MANAGEMENT’S DISCUSSION AND ANALYSIS of Results of Operations and Financial Condition QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Reserve for Losses Derivative Instruments and Hedging Activity debt financing. The Company does not believe that any of these restrictions will prevent the payment by Mortgage Insurance  or the Company of these anticipated dividends or distributions in the foreseeable future. The Company manages its investment portfolio to achieve safety and liquidity, while seeking to maximize total return. The Company believes it can achieve these objectives by active portfolio management and intensive monitoring of investments. Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risk related to financial instruments primarily relates to the investment portfolio, which exposes the Company to risks related to interest rates, default, prepayments, and declines in equity prices. Interest rate risk is the price sensitivity of a fixed income security to changes in interest rates. The Company views these potential changes in price within the overall context of asset and liability management. The Company’s analysts estimate the payout pattern of the mortgage insurance loss reserves to determine their duration, which is the weighted average payments expressed in years. The Company sets duration targets for fixed income investment portfolios that it believes mitigates the overall effect of interest rate risk. As of December 31, 2001, the  average duration of the fixed income portfolio was 5.8 years. Based upon assumptions the Company uses in its duration calculations, increases in interest rates of 100 and 150 basis points would cause decreases in the market value of the  fixed maturity portfolio (excluding short-term investments)  of approximately 7.3% and 10.7%, respectively. Similarly,  a decrease in interest rates of 100 and 150 basis points would cause increases in the market value of the fixed maturity portfolio  of approximately 6.1% and 9.7%, respectively. At December 31, 2001, the Company had no material foreign investments and  its investment in non-investment grade fixed income securities was $6,137,000. At December 31, 2001, the market value and cost of the Company’s equity securities were $120.3 million and $117.0 million, respectively. In addition, the market value and book value of the Company’s long-term debt at December 31, 2001 were $346.3 million and $324.1 million, respectively. Critical accounting policies comprise those policies that require the Company’s most difficult, subjective, and complex judgments. These policies require estimates of which the effect of matters are inherently uncertain. The accounting policies that the Company believes meet the criteria of critical accounting policies are described below. As described in notes 1 and 4 of the Notes to Consolidated Financial Statements, the Company establishes reserves to provide for the estimated costs of settling claims in both  the mortgage insurance and financial guaranty businesses. Setting loss reserves in both the businesses involves the significant use of estimates with regard to the likelihood, magnitude and timing of a loss. In the mortgage insurance business, the incurred loss process is initiated by a borrower’s missed payment. The Company uses historical models based on a variety of loan characteristics, including the status of the loan as reported by the servicer of the insured loan, the economic conditions, and the estimated foreclosure period in the area in which the default exists, to help determine the appropriate loss reserve at any point in time. As the delinquency proceeds toward foreclosure, there is more certainty around these estimates and adjustments are made  to loss reserves to reflect this updated information. The financial guaranty loss reserve is similar, however, the remote probability of losses and the dearth of historical losses in this business makes it more difficult to estimate the appropriate loss reserve. Financial Guaranty has a regular case reserve  committee meeting where experts in the risk management and surveillance area provide input to the finance area before any case reserves are determined, and the surveillance team actively monitors any problem deals and notifies the committee if a change in the reserve is necessary. Financial Guaranty establishes a reserve based on the estimated loss, including expenses associated with the settlement of the loss. As reported in note 1 of the Notes to Consolidated Financial Statements, the Company adopted SFAS No. 133 on January 1, 2001. The two areas where gains and losses on derivative contracts are recognized are in the convertible debt securities contained in the Company’s investment portfolio and in certain financial guaranty contracts. The value of the derivative position of convertible debt securities is calculated by our outside convertible debt portfolio manager by determining the value  of the readily ascertainable comparable debt securities and assigning a value to the equity (derivative) portion by subtracting the value of the comparable debt security from the total value  of the convertible instrument. Changes in such values from period to period represent the gains and losses recorded. The gains and losses on derivative financial guaranty contracts are derived from internally generated models. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates are not necessarily indicative  of amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have an effect on the estimated fair value amounts. CRITICAL ACCOUNTING POLICIES >46