

 
Note 4. Reinsurance
 
In the ordinary course of business, our insurance subsidiaries may use reinsurance to provide protection against adverse loss experience and to expand our capital sources. Reinsurance recoverables are recorded as assets, predicated on a reinsurer's ability to meet their obligations under the reinsurance agreements. If the reinsurers are unable to satisfy their obligations under the agreements, our insurance subsidiaries would be liable for such defaulted amounts.

On March 22, 2018, Essent Guaranty entered into a fully collateralized reinsurance agreement with Radnor Re 2018-1 Ltd. ("Radnor Re"), an unaffiliated special purpose insurer domiciled in Bermuda, that provides for up to $424.4 million of aggregate excess-of-loss reinsurance coverage at inception for new defaults on a portfolio of mortgage insurance policies issued between January 1, 2017 and December 31, 2017. For the reinsurance coverage period, Essent Guaranty and its affiliates will retain the first layer of $224.7 million of aggregate losses, and Radnor Re will then provide second layer coverage up to the outstanding reinsurance coverage amount. Essent Guaranty and its affiliates retain losses in excess of the outstanding reinsurance coverage amount. The reinsurance premium due to Radnor Re is calculated by multiplying the outstanding reinsurance coverage amount at the beginning of a period by a coupon rate, which is the sum of one-month LIBOR plus a risk margin, and then subtracting actual investment income collected on the assets in the reinsurance trust during that period. The aggregate excess of loss reinsurance coverage decreases over a ten-year period as the underlying covered mortgages amortize. Essent Guaranty has rights to terminate the reinsurance agreement, which includes an option to terminate after five years from issuance. If the reinsurance agreement is not terminated after five years from issuance, the risk margin component of the reinsurance premium payable to Radnor Re increases by 50%. Radnor Re financed the coverage by issuing mortgage insurance-linked notes in an aggregate amount of $424.4 million to unaffiliated investors. The notes have ten-year legal maturities and are non-recourse to any assets of Essent Guaranty or its affiliates. The proceeds of the notes were deposited into a reinsurance trust for the benefit of Essent Guaranty that will be the source of reinsurance claim payments to Essent Guaranty and principal repayments on the mortgage insurance-linked notes.

The effect of reinsurance on net premiums written and earned is as follows:
 
 
 
Three Months Ended 
 March 31,
(In thousands)
 
2018
 
2017
Net premiums written:
 
 
 
 
Direct
 
$
165,519

 
$
119,297

Ceded
 
(294
)
 

Net premiums written
 
$
165,225

 
$
119,297

 
 
 
 
 
Net premiums earned:
 
 
 
 
Direct
 
$
152,852

 
$
117,651

Ceded
 
(294
)
 

Net premiums earned
 
$
152,558

 
$
117,651


The amount of monthly reinsurance premium ceded will fluctuate due to changes in one-month LIBOR and changes in money market rates that affect investment income collected on the assets in the reinsurance trust. As the reinsurance premium

10

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


will vary based on changes in these rates, we concluded that the reinsurance agreement contains an embedded derivative that will be accounted for separately like a freestanding derivative. The fair value of this derivative at March 31, 2018 and the change in its fair value from inception of the reinsurance agreement to March 31, 2018 was not material.

In connection with entering the reinsurance agreement with Radnor Re, we concluded that the risk transfer requirements for reinsurance accounting were met as Radnor Re is assuming significant insurance risk and a reasonable possibility of a significant loss. In addition, we assessed whether Radnor Re was a variable interest entity ("VIE") and the appropriate accounting for Radnor Re if it was a VIE. A VIE is a legal entity that does not have sufficient equity at risk to finance its activities without additional subordinated financial support or is structured such that equity investors lack the ability to make significant decisions relating to the entity’s operations through voting rights or do not substantively participate in the gains and losses of the entity. A VIE is consolidated by its primary beneficiary. The primary beneficiary is the entity that has both (1) the power to direct the activities of the VIE that most significantly affect the entity’s economic performance and (2) the obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. While also considering these factors, the consolidation conclusion depends on the breadth of the decision-making ability and ability to influence activities that significantly affect the economic performance of the VIE. We concluded that Radnor Re is a VIE. However, given that Essent Guaranty (1) does not have the unilateral power to direct the activities that most significantly affect Radnor Re’s economic performance and (2) does not have the obligation to absorb losses or the right to receive benefits that could be potentially significant to Radnor Re, Radnor Re is not consolidated in these financial statements.

The following table presents total assets of Radnor Re as well as our maximum exposure to loss associated with Radnor Re, representing the estimated net present value of investment earnings on the assets in the reinsurance trust, each as of March 31, 2018:

 
 
 
 
Maximum Exposure to Loss
(In thousands)
 
Total VIE Assets
 
On - Balance Sheet
 
Off - Balance Sheet
 
Total
Radnor Re 2018-1 Ltd.
 
$
424,412

 
$

 
$
15,466

 
$
15,466

Total
 
$
424,412

 
$

 
$
15,466

 
$
15,466


Note 5. Reserve for Losses and Loss Adjustment Expenses
 
The following table provides a reconciliation of the beginning and ending reserve balances for losses and loss adjustment expenses (“LAE”) for the three months ended March 31:
 
($ in thousands)
 
2018
 
2017
Reserve for losses and LAE at beginning of period
 
$
46,850

 
$
28,142

Less: Reinsurance recoverables
 

 

Net reserve for losses and LAE at beginning of period
 
46,850

 
28,142

Add provision for losses and LAE, net of reinsurance, occurring in:
 
 

 
 

Current period
 
9,952

 
7,090

Prior years
 
(4,643
)
 
(3,397
)
Net incurred losses and LAE during the current period
 
5,309

 
3,693

Deduct payments for losses and LAE, net of reinsurance, occurring in:
 
 

 
 

Current period
 

 
1

Prior years
 
2,193

 
2,366

Net loss and LAE payments during the current period
 
2,193

 
2,367

Net reserve for losses and LAE at end of period
 
49,966

 
29,468

Plus: Reinsurance recoverables
 

 

Reserve for losses and LAE at end of period
 
$
49,966

 
$
29,468

 
 
 
 
 
Loans in default at end of period
 
4,442

 
1,777

 

11

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


For the three months ended March 31, 2018, $2.2 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There has been a $4.6 million favorable prior year development during the three months ended March 31, 2018. Reserves remaining as of March 31, 2018 for prior years are $40.0 million as a result of re-estimation of unpaid losses and loss adjustment expenses. For the three months ended March 31, 2017, $2.4 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There was a $3.4 million favorable prior year development during the three months ended March 31, 2017. Reserves remaining as of March 31, 2017 for prior years were $22.4 million as a result of re-estimation of unpaid losses and loss adjustment expenses. In both periods, the favorable prior years' loss development was the result of a re-estimation of amounts ultimately to be paid on prior year defaults in the default inventory, including the impact of previously identified defaults that cured. Original estimates are increased or decreased as additional information becomes known regarding individual claims.

During the third quarter of 2017, certain regions of the U.S. experienced hurricanes which have impacted our insured portfolio’s performance. Specifically, on August 26, 2017, Hurricane Harvey made landfall in southeastern Texas and on September 10, 2017, Hurricane Irma made landfall in southern Florida and caused property damage in certain counties. Loans in default identified as hurricane-related defaults totaled 2,288 as of December 31, 2017. During the first quarter of 2018, the number of hurricane-related defaults declined to 1,768 as of March 31, 2018 as 520 hurricane-related loans in default cured. Based on prior industry experience, we expect the ultimate number of hurricane-related defaults that result in claims will be less than the default-to-claim experience of non-hurricane-related defaults. In addition, under our master policy, our exposure may be limited on hurricane-related claims. For example, we are permitted to exclude a claim entirely where damage to the property underlying a mortgage was the proximate cause of the default and adjust a claim where the property underlying a mortgage in default is subject to unrestored physical damage. Accordingly, when establishing our loss reserves as of March 31, 2018 and December 31, 2017, we applied a lower estimated claim rate to the hurricane-related defaults than the claim rate we apply to other notices in our default inventory. The reserve for losses and LAE on hurricane-related defaults was $11.1 million at March 31, 2018 and December 31, 2017. The impact on our reserves in future periods will be dependent upon the performance of the hurricane-related defaults and our expectations for the amount of ultimate losses on these delinquencies.

Note 6. Debt Obligations
 
Credit Facility

On May 17, 2017, Essent Group and its subsidiaries, Essent Irish Intermediate Holdings Limited and Essent US Holdings, Inc. (collectively, the "Borrowers"), entered into an amended and restated four-year, secured credit facility with a committed capacity of $375 million (the “Credit Facility”). The Credit Facility amends and restates the three-year, secured revolving credit facility entered into on April 19, 2016, and provides for (i) an increase in the revolving credit facility from $200 million to $250 million, (ii) the issuance of term loans of $125 million, the proceeds of which were used at closing to pay down borrowings outstanding under the revolving credit facility, and (iii) a $75 million uncommitted line that may be exercised at the Borrowers’ option so long as the Borrowers receive commitments from the lenders. Borrowings under the Credit Facility may be used for working capital and general corporate purposes, including, without limitation, capital contributions to Essent’s insurance and reinsurance subsidiaries. Borrowings accrue interest at a floating rate tied to a standard short-term borrowing index, selected at the Company’s option, plus an applicable margin. A commitment fee is due quarterly on the average daily amount of the undrawn revolving commitment. The applicable margin and the commitment fee are based on the senior unsecured debt rating or long-term issuer rating of Essent Group to the extent available, or the insurer financial strength rating of Essent Guaranty. The current annual commitment fee rate is 0.35%. The obligations under the Credit Facility are secured by certain assets of the Borrowers, excluding the stock and assets of its insurance and reinsurance subsidiaries. The Credit Facility contains several covenants, including financial covenants relating to minimum net worth, capital and liquidity levels, maximum debt to capitalization level and Essent Guaranty's compliance with the PMIERs (see Note 12). The $125 million term loans contractually mature on May 17, 2021. This description is not intended to be complete in all respects and is qualified in its entirety by the terms of the Credit Facility, including its covenants. As of March 31, 2018, the Company was in compliance with the covenants and $265 million had been borrowed under the Credit Facility with a weighted average interest rate of 3.82%. As of December 31, 2017, $250 million had been borrowed with a weighted average interest rate of 3.49%.

On May 2, 2018, the Credit Facility was amended to increase the committed capacity by $125 million to $500 million and to increase the uncommitted line by $25 million to $100 million. The revolving component of the Credit Facility was increased from $250 million to $275 million, and the Borrowers issued $100 million of additional term loans, the proceeds of which were used to pay down borrowings outstanding under the revolving component of the Credit Facility. After completing this increase, the Company had $225 million of term loans outstanding and $40 million borrowed under the revolving

12

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


component of the Credit Facility. The interest rate, contractual maturity and other terms of the Credit Facility are otherwise unchanged from those described above.

Note 7. Commitments and Contingencies
 
Obligations under Guarantees
 
Under the terms of CUW Solutions' contract underwriting agreements with lenders and subject to contractual limitations on liability, we agree to indemnify certain lenders against losses incurred in the event that we make an error in determining whether loans processed meet specified underwriting criteria, to the extent that such error materially restricts or impairs the salability of such loan, results in a material reduction in the value of such loan or results in the lender repurchasing the loan. The indemnification may be in the form of monetary or other remedies. We paid less than $0.1 million related to remedies for each of the three months ended March 31, 2018 and 2017. As of March 31, 2018, management believes any potential claims for indemnification related to contract underwriting services through March 31, 2018 are not material to our consolidated financial position or results of operations.
 
In addition to the indemnifications discussed above, in the normal course of business, we enter into agreements or other relationships with third parties pursuant to which we may be obligated under specified circumstances to indemnify the counterparties with respect to certain matters. Our contractual indemnification obligations typically arise in the context of agreements entered into by us to, among other things, purchase or sell services, finance our business and business transactions, lease real property and license intellectual property. The agreements we enter into in the normal course of business generally require us to pay certain amounts to the other party associated with claims or losses if they result from our breach of the agreement, including the inaccuracy of representations or warranties. The agreements we enter into may also contain other indemnification provisions that obligate us to pay amounts upon the occurrence of certain events, such as the negligence or willful misconduct of our employees, infringement of third-party intellectual property rights or claims that performance of the agreement constitutes a violation of law. Generally, payment by us under an indemnification provision is conditioned upon the other party making a claim, and typically we can challenge the other party’s claims. Further, our indemnification obligations may be limited in time and/or amount, and in some instances, we may have recourse against third parties for certain payments made by us under an indemnification agreement or obligation. As of March 31, 2018, contingencies triggering material indemnification obligations or payments have not occurred historically and are not expected to occur. The nature of the indemnification provisions in the various types of agreements and relationships described above are believed to be low risk and pervasive, and we consider them to have a remote risk of loss or payment. We have not recorded any provisions on the condensed consolidated balance sheets related to indemnifications.
 
Note 8. Stock-Based Compensation
 
The following table summarizes nonvested common share and nonvested common share unit activity for the three months ended March 31, 2018:
 
 
 
Time and Performance-
Based Share Awards
 
Time-Based
Share Awards
 
Share Units
(Shares in thousands)
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Share Units
 
Weighted
Average
Grant Date
Fair Value
Outstanding at beginning of year
 
1,595

 
$
17.03

 
410

 
$
21.12

 
536

 
$
29.13

Granted
 
113

 
45.02

 
73

 
45.02

 
115

 
44.19

Vested
 
(1,226
)
 
14.71

 
(271
)
 
18.55

 
(192
)
 
27.53

Forfeited
 

 
N/A

 

 
N/A

 
(3
)
 
31.93

Outstanding at March 31, 2018
 
482

 
$
29.49

 
212

 
$
32.63

 
456

 
$
33.59


In February 2018, certain members of senior management were granted nonvested common shares under the Essent Group Ltd. 2013 Long-Term Incentive Plan ("2013 Plan") that were subject to time-based and performance-based vesting. The time-based share awards granted in February 2018 vest in three equal installments on March 1, 2019, 2020 and 2021. The performance-based share awards granted in February 2018 vest based upon our compounded annual book value per share growth percentage during a three-year performance period that commenced on January 1, 2018 and vest on March 1, 2021. The

13

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


portion of these nonvested performance-based share awards that will be earned based upon the achievement of compounded annual book value per share growth is as follows:
 
Performance level
 
 
Compounded Annual Book Value
Per Share Growth
 
Nonvested Common
Shares Earned
 
 
 
<15
%
 
0
%
Threshold
 
 
15
%
 
25
%
 
 
 
16
%
 
50
%
 
 
 
17
%
 
75
%
Maximum
 
 
≥18
%
 
100
%
 
 
 
 
 
 
 
In the event that the compounded annual book value per share growth falls between the performance levels shown above, the nonvested common shares earned will be determined on a straight-line basis between the respective levels shown.
 
In connection with our incentive program covering bonus awards for performance year 2017, in February 2018, time-based share awards and share units were issued to certain employees that vest in three equal installments on March 1, 2019, 2020 and 2021. In May 2018, 25,712 time-based share units were granted to non-employee directors that vest one year from the date of grant.

The total fair value on the vesting date of nonvested shares or share units that vested was $74.0 million and $19.0 million for the three months ended March 31, 2018 and 2017, respectively. As of March 31, 2018, there was $28.1 million of total unrecognized compensation expense related to nonvested shares or share units outstanding at March 31, 2018 and we expect to recognize the expense over a weighted average period of 2.3 years.
 
Employees have the option to tender shares to Essent Group to pay the minimum employee statutory withholding taxes associated with shares upon vesting. Common shares tendered by employees to pay employee withholding taxes totaled 710,285 in the three months ended March 31, 2018. The tendered shares were recorded at cost and included in treasury stock. All treasury stock has been cancelled as of March 31, 2018.
 
Compensation expense, net of forfeitures, and related tax effects recognized in connection with nonvested shares was as follows:
 
 
 
Three Months Ended March 31,
(In thousands)
 
2018
 
2017
Compensation expense
 
$
3,605

 
$
4,619

Income tax benefit
 
672

 
1,483

 

14

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 9. Earnings per Share (EPS)
 
The following table reconciles the net income and the weighted average common shares outstanding used in the computations of basic and diluted earnings per common share:
 
 
 
Three Months Ended 
 March 31,
(In thousands, except per share amounts)
 
2018
 
2017
Net income
 
$
111,069

 
$
66,598

Less: dividends declared
 

 

Net income available to common shareholders

$
111,069


$
66,598

Basic earnings per share
 
$
1.14

 
$
0.73

Diluted earnings per share
 
$
1.13

 
$
0.72

Basic weighted average shares outstanding
 
97,298

 
91,258

Dilutive effect of nonvested shares

653


1,765

Diluted weighted average shares outstanding
 
97,951

 
93,023

 
There were 166,323 and 162,930 antidilutive shares for the three months ended March 31, 2018 and 2017, respectively.
 
The nonvested performance-based share awards are considered contingently issuable for purposes of the EPS calculation. Based on the compounded annual book value per share growth as of March 31, 2018 and 2017, 100% of the dilutive performance-based share awards would be issuable under the terms of the arrangements at each date if March 31 was the end of the contingency period.

Note 10. Accumulated Other Comprehensive Income (Loss)
 
The following table presents the rollforward of accumulated other comprehensive income (loss) for the three months ended March 31, 2018 and 2017
 
 
Three Months Ended March 31, 2018
(In thousands)
 
Before Tax
 
Tax Effect
 
Net of Tax
Balance at beginning of period
 
$
(1,849
)
 
$
(1,403
)
 
$
(3,252
)
Other comprehensive income (loss):
 
 

 
 

 
 

Unrealized holding gains (losses) on investments:
 
 
 
 
 
 
Unrealized holding losses arising during the period
 
(33,746
)
 
5,120

 
(28,626
)
Less: Reclassification adjustment for gains included in net income (1)
 
(197
)
 
73

 
(124
)
Net unrealized losses on investments
 
(33,943
)
 
5,193

 
(28,750
)
Other comprehensive loss
 
(33,943
)
 
5,193

 
(28,750
)
Balance at end of period
 
$
(35,792
)
 
$
3,790

 
$
(32,002
)


15

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


 
 
Three Months Ended March 31, 2017
(In thousands)
 
Before Tax
 
Tax Effect
 
Net of Tax
Balance at beginning of period
 
$
(14,436
)
 
$
2,181

 
$
(12,255
)
Other comprehensive income (loss):
 
 

 
 

 
 

Unrealized holding gains (losses) on investments:
 
 
 
 
 
 
Unrealized holding gains arising during the period
 
7,566

 
(2,289
)
 
5,277

Less: Reclassification adjustment for gains included in net income (1)
 
(655
)
 
228

 
(427
)
Net unrealized gains on investments
 
6,911

 
(2,061
)
 
4,850

Other comprehensive income
 
6,911

 
(2,061
)
 
4,850

Balance at end of period
 
$
(7,525
)
 
$
120

 
$
(7,405
)
  
 
(1)
Included in net realized investment gains on our condensed consolidated statements of comprehensive income.

Note 11. Fair Value of Financial Instruments
 
We carry certain of our financial instruments at fair value. We define fair value as the current amount that would be exchanged to sell an asset or transfer a liability, other than in a forced liquidation.
  
Fair Value Hierarchy
 
ASC No. 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The level within the fair value hierarchy to measure the financial instrument shall be determined based on the lowest level input that is significant to the fair value measurement. The three levels of the fair value hierarchy are as follows:

Level 1 — Quoted prices for identical instruments in active markets accessible at the measurement date.
 
Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and valuations in which all significant inputs are observable in active markets. Inputs are observable for substantially the full term of the financial instrument.

Level 3 — Valuations derived from one or more significant inputs that are unobservable.
 
Determination of Fair Value
 
When available, we generally use quoted market prices to determine fair value and classify the financial instrument in Level 1. In cases where quoted market prices for similar financial instruments are available, we utilize these inputs for valuation techniques and classify the financial instrument in Level 2. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flows, present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows and we classify the financial instrument in Level 3. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
 
We used the following methods and assumptions in estimating fair values of financial instruments:

Investments available for sale — Investments available for sale are valued using quoted market prices in active markets, when available, and those investments are classified as Level 1 of the fair value hierarchy. Level 1 investments available for sale include investments such as U.S. Treasury securities and money market funds. Investments available for sale are classified as Level 2 of the fair value hierarchy if quoted market prices are not available and fair values are estimated using quoted prices of similar securities or recently executed transactions for the securities. U.S. agency securities, U.S. agency mortgage-backed securities, municipal debt securities, corporate

16

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


debt securities, residential and commercial mortgage securities and asset-backed securities are classified as Level 2 investments.
 
We use independent pricing sources to determine the fair value of securities available for sale in Level 1 and Level 2 of the fair value hierarchy. We use one primary pricing service to provide individual security pricing based on observable market data and receive one quote per security. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing service and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. U.S. agency securities, U.S. agency mortgage-backed securities, municipal and corporate debt securities are valued by our primary vendor using recently executed transactions and proprietary models based on observable inputs, such as interest rate spreads, yield curves and credit risk. Residential and commercial mortgage securities and asset-backed securities are valued by our primary vendor using proprietary models based on observable inputs, such as interest rate spreads, prepayment speeds and credit risk. As part of our evaluation of investment prices provided by our primary pricing service, we obtained and reviewed their pricing methodologies which include a description of how each security type is evaluated and priced. We review the reasonableness of prices received from our primary pricing service by comparison to prices obtained from additional pricing sources. We have not made any adjustments to the prices obtained from our primary pricing service.
 
Assets and Liabilities Measured at Fair Value
 
All assets measured at fair value are categorized in the table below based upon the lowest level of significant input to the valuations. All fair value measurements at the reporting date were on a recurring basis.
 
March 31, 2018 (In thousands)
 
Quoted Prices
in Active 
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Recurring fair value measurements
 
 

 
 

 
 

 
 

Financial Assets:
 
 

 
 

 
 

 
 

U.S. Treasury securities
 
$
204,556

 
$

 
$

 
$
204,556

U.S. agency securities
 

 
32,821

 

 
32,821

U.S. agency mortgage-backed securities
 

 
476,220

 

 
476,220

Municipal debt securities
 

 
478,933

 

 
478,933

Corporate debt securities
 

 
626,943

 

 
626,943

Residential and commercial mortgage securities
 

 
86,430

 

 
86,430

Asset-backed securities
 

 
183,449

 

 
183,449

Money market funds
 
371,775

 

 

 
371,775

Total assets at fair value
 
$
576,331

 
$
1,884,796

 
$

 
$
2,461,127

 

17

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


December 31, 2017 (In thousands)
 
Quoted Prices
in Active 
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Recurring fair value measurements
 
 

 
 

 
 

 
 

Financial Assets:
 
 

 
 

 
 

 
 

U.S. Treasury securities
 
$
227,805

 
$

 
$

 
$
227,805

U.S. agency securities
 

 
33,114

 

 
33,114

U.S. agency mortgage-backed securities
 

 
456,037

 

 
456,037

Municipal debt securities
 

 
465,255

 

 
465,255

Corporate debt securities
 

 
611,728

 

 
611,728

Residential and commercial mortgage securities
 

 
79,407

 

 
79,407

Asset-backed securities
 

 
167,922

 

 
167,922

Money market funds
 
263,797

 

 

 
263,797

Total assets at fair value
 
$
491,602

 
$
1,813,463

 
$

 
$
2,305,065


Note 12. Statutory Accounting
 
Our U.S. insurance subsidiaries prepare statutory-basis financial statements in accordance with the accounting practices prescribed or permitted by their respective state’s department of insurance, which is a comprehensive basis of accounting other than GAAP. We did not use any prescribed or permitted statutory accounting practices (individually or in the aggregate) that resulted in reported statutory surplus or capital that was significantly different from the statutory surplus or capital that would have been reported had National Association of Insurance Commissioners’ statutory accounting practices been followed. The following table presents Essent Guaranty’s and Essent PA’s statutory net income, statutory surplus and contingency reserve liability as of and for the three months ended March 31:
 
(In thousands)
 
2018
 
2017
Essent Guaranty
 
 

 
 

Statutory net income
 
$
93,002

 
$
60,806

Statutory surplus
 
807,363

 
595,102

Contingency reserve liability
 
734,944

 
525,256

 
 
 
 
 
Essent PA
 
 

 
 

Statutory net income
 
$
2,475

 
$
2,805

Statutory surplus
 
46,505

 
43,299

Contingency reserve liability
 
44,606

 
38,219

 
Net income determined in accordance with statutory accounting practices differs from GAAP. In 2018 and 2017, the more significant differences between net income determined under statutory accounting practices and GAAP for Essent Guaranty and Essent PA relate to policy acquisition costs and income taxes. Under statutory accounting practices, policy acquisition costs are expensed as incurred while such costs are capitalized and amortized to expense over the life of the policy under GAAP. We are eligible for a tax deduction, subject to certain limitations for amounts required by state law or regulation to be set aside in statutory contingency reserves when we purchase non-interest-bearing United States Mortgage Guaranty Tax and Loss Bonds (“T&L Bonds”) issued by the Treasury Department. Under statutory accounting practices, this deduction reduces the tax provision recorded by Essent Guaranty and Essent PA and, as a result, increases statutory net income and surplus as compared to net income and equity determined in accordance with GAAP.
 
At March 31, 2018 and 2017, the statutory capital of our U.S. insurance subsidiaries, which is defined as the total of statutory surplus and contingency reserves, was in excess of the statutory capital necessary to satisfy their regulatory requirements.

18

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


 
Effective December 31, 2015, Fannie Mae and Freddie Mac, at the direction of the Federal Housing Finance Agency, implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. As of March 31, 2018 and December 31, 2017, Essent Guaranty, our GSE-approved mortgage insurance company, was in compliance with the PMIERs.
 
Statement of Statutory Accounting Principles No. 58, Mortgage Guaranty Insurance, requires mortgage insurers to establish a special contingency reserve for statutory accounting purposes included in total liabilities equal to 50% of earned premium for that year. During the three months ended March 31, 2018, Essent Guaranty increased its contingency reserve by $56.2 million and Essent PA increased its contingency reserve by $1.5 million. This reserve is required to be maintained for a period of 120 months to protect against the effects of adverse economic cycles. After 120 months, the reserve is released to unassigned funds. In the event an insurer’s loss ratio in any calendar year exceeds 35%, however, the insurer may, after regulatory approval, release from its contingency reserves an amount equal to the excess portion of such losses. Essent Guaranty and Essent PA did not release any amounts from their contingency reserves in the three months ended March 31, 2018 or 2017.

Under The Insurance Act 1978, as amended, and related regulations of Bermuda (the "Insurance Act"), Essent Re is required to annually prepare statutory financial statements and a statutory financial return in accordance with the financial reporting provisions of the Insurance Act, which is a basis other than GAAP. The Insurance Act also requires that Essent Re maintain minimum share capital of $1 million and must ensure that the value of its general business assets exceeds the amount of its general business liabilities by an amount greater than the prescribed minimum solvency margins and enhanced capital requirement pertaining to its general business. At December 31, 2017, all such requirements were met.

Essent Re's statutory capital and surplus was $684.6 million as of March 31, 2018 and $662.6 million as of December 31, 2017. Essent Re's statutory net income was $31.2 million and $20.2 million for the three months ended March 31, 2018 and 2017, respectively. Statutory capital and surplus as of March 31, 2018 and statutory net income in the three months ended March 31, 2018 determined in accordance with statutory accounting practices were not significantly different than the amounts determined under GAAP.


19


Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read together with the “Selected Financial Data” and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K as of and for the year ended December 31, 2017 as filed with the Securities and Exchange Commission and referred to herein as the “Annual Report,” and our condensed consolidated financial statements and related notes as of and for the three months ended March 31, 2018 included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which we refer to as the “Quarterly Report.” In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections entitled “Special Note Regarding Forward-Looking Statements” in this Quarterly Report and Part I, Item 1A “Risk Factors” in our Annual Report. We are not undertaking any obligation to update any forward-looking statements or other statements we may make in the following discussion or elsewhere in this document even though these statements may be affected by events or circumstances occurring after the forward-looking statements or other statements were made.
 
Overview
 
We are an established and growing private mortgage insurance company. We were formed to serve the U.S. housing finance industry at a time when the demands of the financial crisis and a rapidly changing business environment created the need for a new, privately funded mortgage insurance company. We believe that our success in acquiring customers and growing our insurance in force has been driven by the unique opportunity we offer lenders to partner with a well-capitalized mortgage insurer, unencumbered by business originated prior to the financial crisis, that provides fair and transparent claims payment practices, and consistency and speed of service. Essent Guaranty, Inc. ("Essent Guaranty"), our wholly-owned insurance subsidiary, is licensed to write coverage in all 50 states and the District of Columbia. The financial strength of Essent Guaranty, Inc. is rated Baa1 with a stable outlook by Moody’s Investor Services (“Moody's”) and BBB+ with a stable outlook by S&P Global Ratings (“S&P”).
 
Our holding company is domiciled in Bermuda and our U.S. insurance business is headquartered in Radnor, Pennsylvania. We operate additional underwriting and service centers in Winston-Salem, North Carolina and Irvine, California. We have a highly experienced, talented team with 395 employees as of March 31, 2018. We generated new insurance written, or NIW, of approximately $9.3 billion and $8.0 billion for the three months ended March 31, 2018 and 2017, respectively. As of March 31, 2018, we had approximately $115.3 billion of insurance in force. Our top ten customers represented approximately 39.3%, 45.8%, 35.1% and 36.6% of NIW on a flow basis for the three months ended March 31, 2018 and the years ended December 31, 2017, 2016 and 2015, respectively.
 
We also offer mortgage-related insurance and reinsurance through our wholly-owned Bermuda-based subsidiary, Essent Reinsurance Ltd., which we refer to as "Essent Re." As of March 31, 2018, Essent Re provided insurance or reinsurance relating to the risk in force on loans in reference pools acquired by Freddie Mac and Fannie Mae covering approximately $557.7 million of risk, including in connection with Freddie Mac's Agency Credit Insurance Structure ("ACIS") and Fannie Mae's Credit Insurance Risk Transfer ("CIRT") programs. Essent Re has also reinsured 25% of Essent Guaranty’s GSE-eligible mortgage insurance NIW originated since July 1, 2014 under a quota share reinsurance agreement. The insurer financial strength rating of Essent Re is BBB+ with a stable outlook by S&P.
 
Legislative and Regulatory Developments
 
Our results are significantly impacted by, and our future success may be affected by, legislative and regulatory developments affecting the housing finance industry. See Part I, Item 1 “Business—Regulation” and Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Legislative and Regulatory Developments” in our Annual Report for a discussion of the laws and regulations to which we are subject as well as legislative and regulatory developments affecting the housing finance industry.
 
Effective December 31, 2015, Fannie Mae and Freddie Mac, at the direction of the Federal Housing Finance Agency ("FHFA"), implemented new coordinated Private Mortgage Insurer Eligibility Requirements, which we refer to as the "PMIERs." The PMIERs represent the standards by which private mortgage insurers are eligible to provide mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. The PMIERs include financial strength requirements incorporating a risk-based framework that require approved insurers to have a sufficient level of liquid assets from which to pay claims. The PMIERs also include enhanced operational performance expectations and define remedial actions that apply should an approved insurer fail to comply with these requirements. As of March 31, 2018, Essent Guaranty, our GSE-approved

20


mortgage insurance company, was in compliance with the PMIERs. See additional discussion in “— Liquidity and Capital Resources —Private Mortgage Insurer Eligibility Requirements.”

Based on a confidential draft proposal that we received from the GSEs, we believe that the updated PMIERs may be finalized in the second quarter of 2018 and become effective no sooner than the fourth quarter of 2018, 180 days after their release.
 
Factors Affecting Our Results of Operations
 
Net Premiums Written and Earned
 
Premiums associated with our U.S. mortgage insurance business are based on insurance in force ("IIF") during all or a portion of a period. A change in the average IIF during a period causes premiums to increase or decrease as compared to prior periods. Average premium rates in effect during a given period will also cause premiums to differ when compared to earlier periods. IIF at the end of a reporting period is a function of the IIF at the beginning of such reporting period plus NIW less policy cancellations (including claims paid) during the period. As a result, premiums are generally influenced by:
 
NIW, which is the aggregate principal amount of the new mortgages that are insured during a period. Many factors affect NIW, including, among others, the volume of low down payment home mortgage originations and the competition to provide credit enhancement on those mortgages;
 
Cancellations of our insurance policies, which are impacted by payments on mortgages, home price appreciation, or refinancings, which in turn are affected by mortgage interest rates. Cancellations are also impacted by the levels of claim payments and rescissions;
 
Premium rates, which represent the amount of the premium due as a percentage of IIF. Premium rates are based on the risk characteristics of the loans insured, the percentage of coverage on the loans, competition from other mortgage insurers and general industry conditions; and

Premiums ceded or assumed under reinsurance arrangements. Prior to March 2018, we had not ceded any premiums under third-party reinsurance contracts. In March 2018, Essent Guaranty entered into a third-party reinsurance agreement. See Note 4 to our condensed consolidated financial statements.
 
Premiums are paid either on a monthly installment basis (“monthly premiums”), in a single payment at origination (“single premiums”), or in some cases as an annual premium. For monthly premiums, we receive a monthly premium payment which is recorded as net premiums earned in the month the coverage is provided. Monthly premium payments are based on the original mortgage amount rather than the amortized loan balance. Net premiums written may be in excess of net premiums earned due to single premium policies. For single premiums, we receive a single premium payment at origination, which is recorded as “unearned premium” and earned over the estimated life of the policy, which ranges from 36 to 156 months depending on the term of the underlying mortgage and loan-to-value ratio at date of origination. If single premium policies are cancelled due to repayment of the underlying loan and the premium is non-refundable, the remaining unearned premium balance is immediately recognized as earned premium revenue. Substantially all of our single premium policies in force as of March 31, 2018 were non-refundable. Premiums collected on annual policies are recognized as net premiums earned on a straight-line basis over the year of coverage. For the three months ended March 31, 2018, monthly and single premium policies comprised 79.7% and 20.3% of our NIW, respectively.

Premiums associated with our GSE risk share transactions are based on the level of risk in force.
 
Persistency and Business Mix
 
The percentage of IIF that remains on our books after any 12-month period is defined as our persistency rate. Because our insurance premiums are earned over the life of a policy, higher persistency rates can have a significant impact on our profitability. The persistency rate on our portfolio was 83.5% at March 31, 2018. Generally, higher prepayment speeds lead to lower persistency.

 Prepayment speeds and the relative mix of business between single premium policies and monthly premium policies also impact our profitability. Our premium rates include certain assumptions regarding repayment or prepayment speeds of the mortgages. Because premiums are paid at origination on single premium policies, assuming all other factors remain constant, if loans are prepaid earlier than expected, our profitability on these loans is likely to increase and, if loans are repaid slower than

21


expected, our profitability on these loans is likely to decrease. By contrast, if monthly premium loans are repaid earlier than anticipated, our premium earned with respect to those loans and therefore our profitability declines. Currently, the expected return on single premium policies is less than the expected return on monthly policies.
 
Net Investment Income
 
Our investment portfolio was predominantly comprised of investment-grade fixed income securities and money market funds as of March 31, 2018. The principal factors that influence investment income are the size of the investment portfolio and the yield on individual securities. As measured by amortized cost (which excludes changes in fair market value, such as from changes in interest rates), the size of our investment portfolio is mainly a function of increases in capital and cash generated from or used in operations which is impacted by net premiums received, investment earnings, net claim payments and expenses. Realized gains and losses are a function of the difference between the amount received on the sale of a security and the security’s amortized cost, as well as any “other-than-temporary” impairments recognized in earnings. The amount received on the sale of fixed income securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale.
 
Other Income
 
In connection with the acquisition of our mortgage insurance platform, we entered into a services agreement with Triad Guaranty Inc. and its wholly-owned subsidiary, Triad Guaranty Insurance Corporation, which we refer to collectively as “Triad,” to provide certain information technology maintenance and development and customer support-related services. In return for these services, we receive a fee which is recorded in other income. This fee is adjusted monthly based on the number of Triad’s mortgage insurance policies in force and, accordingly, will decrease over time as Triad’s existing policies are cancelled. The services agreement was automatically extended until November 30, 2018 and provides for one subsequent one-year renewal at Triad’s option.
 
Other income also includes revenues associated with contract underwriting services and underwriting services to third-party reinsurers. The level of contract underwriting revenue is dependent upon the number of customers who have engaged us for this service and the number of loans underwritten for these customers. Revenue from underwriting services to third-party reinsurers is dependent upon the number of customers who have engaged us for this service and the number of transactions underwritten for these customers.
 
Provision for Losses and Loss Adjustment Expenses
 
The provision for losses and loss adjustment expenses reflects the current expense that is recorded within a particular period to reflect actual and estimated loss payments that we believe will ultimately be made as a result of insured loans that are in default.
 
Losses incurred are generally affected by:
 
the overall state of the economy, which broadly affects the likelihood that borrowers may default on their loans and have the ability to cure such defaults;
 
changes in housing values, which affect our ability to mitigate our losses through the sale of properties with loans in default as well as borrower willingness to continue to make mortgage payments when the value of the home is below or perceived to be below the mortgage balance;

the product mix of IIF, with loans having higher risk characteristics generally resulting in higher defaults and claims;

the size of loans insured, with higher average loan amounts tending to increase losses incurred;

the loan-to-value ratio, with higher average loan-to-value ratios tending to increase losses incurred;

the percentage of coverage on insured loans, with deeper average coverage tending to increase losses incurred;

credit quality of borrowers, including higher debt-to-income ratios and lower FICO scores, which tend to increase incurred losses;

the level and amount of reinsurance coverage maintained with third parties;

22



the rate at which we rescind policies. Because of tighter underwriting standards generally in the mortgage lending industry and terms set forth in our master policy, we expect that our level of rescission activity will be lower than rescission activity seen in the mortgage insurance industry for vintages originated prior to the financial crisis; and

the distribution of claims over the life of a book. The average age of our insurance portfolio is young with 69% of our IIF as of March 31, 2018 having been originated since January 1, 2016. As a result, based on historical industry performance, we expect the number of defaults and claims we experience, as well as our provision for losses and loss adjustment expenses, to increase as our portfolio seasons. See “— Mortgage Insurance Earnings and Cash Flow Cycle” below.
 
We establish loss reserves for delinquent loans when we are notified that a borrower has missed at least two consecutive monthly payments (“Case Reserves”), as well as estimated reserves for defaults that may have occurred but not yet been reported to us (“IBNR Reserves”). We also establish reserves for the associated loss adjustment expenses (“LAE”), consisting of the estimated cost of the claims administration process, including legal and other fees. Using both internal and external information, we establish our reserves based on the likelihood that a default will reach claim status and estimated claim severity. See Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” included in our Annual Report for further information.
 
We believe, based upon our experience and industry data, that claims incidence for mortgage insurance is generally highest in the third through sixth years after loan origination. As of March 31, 2018, 69% of our IIF relates to business written since January 1, 2016