Item 1.    Business

General

Radian Group Inc. (the “Company”) provides, through its subsidiaries and affiliates, insurance and mortgage 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 mortgage services. The following table shows the percentage contributions to total revenues and net income of these businesses for 2002:

For selected financial information about each segment, see Note 1 of the Notes to Consolidated Financial Statements under the caption “Segment Reporting”. The Consolidated Financial Statements and the Notes to Consolidated Financial Statements are incorporated by reference into this report from the 2002 Annual Report to Stockholders and included as an exhibit to this report.

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

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, 2002, primary insurance made up 93.8% of total risk in force and pool insurance made up 6.2% of total risk in force on first lien mortgages. During the third quarter of

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2000, the Company commenced operations in Radian Insurance, a subsidiary of Radian Guaranty that writes credit insurance and financial guaranty 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 was $0.5 billion at December 31, 2002, which represented less than 1% of the Company’s business.

Primary Insurance

Primary insurance provides mortgage default protection on individual loans at a specified coverage percentage, which is applied to the unpaid loan principal, delinquent interest and certain expenses associated with the default and subsequent foreclosure (collectively, the “claim amount”). The Company’s obligation to an insured lender in respect of a claim is determined by applying the appropriate coverage percentage to the claim amount. The Company’s “risk” on each insured loan is the unpaid loan principal multiplied by the coverage percentage. A large percentage 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”). As of December 31, 2002, approximately 25% of the Company’s primary insurance in force outstanding had such coverages. 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. In March 1999, Freddie Mac announced a similar program for loans approved through its “Loan Prospector” automated underwriting system. Through the end of 2002, a minimal amount of insurance was written in these programs. For more information on these developments, see “Other Direct Regulation—Freddie Mac and Fannie Mae” below.

Under the Company’s master policy, upon a default, the Company has the option of paying the entire claim amount and taking title to the mortgage property (at which time it is typically sold quickly), or paying the coverage percentage in full satisfaction of its obligations under the insurance written. In 2002, the entire claim amount was paid in approximately 2% of filed claims because of the expected economic advantage associated with that choice in those cases. This percentage is lower than in 2001. Good economic conditions experienced over the past few years have kept property values generally strong, but housing values may not remain as strong in the future.

Pool Insurance

Pool insurance differs from primary insurance in that the exposure on pool insurance 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 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, but also has exposure limits on each individual loan.

The Company offers pool insurance on a selective basis, as a credit enhancement to mortgage loans included in mortgage-backed securities or in whole loan sales, and in certain other structured transactions. Since 1996, the Company has offered pool insurance on mortgage products sold to Freddie Mac and Fannie Mae by the Company’s primary insurance customers (such pool insurance, “GSE Pool”). This pool insurance has a very low stop loss, generally 1.0% to 1.5%, and the insured pools contain loans with and without primary mortgage insurance. Loans without primary insurance have an LTV of 80.0% or below. Premium rates on this business are significantly lower than primary mortgage insurance rates, and the expected profitability on this business is lower than that of primary insurance. During 2002, the Company had pool risk written of $174 million or 1.4% of the Company’s total risk written, compared to $255 million in 2001 and $188 million in 2000. The Company expects Mortgage Insurance to continue to write a limited amount of pool insurance in 2003, and will continue to write other forms of pool or modified pool insurance as market opportunities arise.

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Structured Transactions

The Company, from time to time, 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”) or A minus mortgages. Alt-A or A minus mortgages are known as the Company’s “nonprime” 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 2002, the Company wrote $11.8 billion of primary insurance in structured transactions, which represented 24% of primary new insurance written.

Revenue Sharing Products

The Company, like other mortgage insurers, offers financial products to its mortgage lending 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 had approximately 40 active captive reinsurance agreements in place at December 31, 2002 and could enter into several new agreements or modify existing agreements in 2003, some with large national lenders. Premiums ceded to captive reinsurance companies in 2002 were $57.1 million, representing 8.3% of total direct mortgage insurance premiums earned, as compared to $52.8 million, or 8.4% of total premiums earned in 2001. Primary insurance written in 2002 that had captive reinsurance associated with it was $17.0 billion, or 34.8% of the Company’s total primary insurance written as compared to $14.7 billion or 32.9% in 2001. During 2000, Freddie Mac issued standards for captive reinsurance through its mortgage insurance eligibility requirements. Additionally, a task force consisting of lenders, mortgage insurers and accounting firms has been set up to study risk transfer and the appropriate accounting treatment for captive reinsurance.

In addition to captive reinsurance, the Company has entered into 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 2002 were not significant.

Radian Insurance Inc.

Radian Insurance was reorganized and rated in September 2000 to write credit insurance and financial guaranty 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%. 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 obtained 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

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Radian Insurance’s layer of risk. In addition to the Net Worth and Liquidity Maintenance Agreement, the Company intends to capitalize Radian Insurance at all times in an amount that would support the existing risk in force. In October 2001, a substantial part of the business written in Radian Insurance was reinsured by Radian Asset Assurance. Because most of the Company’s financial guaranty business on mortgage-related assets is written in Radian Asset Assurance and most of the Company’s second mortgage insurance is written in Amerin Guaranty, the business written by Radian Insurance was reduced in 2002.

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, Radian 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.

Financial guaranty insurance provides an unconditional and irrevocable guaranty to the holder of a debt obligation of full and timely payment of principal and interest. In the event of a default under the obligation, the insurer has recourse against the issuer and/or any related collateral (which is a component of many insured asset-backed obligations and other structured debt but is not typically a component of municipal obligations) for amounts paid under the terms of the policy. Payments under the insurance policy may not be accelerated by the holder of the debt obligation. Absent payment in full at the option of the insurer, in the event of a default under an insured obligation, the holder continues to receive payments of principal and interest on schedule, as if no default had occurred. Each subsequent purchaser of the obligation generally receives the benefit of such guaranty. Certain financial guaranty business is done by providing an unconditional and irrevocable guaranty of a counterparty’s obligations under a credit default swap in which Financial Guaranty assumes credit risk primarily on portfolios of corporate credits, although portfolios may include asset-backed securities, mortgages or other assets. Such transactions may require immediate 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.”

The issuer of the obligation pays the premium for financial guaranty insurance either in full at the inception of the policy or in installments on an annual basis or quarterly basis. Premium rates are typically calculated as a percentage of either the principal amount of the debt or total exposure (principal and interest). Rate setting reflects such factors as the credit strength of the issuer, type of issue, sources of income, type and amount of collateral pledged, restrictive covenants, maturity and competition from other insurers.

Premiums are generally non-refundable and are earned in proportion to the level of amortization of insured principal over the contract period or over the period that the coverage is provided. This long and relatively predictable earnings pattern is characteristic of the financial guaranty insurance industry and, along with a conservative investment policy, provides a relatively stable source of future revenues to financial guaranty insurers and reinsurers such as Financial Guaranty.

The primary financial guaranty insurance market currently consists of: municipal bond insurance; structured finance business including insurance on collateralized debt obligations, asset-backed securities, and credit default swaps and certain other financial guaranty contracts; and trade credit reinsurance. The following table

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summarizes the net premiums written and earned for the indicated Financial Guaranty lines of business for 2002 and 2001 (from the date of acquisition of EFSG by the Company):

Included in net premiums written and earned for 2002 were $40.4 million and $19.8 million, respectively, of credit enhancement fees on derivative financial guaranty contracts, compared to $5.3 million for both net premiums written and earned in 2001.

Municipal Bond Insurance

Municipal bond insurance 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 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 municipal bond market has been and continues to be a major source of revenue for the financial guaranty insurance industry.

Structured Finance

Asset-backed transactions or 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 and 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 and have insured interests in pools of synthetic assets, such as obligations under credit default swaps. A synthetic credit default swap involves the transfer of credit risk without the removal of assets from the insured’s balance sheet. The asset-backed securities market, including both synthetic and funded collateralized debt obligations, has grown significantly in recent years although consensus estimates are lacking as to the insured volume. The Company anticipates Financial Guaranty’s increased participation in this market on a global basis in 2003.

Since December 2000, Financial Guaranty has provided synthetic credit protection to pools of corporate obligations, typically by insuring a protection seller’s obligations under credit default swaps. Financial Guaranty

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has also provided synthetic credit protection on pools for mortgage-backed obligations and pools of asset-backed securities. Financial Guaranty typically provides synthetic credit protection upon the occurrence of certain defined events for the senior unsubordinated debt obligations of a pool of 100-150 named investment grade (as determined by S&P and/or Moody’s) corporate obligors (but pools have ranged from 49 to 479 obligors). Typically, Financial Guaranty provides $10.0 million in protection per obligor per transaction, and aggregate protection of $20.0 million to $350.0 million per pool (as of December 31, 2002) of obligors. Generally, Financial Guaranty structures its participation in these transactions by requiring sufficient subordination and other protections into the transaction such that Financial Guaranty’s risk attachment point and risk layer are set no lower than at a “AA” or “AAA” level. This is determined based on Financial Guaranty’s use of 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 Evaluation Model. Financial Guaranty further evaluates each deal by analyzing the individual obligors in the pool, the concentration of industries in which they operate, the number of the obligors on credit watch for downgrade and the obligors whose debt obligations then trade with wider spreads than the market norm for similar companies. At December 31, 2002 and 2001, Financial Guaranty had $4.9 billion and $1.2 billion, respectively, of such direct notional exposure consisting of 38 and 12 deals, respectively, as of such dates.

Because the same obligor may exist in a number of transactions, the 10 largest nominal exposures by Financial Guaranty to an individual corporate obligor in its direct written book as of December 31, 2002 ranged from $342.4 million to $264.6 million. 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, Financial Guaranty believes its actual exposure to each corporate obligor is significantly less than such nominal exposure. Typically, initial subordination before Financial Guaranty is obligated to pay ranges from 4% to 6% of the initial total pool size. As of December 31, 2002, the initial subordination for Financial Guaranty’s directly written protection ranged from $15 million to $460.0 million, and the subordination remaining for such transactions ranged from $9.3 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, the remaining subordination in the transactions in which Financial Guaranty has exposure to a particular obligor.

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.

The more important of the various benefits provided by reinsurance to a ceding company is the ability it gives the ceding company to write greater single risks and greater aggregate risks without contravening the 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 such a reduction for reinsurance in an amount that depends 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 correspondingly obligated to assume, a specified portion of a specified type of risk or risks insured by the ceding company during the term of the treaty (although the reinsurance risk thereafter extends for the life of the respective underlying obligations). Under a facultative agreement, the ceding company from time to time during the term of the agreement offers a portion of specific

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risks to the reinsurer, usually in connection with particular debt obligations. A facultative arrangement further differs from a treaty arrangement in that under a facultative arrangement the reinsurer often performs its own underwriting credit analysis to determine whether to accept a particular risk, while in a treaty arrangement the reinsurer generally relies on the ceding company’s credit analysis. Both treaty and facultative agreements are typically entered into for a term of one year, subject to a right of termination under certain circumstances.

Treaty and facultative 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 the premiums, as well as the losses and expenses, of a single risk or group of risks in an agreed percentage. In addition, the reinsurer generally pays the ceding company a ceding commission, which is typically related to the ceding company’s cost of obtaining the business being reinsured. Non-proportional reinsurance relationships are typically on an excess-of-loss basis. An excess-of-loss relationship 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.

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.

Other Financial Guaranty Businesses

Financial Guaranty 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. This reinsurance covers receivables both 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 interfere with the payment from the buyer. As of December 31, 2002, the Company owns a 36.5% interest in EIC Corporation Ltd. (“Exporters”), an insurance holding company that, through its wholly-owned insurance subsidiary licensed in Bermuda, insures primarily foreign trade receivables for multinational companies. Financial Guaranty provides significant reinsurance capacity to this joint venture on a quota share, surplus share and excess-of-loss basis.

Mortgage Services

RadianExpress.com Acquisition

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 has allowed the Company to expand further into the mortgage service business, which is considered an important adjunct to both the primary mortgage insurance business and the second mortgage activities of the Company. RadianExpress had $17.4 million of other income and $23.2 million of operating expenses for 2002, as compared to $16.0 million of other income and $17.4 million of operating expenses for 2001. RadianExpress processed approximately 340,000 applications during 2002 and 402,000 applications during 2001 with approximately 36,000 and 37,000, respectively, of the transactions related to net funding services, whereby RadianExpress receives and disburses mortgages funded on behalf of its customers.

Asset-Based Businesses

The Company is engaged, through minority-owned subsidiaries, in certain asset-based businesses, including the purchase, servicing and/or securitization of special assets, including 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.

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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 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, 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 Loan Servicing’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, 2002, the Company also owned a 45.5% 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 prior originations of 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 Company’s principal customers, 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 2002, approximately 38% 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.

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The number of primary individual mortgage insurance policies the Company had in force was 881,620 at December 31, 2002, 891,693 at December 31, 2001, and 858,413 at December 31, 2000.

The top 10 mortgage insurance customers were responsible for 46.5% of the Company’s primary new insurance written in 2002 compared to 45.0% in 2001 and 43.4% in 2000. The largest single mortgage insurance customer (including branches and affiliates of such customer), measured by primary new insurance written, accounted for 8.1% of primary new insurance written during 2002 compared to 12.6 % in 2001 and 11.2% in 2000.

The Company’s financial guaranty insurance customers consist of many of the major global financial institutions that participate in municipal bond transactions and structured finance transactions involving asset-backed securities and other structured products such as collateralized debt obligations. These institutions are typically large commercial banks or investment banks. It is the Company’s intention to establish a broad relationship with a limited number of such institutions to help ensure consistent, high quality deals in the structured product and municipal areas.

The Company’s financial guaranty reinsurance customers consist primarily of the primary insurance companies licensed to write financial guaranty insurance, known as the Major Monolines: MBIA Insurance Corporation; Ambac Assurance Corporation; Financial Guaranty Insurance Company; and Financial Security Assurance Inc.

The Major Monolines were responsible for 26.7% of Financial Guaranty’s gross premiums written in 2002, compared to 42.0% in 2001 and 43.0% in 2000. In recent years, Financial Guaranty has increased the amount of direct business it writes, thereby reducing its dependence on the Major Monolines. The largest single customer of Financial Guaranty, measured by gross premiums written, accounted for 10.4% of gross premiums written during 2002 compared to 18.8% in 2001 and 17.0% in 2000. This customer concentration results from the small number of primary insurance companies that are licensed to write financial guaranty insurance. One trade credit primary insurer was responsible for 6.2% of gross premiums written during 2002.

Financial Guaranty has maintained close and long-standing relationships with the Major Monolines, dating from either Financial Guaranty’s or the given primary insurer’s inception. In the Company’s opinion, these relationships provide Financial Guaranty with a comprehensive understanding of their procedures and reinsurance requirements and allow the clients to use Financial Guaranty’s underwriting expertise effectively, thus improving the service they receive.

EFSG is a party to reinsurance agreements with the four largest primary financial guaranty insurance companies. 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 below.

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Sales, Marketing and Competition

Sales and Marketing

The Company employs a mortgage insurance field sales force of 72 persons, organized into three regions, providing local sales representation throughout the United States. Each of the three 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 (“KAMs”) 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 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 65% of the Company’s primary new insurance written in 2002 and is expected to provide a similar percentage in 2003.

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 2002, these goals were related to volume and market share and this is generally expected to continue in 2003.

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 municipal bond trading transactions, asset-backed securities and other structured products; (2) reinsurance for municipal bonds and asset-backed securities (in which area one or both of Radian Reinsurance and Radian Asset Assurance currently has either treaty or facultative agreements with all but one of the highest rated monoline primary companies); (3) trade credit reinsurance; and (4) reinsurance for affiliated companies (including Exporters). Financial Guaranty markets directly to the monoline insurers writing credit enhancement business and has direct relationships with their affiliated primary insurers. Specialist reinsurance intermediaries, most of whom are located in London, usually present to Financial Guaranty reinsurance opportunities in the credit insurance sector. These brokers work with Financial Guaranty marketing personnel in introducing Financial Guaranty to the primary credit insurance markets and in structuring reinsurance to meet the needs of the primary insurers. 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. During 2002, the Company was the fourth largest private mortgage insurer measured by market share, and had,

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according to industry data, a market share of new primary mortgage insurance written of 14.4% as compared to 15.6% in 2001. The Company believes that the market share decrease was due to the Company’s efforts to control its contract underwriting expenses and its disciplined approach to engaging in captive reinsurance arrangements.

In addition, 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 2002 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 ACE Limited and RAM Reinsurance Co. Ltd. Another competitor, Axa Reinsurance Finance, S.A., discontinued its financial guaranty reinsurance business in 2002 and is currently in runoff. In addition, several multiline insurers have recently increased their participation in financial guaranty reinsurance. 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 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.

Financial guaranty insurance, including municipal bond insurance and the structured business, 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 municipal bonds 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.

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, interest rate risk, operational risk, and legal risk across all of its businesses, and the development of risk adjusted return on capital models.

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The Company plans to implement during 2003 a redesigned, enterprise-wide credit committee structure, whereby an Enterprise Credit Committee consisting primarily of members of senior management would oversee individual credit committees organized by product line.

Mortgage Insurance Business

Risk Management Personnel

In addition to a centralized Risk Management department in the home office, each of the Company’s mortgage insurance service regions has an assigned Risk Manager responsible for evaluating risk and monitoring the risk profiles of major lenders in the region. The Company employs an underwriting and support staff of approximately 100 persons who are located in Mortgage Insurance’s 19 service centers. Additionally, the Company has agency operations in place for 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. In order to meet this demand, the Company introduced to the marketplace the process referred to as Radian Streamlined Doc (“Streamlined Doc”). A lender utilizing Streamlined Doc can submit loans to the Company for insurance with abbreviated levels of documentation based on the type of loan being submitted for insurance. During 2002, 43% of the commitments issued for primary insurance were received by the Company under the Streamlined Doc program. In the Streamlined Doc program, the Company has agreed to underwrite certain loans with less documentation by relying upon a proprietary scoring model created by the Company in 1996 known as the “Prophet Score ^® ” System (described below under “Mortgage Scoring Models”).

Delegated Underwriting

The Company has a delegated underwriting program with a significant number of its customers. The Company’s delegated underwriting program, which was implemented in 1989, 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, 2002, approximately 23% of the risk in force on the Company’s books was originated on a delegated basis and during 2002 and 2001, respectively, 40% and 37% 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. This credit score-based scorecard is used to predict the future performance of a loan over a one or two year time horizon. The higher the credit score the lower the likelihood that a borrower will default on a loan. The Company’s Prophet Score ^® 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 ^® over the entire life of the loan. In addition to the Prophet Score ^® , the Company’s housing

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analysts regularly review major metropolitan areas to assess the impact that key indicators such as housing permits, employment trends, and median home sale prices have on local lending. The healthier the real estate market, the lower the risk. The Company refers to this score as a GEOScore. Beginning in October 1996, the Prophet Score ^® and GEOScore have appeared on each insurance commitment that the Company issued.

Automated Underwriting

The Company uses a frontline computer system for input and underwriting mortgage loan file information. In using this frontline system, the Company captures information from all segments of a loan file including the borrower’s employment and income history and appraisal information. This information is then channeled through various edits and subfiles (including Prophet Score ^® and GEOScore) to assist the underwriter in determining the total risk profile on a given file. This system also includes: a) tracking loans by borrowers who have previously defaulted on a loan insured by the Company or loans where the Company has paid a claim, b) identifying borrowers who have previously applied for the Company’s insurance, and c) information about the lender involved including volume, commitment rates and delinquency rates.

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 or C loans and has targeted the business insured to specific lenders with proven good results and servicing experience in this area. The Company’s corporate due diligence has identified such lenders as “Tier 1” lenders. 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 2002, non-prime business accounted for $16.2 billion or 33.1% of Mortgage Insurance’s new primary insurance written (72.8% of which was Alt-A) compared to $14.3 billion or 31.9% in 2001. At December 31, 2002, non-prime insurance in force was $25.6 billion or 23.2% of total primary insurance in force as compared to $18.2 billion or 16.8% of primary insurance in force a year ago. The Company anticipates that the mix of non-prime insurance in force could gradually increase but will stay below a targeted level of 30%.

Alt-A Loans

Alt-A loans can now be segregated into two distinct credit profiles: Borrowers with a better credit profile than the Company’s typical insured borrowers, with a FICO score greater than 680 (“FICO >680”), and borrowers with a credit profile equal to the Company’s typical insured borrower, with a FICO score from 660 to 679 (“FICO 660-679”). The Company charges a higher premium for Alt-A business due to the reduced income and/or asset documentation received at origination. The premium rate is also risk adjusted to reflect the difference in credit profile of the FICO >680 borrower and FICO 660-679 borrower. While the Company believes the Alt-A loans in the FICO 660-679 category present a slightly higher risk than its normal business, the premium surcharge compensates the Company for this additional risk. Alt-A loans represented 15.0% of total primary risk in force at the end of 2002 and Alt-A products made up 24.1% of the Company’s primary new insurance written in 2002 as compared to 18.3% in 2001. The default rate on the Alt-A business was 5.2% at December 31, 2002 compared to 4.5% at December 31, 2001. Claims paid on Alt-A loans were $27.3 million and $5.9 million in 2002 and 2001, respectively.

A Minus Loans

The A minus program can also be segregated into two distinct credit profiles. A “near-miss” prime A loan has a FICO score from 590-619 (“FICO 590-619”). These borrowers were forced into the A minus markets in 1996 when the GSEs set a 620 FICO score as the base for a prime borrower. These were typically borrowers

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whose loans the Company insured prior to 1996, and mortgage insurance on loans made to this class of borrowers has resurfaced as the GSEs have entered the A minus market. The Company receives a significantly higher premium for insuring this product that is commensurate with the additional default risk. The second credit profile contains borrowers with a FICO score from 570-589 (“FICO 570-589”). 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 ^® . A minus loans represented 6.5% of total primary risk in force at the end of 2002 and made up 7.1% of the Company’s primary new insurance written in 2002 as compared to 10.0% in 2001. The default rate on the A minus and below loans was 11.3% at December 31, 2002 compared to 6.4% at December 31, 2001. Claims paid on A minus and below loans were $32.1 million and $19.1 million in 2002 and 2001, 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 loans. The Company receives significantly higher premium on these loans due to the increased default risk associated with this type of loan. B/C loans represented approximately 1.9% of total primary new insurance written during 2002 compared to 3.6% of total primary new insurance written during 2001. This decrease is primarily the result of a business decision to not insure these loans.

Contract Underwriting

The Company utilizes its underwriting skills to provide an outsource contract underwriting service to its customers. For a fee, the Company underwrites fully documented loan files for secondary market compliance, while concurrently assessing the file for mortgage insurance if applicable. The automated underwriting service introduced in the latter part of 1997 has become a major part of the Company’s contract underwriting service. This service offers customers access to Fannie Mae’s Desktop Underwriter and Freddie Mac’s Loan Prospector loan origination systems. Contract underwriting continues to be a popular service to mortgage insurance customers. During 2002, loans underwritten via contract underwriting accounted for 30.4% of applications, 28.7% of commitments for insurance and 23.0% 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 2002, 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. 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 2002, the financial impact of these remedies was insignificant although there is no assurance that such results will continue in 2003 and beyond.

Quality Assurance

As part of the Company’s system of internal control, the Risk Management department maintains a Quality Assurance (“QA”) function. The QA function is responsible for ensuring that the Company’s portfolio of insured loans meets good underwriting standards and conforms to the Company’s guidelines for insurability, thus minimizing the Company’s exposure to controllable risk. Among its other activities, the QA function accomplishes this objective primarily by performing contract underwriting audits, delegated lender audits, and due diligence reviews of structured transactions.

Contract Underwriting Audits

The QA 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

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which identifies high-, medium-, and low-risk contract underwriters based upon six 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 its Prophet Score ^® system, the Company is able to monitor the credit quality of loans submitted for insurance. The Company also conducts a periodic, on-site review of a delegated lender’s insured delegated underwriting business. Lenders with significant risk concerns, as identified in past reviews and through the Company’s regular risk reporting and analysis of the business, 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 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.

Due Diligence of Structured Transactions

The QA function, in conjunction with other members of the Risk Management department, also 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.

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

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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 Risk Management 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

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, which process, in the case of reinsurance transactions, supplements the underwriting procedures of the ceding companies. Rather than relying entirely upon the underwriting performed by the ceding companies, Radian Reinsurance and Radian Asset Assurance, as applicable, 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.

The Company carefully evaluates the risk underwriting and management of treaty customers, monitors the insured portfolio performance and conducts a detailed underwriting review of the facultative insurance it writes. The Company believes that the reinsurance of municipal bond 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 detailed reviews of each Major Monoline and other carriers with which it does 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. In connection with the Company’s direct insurance business, it conducts periodic reviews of its insured parties, whether in connection with policy renewal or otherwise. That review includes an examination of the insured party’s operations, internal control procedures, personnel and organization.

Limitations on the Company’s single-risk exposure derive 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 municipal credits, the Company has self-imposed single-risk guidelines which range widely, depending upon the perceived risk of default of the municipal obligation insured or reinsured. For asset-backed transactions, the single-risk guidelines generally follow state insurance regulation limitations, as well as additional self-imposed single risk and cumulative servicer-related risk. On individual underwritings, the credit committee may limit its insurance or reinsurance participation to an amount below that allowed by the single-risk guidelines noted above. Moreover, the Company relies on ongoing oversight by Financial Guaranty’s credit committees with input from the Risk Management department and the surveillance function to avoid undue exposure concentration in any given type of obligation or geographic area.

The Company’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.

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The underwriting criteria applied in evaluating a given issue for primary insurance coverage and the internal procedures (for example, credit committee review) for approval of the issue are substantially the same as for the underwriting of reinsurance. The entire underwriting responsibility rests with Financial Guaranty as the primary insurer. As a result, Financial Guaranty participates more actively in the structuring of the transaction and conducts more detailed reviews of the parties it insures in which Financial Guaranty is a primary insurer than it does as a reinsurer. Financial Guaranty conducts, in most cases annually, in-depth surveillance of issues insured as a primary insurer.

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 are 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.

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 insurance financial strength ratings:

On October 4, 2002, S&P announced that it had downgraded the financial strength rating of Radian Reinsurance from “AAA” to “AA” (and, on the same date, Fitch placed the “AAA” rating of Radian Reinsurance on “negative watch” for possible downgrade). Radian Reinsurance and Radian Asset Assurance are parties to numerous reinsurance agreements with ceding companies which grant the ceding companies 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 ceding companies for the decrease in credit the rating agencies allow the ceding companies for the reinsurance provided by Financial Guaranty.

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As a result of the downgrade by S&P, the ceding companies have the right described above to recapture the financial guaranty reinsurance ceded to Radian Reinsurance, including substantially all of the unearned premium reserves of Radian Reinsurance. As described above, the ceding companies also have 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. In addition, the ceding companies may seek amendments to their agreements with Radian Reinsurance to revise commissions or premiums payable or to recapture only a portion of the business ceded to Radian Reinsurance in a given year. 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, or the exercise by ceding companies of their rights triggered by the downgrade of Radian Reinsurance, 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 S&P or Moody’s will not make further revisions to Radian Reinsurance’s or Radian Asset Assurance’s financial strength ratings which would trigger these rights of the ceding companies.

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.

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 cancelled 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 runoff period equal to four times the annual limit in effect for the calendar year of such nonrenewal. For 2003, this aggregate limit is estimated to be $560 million. The annual retention is determined by a formula that contains variable components. The estimated 2003 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 2003, 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. In 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 ceding commission is paid by the reinsurer to Radian Guaranty and the agreement is noncancelable for 10 years by either party. As of December 31, 2002, the risk in force covered by the VQS treaty was approximately $2.1 billion, or approximately 8.1% of total primary risk in force and $91.8 million, or approximately 5.3% of total pool risk in force. The Company has not reinsured any additional business pursuant to the VQS treaty since 1998.

The financial guaranty business is party to certain facultative retrocession (the ceding of reinsured business) agreements, pursuant to which it cedes to certain retrocessionnaires (the party accepting the cession of reinsurance business) a portion of its reinsurance exposure. Since it is required to pay its obligations in full to the

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ceding company regardless of whether it is entitled to receive payments from its retrocessionnaire, the Company believes that it is important that its retrocessionnaires be very creditworthy. The Company also cedes to reinsurers a portion of its direct insurance exposure, and the foregoing also describes in general the relationship between the Company and its reinsurers. Financial Guaranty 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.

Radian Reinsurance is party to an excess-of-loss reinsurance agreement with a reinsurance company under which it is entitled, subject to certain conditions, to draw from such reinsurer up to $25 million under certain circumstances. The agreement has a term of one year and is cancelable annually at the option of either party, except that Radian Reinsurance has the option to force a seven-year run-off period.

In November 2001, Radian Reinsurance entered into a credit agreement with a group of major foreign banks, which was amended in October 2002, under which Radian Reinsurance is entitled, upon reaching a $340 million threshold of covered losses and subject to certain conditions, to draw from such banks up to $125 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 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 Pennsylvania Department of Insurance.

Defaults and Claims

Defaults

The default and claim cycle on loans that have private mortgage insurance begins with the insurer’s receipt from the lender of notification of a default on an insured loan. The master policy requires lenders to notify the Company of an uncured default on a mortgage loan within 75 days (45 days for an uncured default in the first year of the loan), although many lenders do so earlier. The incidence of default is affected by a variety of factors, including change in borrower income, unemployment, divorce and illness, the level of interest rates and general borrower creditworthiness. Defaults that are not cured result in claims to the Company. Borrowers may cure defaults by making all delinquent loan payments or by selling the property and satisfying all amounts due under the mortgage.

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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, 2002, primary mortgage insurance default rates for the Company’s two largest states measured by risk in force, California and Florida, were 2.3% and 4.2% respectively, compared to 2.9% and 4.6% respectively, at December 31, 2001.

Claims

In the mortgage insurance business, the likelihood that a claim will result from a default and the amount of such claim depends principally on the borrower’s equity at the time of default and the borrower’s (or the lender’s)

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ability to sell the home for an amount sufficient to satisfy all amounts due under the mortgage, as well as the effectiveness of loss mitigation efforts. Claims are also affected by local housing prices, interest rates, unemployment levels and the housing supply.

Claim activity in the mortgage insurance business is not evenly spread through the coverage period of a book of business. Relatively few claims are received during the first two years following issuance of the policy. This is followed by a period of rising claims which, based on industry experience, has historically reached its highest level in the third through fifth years after the year of loan origination. 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 70.7% of the primary risk in force, including most of the Company’s risk in force on alternative products, and approximately 31.9% of the pool risk in force at December 31, 2002 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 questionable property values in those states. The Company’s risk management department identified these issues over a year 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.

In the financial guaranty business, the Company is typically obligated to pay amounts equal to defaulted payments on insured obligations on their respective due dates. For municipal, asset-backed, and other structured products, the Company primarily underwrites with a zero-loss or remote loss underwriting objective. 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 loan workout staff consists of 5 employees, working with borrowers to reduce the frequency and severity of foreclosure losses. The size of the loan workout staff has decreased over the past few

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years relative to the number of defaults, primarily due to an enhancement in the ability of loan servicers to perform this function adequately with less assistance needed by the Company. Once a notice of default is received, the Company scores the default using a proprietary model that predicts the likelihood that the default will become a claim. Using this model the loan workout specialists prioritize cases for proactive intervention to counsel and assist borrowers. Loss mitigation techniques include pre-foreclosure sales, extensions of credit to borrowers to reinstate insured loans, loan modifications and deficiency settlements. The Company still considers its loss mitigation efforts to be an effective way to reduce claim payments.

Subsequent to foreclosure, the Company uses post-foreclosure sales and the exercise of the full claim payment option to further mitigate loss. This was considered an extremely effective loss mitigation tool in 2002 and 2001 due to relatively strong property values, although there can be no assurance that such positive results will continue.

Financial Guaranty’s surveillance 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. This is no assurance, however, that there will be no material losses in the future in Financial Guaranty’s business.

Homeownership Counseling

In 1995, Mortgage Insurance established 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 its 2003 Annual Report to Stockholders, both in the Notes to the Consolidated Financial Statements and in the “Management’s Discussion and Analysis of Results of Operations and Financial Condition” section.

Loss Reserves – Mortgage Insurance

The Company establishes reserves to provide for the estimated costs of settling claims in respect of loans reported to be in default and loans that are in default which have not yet been reported to the Company. Consistent with accounting principles generally accepted in the United States of America (“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 condition 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 will be increased, in stages, to approximately 100% of the Company’s exposure. If the default cures, the reserve for that loan is removed from the reserve for losses and loss adjustment expenses (“LAE”).

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

Loss Reserves – Financial Guaranty Business

The Company establishes a provision for losses and related LAE as to a particular insured risk when the ceding companies report a loss on the risk or when, in its opinion, the risk is in default or a default is probable and the amount of the loss is reasonably estimable. The Company bases the provision for losses and LAE on the estimated loss, including expenses associated with settlement of the loss, through the full term of the insured obligation. In the case of obligations with fixed periodic payments, the provision for losses and LAE represents the present value of the ultimate expected losses, adjusted for estimated recoveries under salvage or subrogation rights. On any given municipal and asset-backed reinsurance transaction, the Company and its primary insurer customers underwrite with a zero-loss underwriting objective. For the trade credit reinsurance business, loss reserves are established based on historical loss development patterns experienced by the Company and by ceding companies in similar businesses. The estimate of reserves for losses and LAE, which includes a non-specific loss reserve, is periodically evaluated by the Company, and changes in estimates are reflected in income currently.

The Company’s non-specific loss reserve for the financial guaranty business, as of December 31, 2002 is $48.0 million, compared to $47.2 million as of December 31, 2001. 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.

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At December 31, 2002, Financial Guaranty had established $139.9 million in net reserves for losses and loss adjustment expenses (of which $62.9 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 2002, 2001, and 2000, Financial Guaranty recorded losses of $36.3 million, $24.9 million and $21.9 million, respectively, in connection with its trade credit and surety businesses.

Analysis of Primary Risk in Force

The Company’s business strategy has been to disperse risk as widely as possible. The Company analyzes its portfolio in a number of ways to identify any concentrations or imbalances in risk dispersion. The Company believes the quality 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.

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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, 2002 and 2001:

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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, 2002 and 2001:

For the years ended December 31, 2002 and 2001, the Company’s revenue attributable to foreign countries was approximately 6% and 3%, respectively (and less than 1% in 2000). In addition, long-lived assets located in foreign countries were immaterial for the 2002, 2001and 2000 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.

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, 2002 and 2001:

Direct Mortgage Insurance Risk in Force

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One of the most important determinants of claim incidence is the relative amount of borrower’s equity, or down payment, in the home. The expectation of claim incidence on 95% LTV loans (“95s”) is approximately two times the expected claim incidence on 90s. The Company believes that the higher premium rates it charges on 95s adequately reflect the additional risk on these loans. The industry and the Company have been insuring 97s since 1995 and 100% LTV loans (“100s”) since 2000. These loans are expected to have a higher claim incidence than 95s; however, with proper counseling efforts and by limiting insurance on these loans to sensible affordable housing programs, it is the Company’s belief that the claim incidence should not be materially (more than one and one-half times) worse than on 95s, although there can be no assurance that claim incidence will not be materially worse on 97s or 100s than on 95s. Premium rates on 100s and 97s are higher than on 95s to compensate for the additional risk and the higher expected frequency and severity of claims. The Company insures an immaterial amount of loans having an LTV over 100%.

In recent years, the Company has decreased its insurance on mortgage loans identified by its customers as “affordable housing” loans. These loans are typically made to low- and moderate-income borrowers in conjunction with special programs developed by state or local housing agencies, Fannie Mae or Freddie Mac. Such programs usually include 95s, 97s and 100s and may require the liberalization of certain underwriting guidelines in order to achieve their objectives. The Company’s participation in these programs is dependent upon acceptable borrower counseling. Default experience on these programs has been worse than non-“affordable housing” loans; however, the Company does not believe the ultimate claims will materially affect its financial results due to the relatively small amount of such business in the Company’s insured book combined with higher premium rates and risk-sharing elements.

The Company believes that the risk of claim on non-prime loans is significantly higher than that on prime loans. Non-prime loans generally include Alt-A and A minus products and although higher premium rates and surcharges are charged in order to compensate for the additional risk, these products are relatively new and have never been insured in an adverse economic situation so there is no assurance that the premium rates are adequate or the loss performance will be at, or close to, expected levels.

The Company’s claim frequency on insured ARMs has been higher than on all other loan types. The Company believes that the risk on ARM loans is greater than on fixed rate loans due to possible monthly payment increases if interest rates rise.

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The Company believes that 15-year mortgages present a lower level of risk than 30-year mortgages, primarily as a result of the faster amortization and the more rapid accumulation of borrower equity in the property. Premium rates for 15-year mortgages are lower to reflect the lower risk.

The Company believes that the risk of claim is also affected by the type of property securing the insured loan. In the Company’s opinion, loans on single-family detached housing are subject to less risk of claim incidence than loans on other types of properties. Conversely, loans on attached housing types, particularly condominiums and cooperatives, are generally considered by the Company to be a higher risk, due to the higher density of such properties and because a detached unit is the preferred housing type in most areas. The Company’s more stringent underwriting guidelines on condominiums and cooperatives reflect this higher expected risk.

The Company believes that the risk of claim on relocation loans and loans originated by credit unions is extremely low and offers lower premium rates on such loans to compensate for the lower risk.

The Company believes that loans on non-owner occupied homes purchased for investment purposes represent a substantially higher risk of claim incidence, and are subject to greater value declines than loans on either primary or second homes. The Company underwrites loans on non-owner occupied homes more stringently, and sometimes requires that the investor indemnify the Company directly for any loss suffered by the Company. The Company also charges a significantly higher premium rate than the rate charged for insuring loans on owner occupied homes.

The Company believes that higher priced properties experience wider fluctuations in value than moderately priced residences and that the income of many people who buy higher priced homes is less stable than that of people with moderate incomes. Underwriting guidelines for such higher priced properties reflect this concern.

The following table sets forth the distribution of the Company’s financial guaranty insurance in force by type of issue and as a percentage of total financial guaranty insurance in force as of December 31, 2002 and 2001: