UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission file number 0-22342

Triad Guaranty Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(336) 723-1282

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

None

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

Title of Each Class

Common Stock, par value $.01 per share

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

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    o

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

     State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $508,291,271 as of June 30, 2004, which amount excludes the value of all shares beneficially owned (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) by officers and directors of the registrant (however this does not constitute a representation or acknowledgment that any such individual is an affiliate of the registrant).

     The number of shares of the registrant’s common stock, par value $.01 per share, outstanding as of February 14, 2005, was 14,678,418.

TABLE OF CONTENTS

PART I

      Triad Guaranty Inc. is a holding company which, through its wholly–owned subsidiary, Triad Guaranty Insurance Corporation (“Triad”), provides private mortgage insurance (“MI”) coverage in the United States to residential mortgage lenders and investors. Triad Guaranty Inc. and its subsidiaries are collectively referred to as the “Company.” The “Company” when used within this document refers to the holding company and/or one or more of its subsidiaries, as appropriate.

      Private mortgage insurance, also known as mortgage guaranty insurance, is issued in many home purchases and refinancings involving conventional residential first mortgage loans to borrowers with equity of less than 20%. If the homeowner defaults on the mortgage, private mortgage insurance reduces, and in some instances eliminates, the loss to the insured lender. Private mortgage insurance also facilitates the sale of low down payment mortgage loans in the secondary mortgage market, principally to the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). Under risk–based capital regulations applicable to most financial institutions, private mortgage insurance also reduces the capital requirement for such lenders on residential mortgage loans not sold that have equity of less than 20%. Mortgage insurance is also purchased by investors and lenders who seek additional default protection or capital relief on loans with equity of greater than 20%.

      Private mortgage insurance has traditionally involved underwriting and insuring an individual loan. This type of mortgage insurance is known as “flow” mortgage insurance and will be referred to as such throughout this document. Additionally, the Company participates in structured bulk transactions that involve underwriting and insuring a group of loans. This type of mortgage insurance is known as “structured bulk” or “bulk” mortgage insurance and will be referred to as such throughout this document.

      Triad was formed in 1987 as a wholly–owned subsidiary of Primerica Corporation and began writing private mortgage insurance in 1988. In September 1989, Triad was acquired by Collateral Mortgage, Ltd. (“CML”), a mortgage banking and real estate lending firm located in Birmingham, Alabama. In 1990, CML contributed the outstanding stock of Triad to its affiliate, Collateral Investment Corp. (“CIC”), an insurance holding company.

      The Company was incorporated by CIC in Delaware in August 1993, for the purpose of holding all the outstanding stock of Triad and to undertake the initial public offering of the Company’s Common Stock, which was completed in November 1993. CIC currently owns 17.6% and CML owns 17.6% of the outstanding Common Stock of the Company.

      The principal executive offices of the Company are located at 101 South Stratford Road, Winston–Salem, North Carolina 27104. Its telephone number is (336) 723–1282.

Types of Mortgage Insurance Products

      Primary insurance provides mortgage default protection to lenders on individual loans and covers a percentage of unpaid loan principal, delinquent interest, and certain expenses associated with the default and subsequent foreclosure (collectively, the “claim amount”). The claim amount, to which the appropriate coverage percentage is applied, generally ranges from 110% to 115% of the unpaid principal balance of the loan. The Company’s obligation to an insured lender with respect to a claim is determined by applying the appropriate coverage percentage to the claim amount. Under its master policy, the Company has the option of paying the entire claim amount and taking title to the mortgaged property or paying the coverage percentage in full satisfaction of its obligations under the insurance written. “Insurance written” is defined as the entire loan balance for which a lender has requested mortgage insurance and is generally utilized as a term to measure sales success. Primary insurance can be placed on many types of loan instruments and generally applies to loans secured by mortgages on owner occupied homes.

      The Company offers primary coverage generally from 6% to 45% of the loan amount, with most coverage from 12% to 37% as of December 31, 2004. The coverage percentage provided by the Company is selected by the insured lender, subject to the Company’s underwriting approval, usually in order to comply with investor’s requirements to reduce investor loss exposure on loans they purchase.

      Fannie Mae and Freddie Mac are the ultimate purchasers of a large percentage of the loans insured by the Company. Generally they require a coverage percentage that will reduce their loss exposure on loans they purchase to 75% or less of the property’s value at the time the loan is originated. Since 1999, Fannie Mae and Freddie Mac have accepted lower coverage percentages for certain categories of mortgages when the loan is approved by their automated underwriting services. The reduced coverage percentages limit loss exposure to 80% or less of the property’s value at the time the loan is originated.

      The Company’s premium rates vary depending upon various factors including the loan–to–value (LTV) ratio, loan type, mortgage term, coverage amount, documentation required, credit score and use of property, which all affect the perceived risk of default on the insured mortgage loan. Usually, premium rates cannot be changed after issuance of coverage. Consistent with industry practice, the Company generally utilizes a nationally based, rather than a regional or local, premium rate structure for its flow business, although special risk rates are utilized as well.

      Premiums on flow mortgage insurance are paid by either the borrower (borrower-paid) or the lender (lender-paid). Under the Company’s borrower-paid plan, mortgage insurance premiums are charged to the mortgage lender or servicer that collects the premium from the borrower and, in turn, remits the premiums to the Company. Under the Company’s lender–paid plan, mortgage insurance premiums are charged to the mortgage lender or loan servicer that pays the premium to the Company. The lender may recover the premium through an increase in the borrower’s interest rate. Approximately 77% and 69% of the Company’s flow insurance was written under its borrower-paid plan during 2004 and 2003, respectively. The remainder was written under its lender-paid plan (23% and 31% of flow insurance during 2004 and 2003, respectively). The Company’s lender-paid volume is concentrated among larger mortgage lender customers.

      Premiums may be remitted to the Company monthly, annually, or in one single payment. The monthly premium payment plan involves the payment of one or two months’ premium at the mortgage loan closing. Thereafter, level monthly premiums are collected by the loan servicer for monthly remittance to the Company. The Company also offers a plan under which the first monthly mortgage insurance payment is deferred until the first loan payment is remitted to the Company. This deferred monthly premium product decreases the amount of cash required from the borrower at closing, thereby making home ownership more affordable. Monthly premium plans represented approximately 92% and 76% of flow insurance written in 2004 and 2003, respectively.

      The annual premium payment plan requires a first–year premium paid at mortgage loan closing with annual renewal payments. With respect to the Company’s borrower-paid plans, renewal payments are collected monthly from the borrower and held in escrow by the mortgage lender or servicer for annual remittance to the Company in advance of each renewal year. Annual premium plans represented approximately 8% and 23% of flow insurance written in 2004 and 2003, respectively.

      The single premium payment plan requires a single payment paid at loan closing. The single premium payment can be financed by the borrower by adding it to the principal amount of the mortgage or can be paid in cash at closing by the borrower. Single premium plans represented less than 1% of flow insurance written in 2004 and 2003.

      Pool insurance generally has been offered by private mortgage insurers to lenders as an additional credit enhancement for certain mortgage–backed securities and provides coverage for the full amount of the net loss on each individual loan included in the pool, subject to an aggregate stop loss limit and/or a deductible. The Company does not offer this traditional form of pool insurance.

      The Company participates in structured bulk transactions, which involve insuring a group of loans with individual coverage for each loan. Structured bulk transactions are typically initiated by secondary mortgage market participants, including underwriters of mortgage-backed securities, mortgage lenders, and mortgage investors such as Fannie Mae and Freddie Mac, where mortgage insurance is used as a credit enhancement. Insurance issued in structured bulk transactions is generally either primary, supplemental if the policy already has primary coverage, or a combination of both. Coverage on structured bulk transactions is determined at the individual loan level, sufficient to reduce the insured’s exposure on any loan in the transaction down to a stated percentage of the loan balance (“down-to” coverage). The Company is provided loan-level information on the group of loans and, based on the risk characteristics of the entire group of loans and the requirements of the secondary mortgage market participant, the Company submits a price for insuring the entire group of loans. The Company competes against other mortgage insurers as well as other forms of credit enhancement provided by capital markets for these transactions. During 2004, insurance written related to structured bulk transactions represented 39% of the total insurance written compared to 19% in 2003.

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

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

      Trust accounts are established with the counterparties to all of our reinsurance agreements to support the reinsurers’ obligations under the reinsurance agreements. The captive reinsurer is the grantor of the trust and Triad is the beneficiary of the trust. The trust agreement includes covenants regarding minimum and ongoing capitalization, required reserves, authorized investments, and withdrawal of assets and is funded by ceded premium and investment earnings on trust assets as well as capital contributions by the reinsurer.

      The ultimate impact on the Company’s financial performance of an excess-of-loss captive structure is primarily dependent on the total level of losses and the persistency rates during the life of a given book year of business. We define persistency as the percentage of insurance in force remaining from twelve months prior. The Company believes that its excess-of-loss captive reinsurance programs provide valuable reinsurance protection by limiting the aggregate level of losses, and under normal operating environments, potentially reduce the degree of volatility in the Company’s earnings from the development of such losses over time. At December 31, 2004 and 2003, 43% and 44% of insurance in force was subject to captive reinsurance programs.

Cancellation of Insurance

      Mortgage insurance coverage cannot be canceled by the Company except for nonpayment of premium or certain material violations of the master policy and remains renewable at the option of the insured lender.

Generally, mortgage insurance is renewable at a rate determined when the insurance on the loan was initially issued.

      Insured lenders may cancel insurance at any time at their option. Pursuant to the Homeowners Protection Act, lenders are required to automatically cancel the borrower paid private mortgage insurance on most loans made on or after July 29, 1999, when the outstanding loan amount is 78% or less of the property’s original purchase price and certain other conditions are met. A borrower may request that a loan servicer cancel borrower-paid mortgage insurance on a mortgage loan when the loan balance is less than 80% of the property’s current value, but loan servicers are generally restricted in their ability to grant such requests by secondary market requirements and by certain other regulatory restrictions.

      Mortgage insurance coverage can also be cancelled when an insured loan is refinanced. If the Company provides insurance on the refinanced mortgage, the policy on the refinanced home loan is considered new insurance written. Therefore, continuation of the Company’s coverage from a refinanced loan to a new loan results in both a cancellation of insurance and new insurance written.

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

Customers

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

      To obtain insurance from the Company written on a flow basis, a mortgage lender must first apply for and receive a master policy from the Company. The Company’s approval of a lender as a master policyholder is based upon evaluation of the lender’s financial position and demonstrated adherence to sound lending practices as well as other factors.

      The master policy sets forth the terms and conditions of the Company’s mortgage insurance policy. The master policy does not obligate the lender to obtain insurance from the Company, nor does it obligate the Company to issue insurance on a particular loan. The master policy provides that the lender must submit individual loans for insurance to the Company, and each loan, subject to certain underwriting criteria, must be approved by the Company to effect coverage (except in the case of delegated underwriting or when the originator has the authority to approve coverage within certain guidelines).

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

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

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

Sales and Marketing

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

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

      The marketing department’s mission is to develop and implement programs in support of the Company’s sales objectives and to promote the Company’s image. A variety of tools are used to achieve these goals including public relations, marketing materials, internal/external publications, convention trade shows, and the Internet. A national advertising and public relations campaign designed to raise corporate visibility to lenders and investors is also part of the Company’s integrated marketing approach.

Contract Underwriting

      The Company provides fee–based contract underwriting services that enable customers to improve the efficiency of their operations by outsourcing all or part of their mortgage loan underwriting. The fee charged is intended to cover the cost of providing the services. Contract underwriting involves examining a prospective borrower’s information contained in a lender’s mortgage application file and making a determination whether the borrower is approved for a mortgage loan subject to the lender’s underwriting guidelines. In addition, the Company offers Fannie Mae’s Desktop Originator® and Desktop Underwriter® and Freddie Mac’s Loan Prospector® as a service to its contract underwriting customers. These products, which are designed to streamline and reduce costs in the mortgage origination process, supply the Company’s customers with fast and accurate service regarding compliance with underwriting standards and Fannie Mae’s or Freddie Mac’s decision for loan purchase or securitization. The Company provides contract underwriting services through its own employees as well as independent contractors, and these services are provided for loans that require mortgage insurance as well as loans that do not require mortgage insurance. In the event that Triad fails to properly underwrite a loan subject to the lender’s underwriting guidelines, Triad may be required to provide monetary or other remedies to the lender customer. The potential remedies are not significant to the Company.

Competition and Market Share

      The Company and other private mortgage insurers compete directly with federal and state governmental and quasi–governmental agencies, principally the Federal Housing Administration (“FHA”). These agencies sponsor government–backed mortgage insurance programs under which approximately 33% of high LTV loans were insured in 2004 compared to 36% in 2003. In addition to competition from federal agencies, the Company and other private mortgage insurers face competition from state–supported mortgage insurance funds, some of which are either independent agencies or affiliates of state housing agencies. Indirectly, the Company also competes with certain mortgage lenders that forego private mortgage insurance to self–insure against the risk of loss from defaults on all or a portion of their low down payment mortgage loans.

      Fannie Mae and Freddie Mac have the ability to modify the required level of mortgage insurance coverage that should be maintained by lenders on loans that they purchase. Both Fannie Mae and Freddie Mac have programs that reduce the required amount of private mortgage insurance in exchange for an upfront delivery fee from the lender. The Company’s financial condition and results of operations could be adversely affected as a result of these programs or if Fannie Mae and/or Freddie Mac adopt private mortgage insurance substitutes.

      Various proposals are periodically discussed by Congress and certain federal agencies to reform or modify the FHA. Management is unable to predict the scope and content of such proposals, or whether any such proposals will be enacted into law, and if enacted, what effect they may have on the Company.

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

      Management believes the Company competes with other private mortgage insurers principally on the basis of personalized and professional service, a strong management and sales team, responsive and versatile technology, and innovative products in the flow market. The Company competes in competitive bid transactions in the structured bulk market with both the other private mortgage insurers and providers of other forms of credit enhancements.

Underwriting Practices

      The Company considers effective risk management to be critical to its long–term financial stability. Market analysis, prudent underwriting, the use of automated risk evaluation models, auditing, and customer service are all important elements of the Company’s risk management process.

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

      The Company employed an underwriting staff of approximately 35 at December 31, 2004. The Company’s field underwriters and underwriting managers are limited in their authority to approve programs for certain mortgage loans. The authority levels are tied to underwriting position, knowledge, and experience and relate primarily to loan amounts and property type. All loans insured by the Company are subject to quality control reviews.

      The Company evaluates risk based on historical performance of risk factors and utilizes automated underwriting systems in the risk selection process to assist the underwriter with decision-making. This process evaluates the following categories of risk:

      The Company accepts applications for insurance under three basic programs: a fully–documented program, a credit–score driven reduced documentation program, and a delegated underwriting program which allows a lender’s underwriters to commit insurance to a loan based on strict, agreed upon underwriting guidelines. The Company also accepts loans approved through Freddie Mac’s or Fannie Mae’s automated underwriting systems.

      The Company generally utilizes nationwide underwriting guidelines to evaluate the potential risk of default on mortgage loans submitted for insurance coverage. These guidelines have evolved over time and take into account the loss experience of the entire private mortgage insurance industry. They also are largely influenced by the underwriting guidelines of Fannie Mae and Freddie Mac. Specific underwriting guidelines applicable to a given local, state, or regional market are utilized to address concerns resulting from the Company’s review of regional economies and housing patterns.

      Subject to the Company’s underwriting guidelines and exception approval procedures, the Company expects its internal underwriters and contract underwriters to utilize their experience and business judgment in evaluating each loan on its own merits. Accordingly, the Company’s underwriting staff has discretionary authority to insure loans that deviate in certain minor respects from the Company’s underwriting guidelines. More significant exceptions are subject to management approval. In all such cases, other compensating factors must be identified. The predominant deviations involve instances where the borrower’s debt–to–income ratio exceeds the Company’s guidelines. To compensate for exceptions, the Company’s underwriters give favorable consideration to factors such as excellent borrower credit history, the availability of satisfactory cash reserves after closing, and borrower employment stability.

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

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

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

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

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

      The Company employs a comprehensive internal audit plan to determine whether underwriting decisions being made are consistent with the policies, procedures, and expectations for quality set forth by management. All areas of business activity that involve an underwriting decision are examined, with emphasis on new products, new procedures, contract underwritten loans, delegated loans, new employees, new master policyholders, and new branches of an existing master policyholder. The process used to identify categories of loans selected for audit begins with identification and evaluation of certain defined and verifiable risk elements. Each loan is then tested against these elements to identify loans that fail to meet prescribed policies or an identified norm. The procedure allows the Company’s management to identify concerns that may exist within individual loans as well as concerns that may exist within a given category of business.

Financial Strength Rating

      Credit ratings generally are considered an important element in a mortgage insurer’s ability to compete for new business, indicating the insurer’s present financial strength and capacity to pay future claims. Certain national mortgage lenders and a large segment of the mortgage securitization market, including Fannie Mae and Freddie Mac, generally will not purchase high LTV mortgages or mortgage–backed securities unless the insurer issuing private mortgage insurance coverage has a financial strength rating of at least “AA–” by either Standard & Poor’s Ratings Services (“S&P”) or Fitch Ratings (“Fitch”) or a rating of at least “Aa3” from Moody’s Investors Service (“Moody’s”). Triad is rated “AA” by both S&P and Fitch and “Aa3” by Moody’s. Private mortgage insurers are not rated by any other independent nationally–recognized insurance industry rating organization or agency (such as the A.M. Best Company).

      When assigning a financial strength rating, S&P, Fitch, and Moody’s generally consider: (i) the specific risks associated with the mortgage insurance industry, such as regulatory climate, market demand, growth, and competition; (ii) management depth, corporate strategy, and effectiveness of operations; (iii) historical operating results and expectations of current and future performance of the insurer’s specific portfolio; and (iv) long–term capital structure, the ratio of debt to equity, the ratio of risk to capital, near–term liquidity, and

cash flow levels, as well as any reinsurance relationships and the financial strength ratings of such reinsurers. Ratings are based on factors relevant to policyholders. Such ratings are not directed to the protection of investors and do not apply to any securities issued by the Company.

      Some rating agencies issue financial strength ratings based, in part, upon a company’s performance sensitivity to various economic depression scenarios. In determining capital levels required to maintain a company’s rating, the rating agencies allow the use of different forms of capital including statutory capital, reinsurance, and debt. In January 1998, the Company completed a $35 million private offering of notes due January 15, 2028. The notes, which are rated “A” by S&P and “A+” by Fitch, were issued to provide additional capital considered in the rating agency’s depression models.

      S&P, Fitch, and Moody’s will periodically review Triad’s rating as they do with all rated insurers. Ratings can be withdrawn or changed at any time by a rating agency. A reduction in the Company’s rating by S&P, Fitch, or Moody’s, while not anticipated, could materially impact the ability of the Company to write new business.

Reinsurance

      Triad’s product offerings include captive mortgage reinsurance programs whereby an affiliate of a lender reinsures a portion of the insured risk on loans originated or purchased by the lender. These programs are designed to allow the lenders to share in the risk of the business. See further discussion of these programs under the Risk-sharing Products section above.

      Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie Mac, certain loans eligible for sale to such enterprises with a loan–to–value ratio over 90% require insurance with a coverage percentage of 30% or more. Certain states limit the amount of risk a mortgage insurer may retain with respect to coverage of an insured loan to 25% of the claim amount, and, as a result, the deeper coverage portion of such insurance must be reinsured. To minimize reliance on third-party reinsurers and to permit the Company to retain the premiums and related risk on deeper coverage business, Triad reinsures this deeper coverage business with its wholly–owned subsidiary, Triad Guaranty Assurance Corporation (“TGAC”). As of December 31, 2004 and 2003, TGAC assumed approximately $73 million and $59 million in risk from Triad, respectively.

      The Company continues to maintain excess of loss reinsurance arrangements designed to protect the Company in the event of a catastrophic level of losses. The Company currently maintains $125 million of excess of loss reinsurance through non-affiliated reinsurers that have financial strength ratings of “AA” or better from Standard & Poor’s.

      The use of reinsurance as a source of capital and as a risk management tool is well established within the mortgage insurance industry. Reinsurance does not legally discharge an insurer from its primary liability for the full amount of the risk it insures, although it does make the reinsurer liable to the primary insurer. There can be no assurance that the Company’s reinsurers will be able to meet their obligations under the reinsurance agreements.

Defaults and Claims

      The claim process on private mortgage insurance begins with the lender’s notification to the insurer of a default on an insured’s loan. Default is defined in the primary master policy as the failure by the borrower to pay, when due, an amount at least equal to the scheduled monthly mortgage payment under the terms of the mortgage. The master policy requires lenders to notify the Company of default on a mortgage payment within 10 days of either (i) the date on which the borrower becomes four months in default or (ii) the date on which any legal proceeding affecting the loan commences, whichever occurs first. Notification is required within 45 days of default if it occurs when the first payment is due. The incidence of default is affected by a variety of factors including, but not limited to, changes in borrower income, unemployment, divorce, illness, and the level of interest rates. Borrowers may cure defaults by making all delinquent loan payments or by selling the

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

      Claims result from defaults that are not cured. During the default period, the Company works with the insured as well as the borrower in an effort to reduce its losses through the loss mitigation efforts described below. The frequency of claims does not directly correlate to the frequency of defaults due, in part, to the Company’s loss mitigation efforts and the borrower’s ability to overcome temporary financial setbacks. The likelihood that a claim will result from a default, and the amount of such claim, principally depend on the borrower’s equity at the time of default and the borrower’s (or the lender’s) ability to sell the home for an amount sufficient to satisfy all amounts due under the mortgage, as well as the effectiveness of loss mitigation efforts. The time frame from when the Company first receives a notice of default and when the ultimate claim is paid generally ranges from six to eighteen months. Changes in various macroeconomic conditions such as house price appreciation, employment, and other market conditions over that time frame also positively or negatively impact the amount of the ultimate claim paid.

      The payment of claims is not evenly spread through the coverage period. For flow business, relatively few claims are paid during the first two years following issuance of insurance. A period of rising claim payments follows, which, based on industry experience, has historically reached its highest level in the third through sixth years after loan origination. Thereafter, the number of claim payments made has historically declined at a gradual rate, although the rate of decline can be affected by local economic conditions. For our structured bulk business, the claim pattern develops earlier, with the highest claim payment levels reached in the second through fourth years. There can be no assurance that the historical pattern of claims will continue in the future.

      Generally, the Company does not pay a claim for loss under the master policy if the application for insurance for the loan in question contains fraudulent information, material omissions, or misrepresentations that increase the risk characteristics of the loan. The Company’s master policy also excludes any cost or expense related to the repair or remedy of any physical damage (other than “normal wear and tear”) to the property collateralizing an insured mortgage loan. Such physical damage may be caused by accident, natural occurrence, or other conditions.

      Under the terms of the master policy, the lender is required to file a claim with the Company no later than 60 days after it has acquired borrower’s title to the underlying property through foreclosure, a negotiated short sale, or a deed-in-lieu of foreclosure. A primary insurance claim amount includes (i) the amount of unpaid principal due under the loan; (ii) the amount of accumulated delinquent interest due on the loan (excluding late charges) to the date of claim filing; (iii) expenses advanced by the insured under the terms of the master policy, such as hazard insurance premiums, property maintenance expenses and property taxes prorated to the date of claim filing; and (iv) certain foreclosure and other expenses, including attorneys fees. Such claim amount is subject to review and possible adjustment by the Company. The Company’s experience indicates that the claim amount on a policy generally ranges from 110% to 115% of the unpaid principal amount of a foreclosed loan.

      Within 60 days after the claim has been filed, the Company has the option of either (i) paying the coverage percentage specified on the certificate of insurance (usually 12% to 40% of the claim), with the insured retaining title to the underlying property and receiving all proceeds from the eventual sale of the property, or (ii) paying 100% of the claim amount in exchange for the lender’s conveyance of good and marketable title to the property to the Company, with the Company selling the property for its own account. The Company chooses the claim settlement option believed to cost the least. In most cases, the Company settles claims by paying the coverage percentage of the claim amount. At December 31, 2004, the Company held two properties with a combined net realizable value of approximately $211,000 that were acquired by electing to pay 100% of the claim amount.

Loss Mitigation

      Once a default notice is received, the Company attempts to mitigate its loss. Through proactive intervention with insured lenders and borrowers, the Company has been successful in reducing the number and severity of its claims for loss. Loss mitigation techniques include pre–foreclosure sales, property sales after foreclosure, advances to assist distressed borrowers who have suffered a temporary economic setback, and the use of repayment schedules, refinances, loan modifications, forbearance agreements, and deeds–in–lieu of foreclosure. Such mitigation efforts typically result in a savings to the Company over the percentage coverage amount payable under the certificate of insurance. As a result of loss mitigation efforts, the Company paid out only approximately 60% and 66% of its potential exposure on claims in 2004 and 2003, respectively.

Loss Reserves

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

Analysis of Direct Risk in Force

      A foundation of the Company’s business strategy is proactive risk selection. The Company analyzes its portfolio in a number of ways to identify any concentrations of risk or imbalances in risk dispersion. The Company believes that the quality of its insurance portfolio is affected predominantly by (i) the quality of loan originations (including the strength of the borrower and the marketability of the property); (ii) the attributes of loans insured (including LTV ratio, purpose of the loan, type of loan instrument, and type of underlying property securing the loan); (iii) the seasoning of the loans insured; (iv) the geographic dispersion of the underlying properties subject to mortgage insurance; and (v) the quality, integrity and past performance of lenders from which the Company receives loans to insure.

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

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

Risk in Force(1)

      An important determinant of claim incidence is the relative amount of borrower’s equity in the home. For the industry as a whole, historical evidence indicates that, in general, claim incidence on loans with a higher LTV is greater than