## DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES 

The Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, on January 1, 2001. The statement establishes accounting and reporting standards for derivative instruments and hedging activity and requires that all derivatives be measured at fair value and recognized as either assets or liabilities in the financial statements. Changes in the fair value of derivative instruments are recorded each period in current earnings. This represents a change from the Company’s prior accounting practices whereby these changes were recorded as a component of stockholders’ equity. Transactions that the Company has entered into that are accounted for under SFAS No. 133, as amended, include convertible debt securities, credit default swaps and certain financial guaranty contracts that are considered credit default swaps. Credit default swaps and certain financial guaranty contracts that are accounted for under SFAS No. 133, are part of the Company’s overall business strategy of offering financial guaranty protection to its customers. Currently, none of the Company’s derivatives qualify as hedges. 

Upon adoption of SFAS No. 133, the balance of the Company’s convertible debt portfolio was approximately $104.6 million. SFAS No. 133 requires that the Company split its convertible debt securities into the derivative and debt host components. Over the term of the securities, changes in the fair value of the debt instrument are recorded in the Company’s consolidated statement of changes in common stockholders’ equity, through accumulated other comprehensive income or loss. Concurrently, a deferred tax liability or benefit is recognized as the recorded value of the debt host increases or decreases. A change in the fair value of the derivative is recorded as a gain or loss in the Company’s consolidated statements of income. In connection with the adoption of SFAS No. 133, the Company reclassified $13.8 million from fixed maturities available for sale to trading securities on its consolidated balance sheet 

as of January 1, 2001. At December 31, 2001 the fair value of the Company’s derivative instruments, classified as trading securities, was $21.7 million, as compared to an amortized value of $22.6 million, and the Company recognized $0.6 million, net of tax, of loss on changes in the fair value of derivative instruments in the consolidated statements of income for 2001. The notional value of the Company’s credit default swaps and certain other financial guaranty contracts accounted for under SFAS No. 133 was $2.9 billion at December 31, 2001. 

The application of SFAS 133, as amended, could result in volatility from period to period in gains and losses as reported on the Company’s consolidated statements of income. The Company is unable to predict the effect this volatility may have on its financial position or results of operations. 

## COMPANY-OWNED LIFE INSURANCE 

The Company is the beneficiary of insurance policies on the lives of certain officers and employees of the Company. The Company has recognized the amount that could be realized under the insurance policies as an asset in its consolidated balance sheet. At December 31, 2001 and 2000, the amount of Company-owned life insurance totaled $53,190,000 and $50,374,000, respectively, and is included as a component of other assets. 

## STOCK SPLIT 

On May 1, 2001, the Company’s board of directors authorized a stock split, paid June 20, 2001, in the form of a dividend of one additional share of the Company’s common stock for each share owned by stockholders of record on June 14, 2001. To effect the stock split, the Company’s stockholders approved an increase in the number of authorized shares of common stock, from 80 million to 200 million, on June 14, 2001. The dividend was accounted for as a two-for-one stock split and the par value of the Company’s common stock remained at $.001 per share. Accordingly, all references to common shares and per share data, except where noted otherwise, have been adjusted to give effect to the stock split. In conjunction with the stock split, 

the Company’s board of directors voted to increase the quarterly dividend from $.015 per share to $.02 per share of common stock outstanding after the split was effected. 

## ACCOUNTING FOR STOCK-BASED COMPENSATION 

The Company accounts for stock-based compensation in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages, but does not require, the recognition of compensation expense for the fair value of stock options and other equity instruments granted as compensation to employees. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”), and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. 

In March 2000, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation” (“FIN 44”). FIN 44 clarifies the application of APB 25 for certain issues. The Company adopted the provisions of FIN 44 in 2000. The adoption of this interpretation did not have a material effect on the Company’s financial statements. 

## NET INCOME PER SHARE 

The Company is required to disclose both “basic” net income per share and “diluted” net income per share. Basic net income per share is based on the weighted average number of common shares outstanding, while diluted net income per share is based on the weighted average number of common shares outstanding and common share equivalents that would arise from the exercise of stock options. 

