EXHIBIT 13.1
------------
ITEM 6. SELECTED FINANCIAL DATA
THE PMI GROUP, INC. AND SUBSIDIARIES
ELEVEN-YEAR SUMMARY OF FINANCIAL DATA
(Dollars in thousands, except per share data or otherwise noted Year ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Summary of consolidated operations
Net premiums written $ 757,839 $ 639,062 $ 571,253 $ 489,100 $ 432,052 $ 403,020
==================================================================================
Premiums earned $ 754,771 $ 634,362 $ 558,623 $ 491,226 $ 453,948 $ 412,738
Investment income 149,987 119,199 95,142 84,681 83,136 67,442
Net realized capital gains 11 432 509 24,636 19,584 14,296
Other Income 32,194 8,578 15,850 20,366 7,979 6,948
----------------------------------------------------------------------------------
Total revenues 936,963 762,572 670,124 620,909 564,647 501,424
Total losses and expenses (1) 489,997 388,706 380,038 353,961 321,780 279,318
----------------------------------------------------------------------------------
Income from continuing operations 446,966 373,866 290,086 266,948 242,867 222,106
Income (loss) from discontinued operations - - - - - -
Income tax (benefit) (2) 134,949 113,654 85,620 76,588 67,558 64,188
Extraordinary loss on early
extinguishment of debt, net of income
tax benefit of $2,588 4,805 - - - - -
----------------------------------------------------------------------------------
Net Income $ 307,212 $ 260,212 $ 204,466 $ 190,360 $ 175,309 $ 157,918
==================================================================================
U.S Mortgage Insurance Operating Ratios
Loss ratio 18.6% 18.9% 24.7% 32.8% 38.2% 41.9%
Net expense ratio (3) 25.2% 25.3% 29.2% 25.5% 22.7% 18.4%
----------------------------------------------------------------------------------
Combined ratio 43.8% 44.2% 53.9% 58.3% 60.9% 60.3%
==================================================================================
Consolidated Balance Sheet Data
Total assets $ 2,989,952 $ 2,392,657 $ 2,100,762 $ 1,777,870 $ 1,686,603 $ 1,509,919
Reserve for losses and loss adjustment expenses $ 314,590 $ 295,089 $ 282,000 $ 215,259 $ 202,387 $ 199,774
Long-term debt $ 422,950 $ 136,819 $ 145,367 $ 99,476 $ 99,409 $ 99,342
Preferred capital securities of
subsidiary trust $ 48,500 $ 99,109 $ 99,075 $ 99,040 $ 99,006 $ -
Shareholders' equity $ 1,786,688 $ 1,499,211 $ 1,217,268 $ 1,097,515 $ 1,061,180 $ 986,862
Shares outstanding 44,581,302 44,309,922 44,702,080 45,417,902 48,691,871 51,764,729
(Dollars in thousands, except per share data or otherwise noted
- -------------------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
- -------------------------------------------------------------------------------------------------------------------------
Summary of consolidated operations
Net premiums written $ 314,021 $ 277,747 $ 291,089 $ 208,602 $ 143,305
===============================================================
Premiums earned $ 328,756 $ 296,345 $ 268,554 $ 173,039 $ 120,195
Investment income 62,041 56,774 45,733 40,847 40,402
Net realized capital gains 11,934 3,064 1,229 686 1,335
Other Income 2,309 3,802 - - -
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Total revenues 405,040 359,985 315,516 214,572 161,932
Total losses and expenses (1) 224,499 221,434 202,543 119,912 39,879
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Income from continuing operations before taxes 180,541 138,551 112,973 94,660 122,053
Income (loss) from discontinued operations - - (28,863) 6,726 3,709
Income tax (benefit) (2) 45,310 32,419 24,305 (10,911) 69,661
Extraordinary loss on early
extinguishment of debt, net of income
tax benefit of $2,588 - - - - -
---------------------------------------------------------------
Net Income $ 135,231 $ 106,132 $ 59,805 $ 112,297 $ 56,101
===============================================================
U.S Mortgage Insurance Operating Ratios
Loss ratio 38.5% 40.5% 41.4% 33.2% 3.1%
Net expense ratio (3) 24.9% 30.1% 28.2% 27.0% 25.3%
---------------------------------------------------------------
Combined ratio 63.4% 70.6% 69.6% 60.2% 28.4%
===============================================================
Consolidated Balance Sheet Data
Total assets $ 1,304,440 $ 1,097,421 $ 985,129 $ 815,136 $ 663,215
Reserve for losses and loss adjustment
expenses $ 192,087 $ 173,885 $ 135,471 $ 94,002 $ 78,045
Long-term debt $ - $ - $ - $ - $ -
Preferred capital securities of
subsidiary trust $ - $ - $ - $ - $ -
Shareholders' equity $ 870,503 $ 687,178 $ 575,300 $ 513,583 $ 399,489
Shares outstanding 52,514,841 52,500,000 52,500,000 52,500,000 52,500,000
Per Share Data (4)
Net income
Operating (3) $ 6.88 $ 5.85 $ 4.51 $ 3.69 $ 3.23
Basic $ 6.91 $ 5.88 $ 4.55 $ 4.04 $ 3.50
Diluted $ 6.78 $ 5.78 $ 4.52 $ 4.02 $ 3.49
Shareholders' equity $ 40.08 $ 33.83 $ 27.23 $ 24.16 $ 21.79
Price/Earnings Ratio (5) 9.7 11.6 10.8 8.9 14.9
Stock price (6) : Close 67.01 67.69 48.81 32.92 48.20
High 74.50 74.94 55.50 57.00 49.32
Low 48.38 33.50 26.67 22.00 31.83
Cash dividends declared $ 0.16 $ 0.16 $ 0.14 $ 0.13 $ 0.13
PMI Operating and Statutory Data
Number of policies in force 905,906 820,213 749,985 714,210 698,831
Default rate 2.86% 2.21% 2.12% 2.31% 2.38%
Persistency 63.0% 80.3% 71.9% 68.0% 80.8%
Direct primary insurance in force $ 109,158 $ 96,914 $ 86,729 $ 80,682 $ 77,787
(in millions)
Direct primary risk in force (in $ 25,772 $ 23,559 $ 21,159 $ 19,324 $ 18,092
millions)
Statutory capital $ 1,900,709 $ 1,617,519 $ 1,372,273 $ 1,193,899 $ 1,114,342
Risk-to-capital ratio 13.0:1 14.1:1 14.8:1 14.9:1 14.6:1
New insurance written $48,089,327 $27,294,908 $28,732,505 $27,820,065 $15,307,147
Policies issued 335,213 206,493 219,038 211,161 119,190
New insurance written market share 17.0% 16.7% 16.3% 14.8% 12.7%
Return on equity 19.6% 19.9% 18.5% 19.0% 18.3%
Tax rate 30.1% 30.4% 29.5% 28.7% 27.8%
Total employees 1,235 1,117 1,113 1,016 916
Per Share Data (4)
Net income
Operating (3) $ 2.83 $ 2.43 $ 1.98 $ 1.12 $ 2.13 $ 1.05
Basic $ 3.01 $ 2.58 $ 2.02 $ 1.14 $ 2.14 $ 1.07
Diluted $ 3.00 $ 2.57 $ 2.02 $ 1.14 $ 2.14 $ 1.07
Shareholders' equity $ 19.06 $ 16.58 $ 13.09 $ 10.96 $ 9.78 $ 7.61
Price/Earnings Ratio (5) 13.0 12.5 - - - -
Stock price (6) : Close 36.92 30.17 - - - -
High 40.00 35.67 - - - -
Low 26.58 24.00 - - - -
Cash dividends declared $ 0.13 $ 0.10 $ - $ - $ - $ -
PMI Operating and Statutory Data
Number of policies in force 700,084 657,800 612,806 543,924 428,745 347,232
Default rate 2.19% 1.98% 1.88% 1.81% 2.03% 2.38%
Persistency 83.3% 86.4% 83.6% 70.0% 74.6% 85.2%
Direct primary insurance in force $ 77,312 $ 71,43 $ 65,982 $ 56,991 $ 43,698 $ 31,982
(in millions)
Direct primary risk in force (in $ 17,336 $ 15,130 $ 13,243 $ 11,267 $ 8,676 $ 6,481
millions)
Statutory capital $ 988,475 $ 824,156 $ 659,402 $ 494,621 $ 456,931 $ 372,568
Risk-to-capital ratio 15.9:1 15.8:1 17.7:1 20.8:1 19.0:1 18.8:1
New insurance written $17,882,702 $14,459,260 $18,441,612 $25,469,907 $19,463,000 $8,663,000
Policies issued 142,900 119,631 156,055 207,356 161,893 75,095
New insurance written market share 14.1% 13.2% 14.0% 18.6% 19.4% 15.9%
Return on equity 17.8% 18.1% 17.3% 11.0% 24.6% 15.2%
Tax rate 28.9% 25.1% 23.4% 21.5% -11.5% 57.1%
Total employees 586 578 586 632 529 410
- ----------
(1) In 1991, the Company significantly revised its estimate for losses and loss
adjustment expense, reducing total losses by $42.1 million and the loss
ratio by 35 percentage points, and increasing income from continuing
operations by $27.8 million.
(2) During 1991, the Company increased its tax liabilities and income tax
expense by $40.9 million in light of an unfavorable judgment by the U.S.
Tax Court. In 1992, the 1991 judgment was overturned, and the company
re-evaluated its tax balances and reduced its tax liabilities and income
tax expense by $30.9 million.
(3) Excluded a pre-tax litigation settlement charge of $5.7 million and an
after tax extraordinary loss of $4.8 million in 2001.
(4) Per Share Data and shares outstanding adjusted to reflect 3-for-2 stock
split
(5) Based on the closing price as of December 31, and on trailing twelve-month
operating earnings.
(6) Closing price as of December 31. High and low price for trailing
twelve-month period.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT
Written and oral statements made or incorporated by reference from
time to time by us or our representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, or are preceded by, followed by or
that include the words "believes," "expects," "anticipates," "estimates," or
similar expressions, and that relate to future plans, events or performance are
"forward-looking" statements within the meaning of the federal securities laws.
Forward-looking statements in this Item 7 include:
. our anticipation that negotiated bulk transactions in 2002 will
continue to be a significant portion of the total insurance
originated in the private mortgage insurance market;
. our belief that PMI's persistency rate will increase in the second
half of 2002 as a result of anticipated rising interest rates;
. our belief that the percentage of PMI's risk in force related to
risk-sharing programs will continue to increase as a percentage of
total risk in force in 2002;
. our anticipation that contract underwriting services will continue
to account for a significant portion of PMI's acquisition costs;
. our belief that the use of electronic origination and delivery of
our products will continue to increase in 2002; and
. our belief that we have sufficient cash to meet all of our short-
and medium-term obligations and that we maintain adequate liquidity
to support our operations.
When a forward-looking statement includes an underlying assumption, we caution
that, while we believe the assumption to be reasonable and make it in good
faith, assumed facts almost always vary from actual results, and the difference
between assumed facts and actual results can be material. Where, in any
forward-looking statement, we express an expectation or belief as to future
results, there can be no assurance that the expectation or belief will result.
Our actual results may differ materially from those expressed in any
forward-looking statements made by us. Forward-looking statements involve a
number of risks of uncertainties including, but not limited to, the risks
described under the heading "Investment Considerations." All forward-looking
statements are qualified by and should be read in conjunction with those risk
factors. Except as may be required by applicable law, we undertake no obligation
to publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise.
RESULTS OF OPERATIONS
Summary
The following chart presents highlights of our consolidated financial results
for 2001, 2000 and 1999.
Percentage change
-----------------
2001 2000
vs. vs.
(In millions except per share data and percentages) 2001 2000 1999 2000 1999
- ----------------------------------------------------------------------------------------------------
Net income $ 307 $ 260 $ 204 18% 27%
Per share data:*
Net income $6.78 $5.78 $4.52 17% 28%
Operating income $6.88 $5.85 $4.51 18% 30%
Revenues $ 937 $ 763 $ 670 23% 14%
* Earnings per share calculations are based on diluted shares outstanding.
The increases in our consolidated net income and net income per share for the
year ended December 31, 2001 were due to increases in premiums earned, net
investment income and other income, partially offset by increases in other
underwriting and operating expenses, losses and loss adjustment expenses and
amortization of deferred policy acquisition costs. The increases in our
consolidated net income and net income per share in 2000 were due to increases
in premiums earned and net investment income, partially offset by increases in
other underwriting and operating expenses. Our net income for 2001 included an
after tax extraordinary loss of $4.8 million as a result of our early
extinguishment of certain debt. Our net income for 2000 included a pre-tax
litigation settlement charge of $5.7 million.
Operating income represents net income excluding realized investment gains and
losses, and non-recurring expenses. Diluted operating income per share in 2001
excluded realized investment gains of less than $0.01 per share and
extraordinary losses of $0.10 per share, while 2000 diluted operating income per
share excluded realized investment gains of $0.01 per share and a litigation
charge of $0.08 per share. We believe operating income and operating income per
share are meaningful measurements of our underlying profit and they are used
to measure our management's performance for annual bonus purposes. Consolidated
revenues growth in 2001 and 2000 were due primarily to significant increases in
the amount of primary new insurance written, the growth in our insurance
portfolio, and increases in net investment income. New insurance written is the
total principal amount of mortgages newly insured by us. 2001 revenues also
included investment income generated from the proceeds of the $360.0 million
Senior Convertible Debentures offered in July 2001.
U.S. Mortgage Insurance Operations
Our primary operating subsidiary, PMI Mortgage Insurance Co., or PMI, provides
private mortgage insurance in the United States to residential mortgage lenders
and investors. Private mortgage insurance insures lenders and investors against
potential losses in the event of borrower default. Private mortgage insurance is
also purchased by lenders and investors seeking additional protection against
default risk, capital relief, or credit enhancement for secondary market
mortgage transactions. Although PMI's revenues have increased in each of the
last three years, PMI generated 69% of our consolidated revenues in 2001,
compared to 79% in 2000 and 90% in 1999. The change in proportion is the result
of the implementation of corporate diversification strategies.
Primary insurance and new insurance written - PMI issues primary insurance
coverage on individual loans at specified coverage percentages and PMI is in the
first loss position when a borrower defaults on
an insured mortgage. PMI's new insurance written does not include pool insurance
written (see Pool Insurance below), primary mortgage insurance placed
upon loans more than twelve months after loan origination, or loans where the
insurance coverage exceeds 50%. The following table shows the total new
insurance written by PMI; combined new insurance written by PMI and CMG; total
new insurance written for the private mortgage insurance industry as reported by
the industry's trade association, Mortgage Insurance Companies of America, or
MICA; and the total residential mortgage originations as reported by Mortgage
Bankers Association of America, or MBA:
Percentage change
-----------------
2001 2000
vs. vs.
2001 2000 1999 2000 1999
- ----------------------------------------------------------------------------------------------------------
PMI new insurance written (in millions) $ 48,089 $ 27,295 $ 28,733 76% (5)%
PMI and CMG new insurance written (in millions) $ 52,050 $ 29,519 $ 31,146 76% (5)%
MICA total new insurance written (in millions) * $283,233 $163,147 $188,868 N/A N/A
Residential mortgage originations (in billions) $ 2,100 $ 1,073 $ 1,284 96% (16)%
* As of August 2001, MICA modified the definitions used to compile their
monthly statistical reports to better reflect industry activity. As a
result, MICA total new insurance written for 2001 is not necessarily
comparable to prior years.
We believe that PMI's increase in new insurance written in 2001 was due to
higher levels of residential mortgage origination activity and the growth in the
private mortgage insurance market. A decrease in new insurance written in 2000
was due to lower residential mortgage origination volume and a decline in the
private mortgage insurance market. The private mortgage insurance industry's
market share is the total new insurance written by private mortgage insurance
companies, as reported by MICA, as a percentage of total insured loans including
insurance offered by private mortgage insurers, the Federal Housing Authority
and the Veterans Administration.
The total residential mortgage originations in 2001 reached a record level and
nearly double the volume in 2000, as estimated by the MBA. The increase in total
mortgage originations in 2001 was primarily driven by heavy refinancing activity
as a result of declining mortgage interest rates in 2001. The decrease in total
mortgage originations in 2000 was attributed to lower refinancing activity due
to rising interest rates during the first half of 2000. Residential mortgage
originations in connection with refinancing transactions represented
approximately 56% of total mortgage originations during 2001 compared with
approximately 19% during 2000 and approximately 36% during 1999, according to
the MBA. PMI's new insurance written from refinancing activity as a percentage
of total insurance written increased to 34% in 2001, compared to 10% in 2000 and
22% in 1999.
PMI engages in negotiated bulk transactions, primarily in the secondary mortgage
market, through a bidding process to obtain new business. Insurance issued in
negotiated bulk transactions includes primary insurance, pool insurance, or a
combination of both. We anticipate that in 2002 bulk transactions will continue
to be a significant portion of the total insurance originated in the private
mortgage insurance market. Bulk transactions often include non-traditional
loans, which refer to Alternative A, Alternative A- and less than A quality
loans. PMI also insures non-traditional loans outside of its bulk transaction
activities. Non-traditional loans accounted for 19% of PMI's new insurance
written in 2001 compared to 20% in 2000 and 7% in 1999. At December 31, 2001,
non-traditional loans composed 15% of PMI's insurance in force compared to 9% at
year-end 2000 and 7% at year-end 1999. Loan characteristics, credit quality,
loss development, pricing structures and persistency related to non-traditional
loans can vary significantly from PMI's traditional primary business. We expect
higher delinquencies and default rates for non-traditional loans and incorporate
these assumptions into our pricing. However, mortgage insurance on
non-traditional loans may not generate the same returns as the traditional
primary business, and the premiums earned may not adequately offset the
associated risk.
In August 2001, MICA, on behalf of the private mortgage insurance industry,
revised and standardized several categories of insurance that are reported by
mortgage insurers to MICA. These categories include new insurance written,
traditional primary insurance, bulk primary insurance and pool insurance. PMI
implemented the definitional change effective for the third quarter of 2001 and
the new insurance written reported for the second half of 2001 was based upon
these newly defined categories. As a result, for the year ended December 31,
2001, PMI reported approximately $1.8 billion of additional primary new
insurance written that previously would have been included in pool insurance. We
believe that this new definitional change does not materially impact PMI's
previously reported new insurance written.
Primary insurance and risk in force - PMI's primary insurance in force refers to
the principal balance of all mortgage loans with primary insurance as of a given
date. PMI's primary risk in force is the dollar amount equal to the sum of each
individual insured mortgage loan's current principal balance multiplied by the
percentage specified in the policy of the insurance coverage. Primary insurance
in force and risk in force for PMI, and on a combined basis with CMG, are
presented in the table below:
Percentage change
-----------------
2001 2000
As of December 31, vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- -----------------------------------------------------------------------------------------------
Primary insurance in force, PMI $109,158 $ 96,914 $86,729 13% 12%
Primary insurance in force, PMI and CMG $118,111 $103,987 $92,524 14% 12%
Primary risk in force, PMI $ 25,772 $ 23,559 $21,159 9% 11%
Primary risk in force, PMI and CMG $ 27,902 $ 25,306 $22,581 10% 12%
PMI's growth in primary insurance in force and risk in force in 2001 and 2000
were largely due to increases in new insurance written, partially offset by
policy cancellations. In recent years, cancellation levels were significantly
impacted by the refinance market and the movements in interest rates. Policy
cancellations in 2001 increased 110% to $35.8 billion due to heavy refinance
activity in 2001. Cancellations decreased to $17.1 billion in 2000 from $22.2
billion in 1999 due to lower refinance levels in 2000. Consequently, PMI's
persistency rate was 63.0% at December 31, 2001, 80.3% at year-end 2000 and
71.9% at year-end 1999. PMI's persistency rate refers to the percentage of
insurance policies at the beginning of a period that remains in force at the end
of the twelve-month period. We presently believe that our persistency rate will
increase in the second half of 2002 as a result of anticipated rising interest
rates.
Pool insurance - PMI offers pool insurance coverage in response to lender or
investor requests. Pool insurance is typically issued in negotiated
transactions, as part of the restructuring of primary mortgage insurance or to
provide an additional layer of coverage. Pool insurance may be attractive to
lenders and investors seeking capital relief or the reduction of default risk
beyond the protection provided by existing primary mortgage insurance.
PMI offers traditional pool insurance that covers all losses on any individual
loan held within a group of insured loans up to an agreed aggregated amount for
the entire pool. PMI's traditional pool products include GSE Pool, which
represents mortgage loans held by, or sold to, Fannie Mae and Freddie Mac, or
the GSEs. PMI wrote $19.5 million of GSE Pool risk in 2001 compared to $106.0
million in 2000 and $230.9 million in 1999. GSE Pool risk in force at December
31, 2001 was $801.5 million, $785.6 million at year-end 2000 and $681.4 million
at year-end 1999. Another of PMI's traditional pool products is Old Pool, which
is the capital markets pool product that PMI offered and insured prior to 1994.
We believe that this portfolio has past its peak claim period. Old Pool risk in
force was $1.11 billion as of December 31, 2001, $1.39 billion as of December
31, 2000 and $1.41 billion as of December 31, 1999. PMI also
provides various other traditional pool insurance to state housing authorities,
lenders and investors. The risk written for those pool products was immaterial
in 2001. PMI is not actively offering traditional pool insurance.
PMI offers modified pool insurance products, primarily to the GSEs, which have
exposure limits on each individual loan in addition to having a stated aggregate
loss limit for the pool. Modified pool insurance may be used as an alternative
to primary insurance, used to cover loans that do not require primary mortgage
insurance, or used as an additional credit enhancement for secondary market
mortgage transactions. Modified pool insurance written may be included in PMI's
new insurance written or pool risk written, depending upon a number of factors
including whether primary mortgage insurance coverage was previously placed on
the mortgage loans and the percentages of coverage offered by the modified pool
policy. The additional $1.8 billion of primary new insurance written, or $66
million primary risk written, noted above was in the form of modified pool
coverage. In 2001, PMI wrote $414.7 million of modified pool risk, compared to
$85.7 million in 2000. Modified pool risk in force was $554.1 million at
December 31, 2001.
Premiums written and earned - PMI's net premiums written refers to the amount of
premiums received during a given period, net of refunds and premiums ceded under
reinsurance arrangements, including captive reinsurance arrangements. Captive
reinsurance is a reinsurance product in which PMI shares portions of its risk
written on loans originated by certain lenders with captive reinsurance
companies affiliated with such lenders. In return, a proportionate amount of
PMI's gross premiums written is ceded to the captive reinsurance companies. The
components of PMI's net premiums written and premiums earned for the last three
years are as follows:
Percentage change
-----------------
2001 2000
vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- --------------------------------------------------------------------------------
Gross premiums written $623 $545 $500 14% 9%
Ceded premiums 61 36 25 69% 44%
Refunded premiums 18 11 16 64% (31)%
---- ---- ----
Net premiums written $544 $498 $459 9% 8%
==== ==== ====
Premiums earned $553 $504 $447 10% 13%
In 2001 and 2000, increases in net premiums written were due largely to the
growth of PMI's primary insurance in force and pool risk in force as discussed
above. The increase in ceded premiums in 2001 and 2000 were the result of
increases in captive reinsurance agreements and, with respect to 2001, the heavy
volume of refinance activity. During 2001, 43% of new insurance written and 8%
of total premiums were subject to captive agreements; 34% of new insurance
written and 6% of total premiums were subject to captive agreements during 2000;
and approximately 25% of new insurance written and 5% of total premiums were
subject to captive agreements during 1999. We anticipate that higher levels of
captive reinsurance cessions will continue to reduce our net premiums written
and earned due to the increasing percentage of new insurance written associated
with captive reinsurance agreements. Primary risk in force under all reinsurance
arrangements, including captive agreements, with PMI's customers represented 38%
of primary risk in force at December 31, 2001 compared to 33% at December 31,
2000 and 28% at December 31, 1999. We anticipate that the percentage of PMI's
risk in force related to reinsurance arrangements will continue to increase as a
percentage of total risk in force due to the increasing captive reinsurance
agreements.
The increase in refunded premiums in 2001 and decrease in refunded premiums in
2000 were driven by the levels of policy cancellations, as discussed above. The
amount of premiums recognized as revenue
for accounting purposes, or premiums earned, increased in 2001 and 2000. These
increases were primarily attributable to increases in premiums written related
to the growth of our insurance portfolio.
Losses and loss adjustments expenses - PMI's losses and loss adjustment expenses
reflects amounts paid on insurance claims and increases or decreases in loss
reserves during the corresponding period. We establish loss reserves based upon
estimated claim rates and average claim sizes for the default inventory and
defaults incurred but not reported. PMI's losses and loss adjustment expenses
and related claims data are shown in the following table:
Percentage change
-----------------
2001 2000
vs. vs.
2001 2000 1999 2000 1999
- --------------------------------------------------------------------------------------------------------
Losses and loss adjustment expenses (in millions) $ 103 $ 95 $ 111 8% (14)%
Primary claims paid (in millions) $ 77 $ 67 $ 80 15% (16)%
Number of primary claims paid 3,695 3,518 3,945 5% (11)%
Average primary claim size (in thousands) $ 21 $ 19 $ 20 11% (5)%
Primary loans in default 25,907 18,093 15,893 43% 14%
The increases in losses and loss adjustment expenses and total primary claims
paid in 2001 were due, in part, to the economic downturn in 2001 and the
maturation of our 1996 through 1999 books of business, which we believe are in
their peak delinquency years. The 1996 through 1999 books of business accounted
for approximately 36% of our total primary loans in force at December 31, 2001.
In 2001, the average size of primary claims paid increased as a result of the
economic slowdown offset, in part, by relatively stable home prices in many
regions of the United States and PMI's continued loss mitigation efforts. PMI's
loss mitigation efforts, which focus on selecting the optimal claim settlement
on a case-by-case basis, could be limited in the future by any deterioration in
housing prices or by the weakening economy. The declines in losses and loss
adjustment expenses and primary claims paid in 2000 were primarily due to the
favorable housing market and strong home prices nationwide during that period.
The increases in PMI's primary loans in default in 2000 and 2001 were primarily
due to the maturation of the 1996 through 1999 books of business and the
addition of non-traditional loans to PMI's insurance portfolio in 2000 and 2001.
Non-traditional loans are often insured through negotiated bulk transactions,
and are generally riskier than loans in PMI's traditional primary insurance
portfolio. As of December 31, 2001, 58% of our primary loans in force generated
from bulk transactions were non-traditional loans, compared to 53% in 2000 and
3% in 1999. PMI's delinquency rate, the percentage of insured loans in force
that are in default at a given time, for bulk loans was 5.55% at December 31,
2001. PMI's primary insurance loan delinquency rate, excluding bulk loans, was
2.54% at December 31, 2001. PMI's primary insurance loan delinquency rate,
including bulk loans, was 2.86% at December 31, 2001 compared to 2.21% at
December 31, 2000 and 2.12% at December 31, 1999.
Total operating expenses - Total operating expenses reported in the current
period can be divided into two categories: (i) amortization of deferred policy
acquisition costs, which relate to incurred costs for acquiring, underwriting
and processing new business, are recorded as assets and amortized principally
over a two-year period; and (ii) other underwriting and operating expenses and
corporate overhead, which are all other costs that are not accounted for as
acquisition costs and are recorded as expenses when incurred. The composition of
PMI's total operating expenses for the last three years is shown below:
Percentage change
-----------------
2001 2000
vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- -------------------------------------------------------------------------------------------------
Amortization of deferred policy acquisition costs $ 76 $ 77 $ 80 (1)% (4)%
Other underwriting and operating expenses 61 55 54 11% 1%
---- ---- ----
Total operating expenses $137 $132 $134 4% (1)%
==== ==== ====
Policy acquisition costs incurred and deferred $ 78 $ 75 $ 86 4% (13)%
The amortization of deferred policy acquisition costs is determined by the
proportion of the policy acquisition costs deferred in the current year and the
remaining balance of deferred acquisition costs from the prior year. The
amortization for deferred policy acquisition costs is accelerated in the first
year due to different depreciation methods used for the two-year period. Other
non-acquisition related operating costs increased in 2001 and 2000 primarily due
to increases in payroll and related expenses.
Policy acquisition costs - PMI's policy acquisition costs are deferred and
include all underwriting, contract underwriting, field operations and sales
related expenses. These costs are amortized to expenses based on the estimated
gross profits. An increase in policy acquisition costs incurred and deferred in
2001 was due to the growth in new insurance written, partially offset by the use
of PMI's electronic origination and delivery methods. A decrease in policy
acquisition costs incurred and deferred in 2000 was due to lower new insurance
written coupled with the use of electronic origination and delivery methods.
During 2001, electronic delivery accounted for 52% of PMI's insurance
commitments, excluding bulk transactions, compared to 23% in 2000 and 15% in
1999. We believe that the use of electronic origination and delivery of our
products will increase in 2002.
A large part of PMI's policy acquisition costs relates to the business processed
and underwritten through our contract underwriting services. PMI provides
contract underwriting services to our customers for both mortgage loans which
PMI insures and for loans which PMI does not insure. New policies processed by
contract underwriters represented 26% of new insurance written during 2001
compared to 23% during 2000 and 36% during 1999. We anticipate that costs
incurred by contract underwriting will continue to account in 2002 for a
significant portion of PMI's acquisition costs as our customers continue to
outsource mortgage loan underwriting activities.
Ratios - PMI's loss, expense and combined ratios for the last three years are
shown in the following table:
Variance
-------------------
2001 2000
vs. vs.
2001 2000 1999 2000 1999
- --------------------------------------------------------------------------------
Loss ratio 18.6% 18.9% 24.7% (0.3)% (5.8)%
Expense ratio 25.2 25.3 29.2 (0.1)% (3.9)%
----- ----- -----
Combined ratio 43.8% 44.2% 53.9% (0.4)% (9.7)%
===== ===== =====
The loss ratio is the ratio of losses and loss adjustment expenses to premiums
earned. The expense ratio is the ratio of amortization of acquisition costs and
other underwriting and operating expenses, excluding interest expense, to the
net amount of premiums written during a given period. The combined ratio is the
sum of the loss ratio and the expense ratio.
International Mortgage Insurance Operations
International Mortgage Insurance operations include the results of PMI Mortgage
Insurance Ltd, or PMI Ltd, and PMI Indemnity Limited, collectively referred to
as PMI Australia; as well as PMI Mortgage Insurance Company Limited, or PMI
Europe. The financial results of international operations are subject to
currency rate adjustments in translation to U.S. dollar reporting.
The reported results of PMI Ltd were affected by the devaluation in the
Australian dollar from 1999 to 2001. The average AUD/USD exchange rate was 0.520
in 2001, 0.585 in 2000, and 0.645 from September through December 1999. We
acquired PMI Indemnity Limited in September 2001, and its results were included
in the 2001 fourth quarter results of our Australian operations. The results of
our Australian operations for 2000 reflect eleven months of activity of PMI Ltd
due to the one-month lag reporting period, whereas 2001 results reflect thirteen
months of activity as we began to report our foreign subsidiaries on the same
calendar month as U.S. operations. Because we commenced operations in Australia
in August 1999 through the acquisition of PMI Ltd, the 1999 results represent
operations from the date of acquisition. Accordingly, the results of our
Australian operations for 2001 are not comparable to the prior years.
The table below summarizes the reported results of our Australian operations
from August 1999 through the end of 2001:
(In millions) 2001 2000 1999
- --------------------------------------------------------------------------------
Net income $ 32 $ 16 $ 7
Net premiums written $ 56 $ 37 $ 12
Premiums earned $ 44 $ 27 $ 11
Net investment income $ 23 $ 12 $ 5
Losses and loss adjustment expenses $ 9 $ 6 $ 1
Underwriting and other expenses $ 11 $ 7 $ 3
New insurance written $11,293 $ 6,841 $ 2,149
Insurance in force $43,340 $20,057 $20,370
Risk in force $38,129 $19,080 $19,419
PMI Europe commenced operations in February 2001 and generated $5.5 million of
net income in 2001, including currency translation gains of $4.6 million and
investment income. Financial results for the operations in Hong Kong were
immaterial during 2001, 2000 and 1999.
Title Insurance Operations
The following table sets forth the results of our title insurance subsidiary,
American Pioneer Title Insurance Company, or APTIC:
Percentage change/variance
--------------------------
2001 2000
vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- ----------------------------------------------------------------------------------------------------
Net income $ 9 $ 6 $ 8 50% (25)%
Premiums earned $ 158 $ 104 $ 100 52% 4%
Underwriting and other expenses $ 142 $ 94 $ 88 51% 7%
Combined ratios 93.8% 92.7% 89.1% 1.1% 3.6%
The increase in 2001 premiums earned was due to an increase in total residential
mortgage originations and continued geographic expansion of our title insurance
operations. The increase in premiums earned
in 2000 compared to 1999 was due to the geographic expansion, offset by a
decline in residential mortgage originations. In 2001, 51% of APTIC's premiums
earned was generated in Florida compared to 64% in 2000 and 73% in 1999. APTIC
wrote title insurance policies in 39 states in 2001 compared to 35 states in
2000 and 33 states in 1999. The increases in underwriting and other expenses in
2001 and 2000 were primarily due to increases in agency fees and commissions
related to higher premiums earned and to the costs associated with expansion
efforts.
Other
Other income, which was generated by PMI Mortgage Services Co., or MSC, and our
holding company, or TPG, was $27.8 million in 2001, $8.2 million in 2000 and
$15.9 million in 1999. The increase in 2001 was primarily attributed to
increased contract underwriting activity in connection with higher mortgage
origination volume, and to an increase in the billing rates for contract
underwriting services. The decrease in 2000 was due to a decline in contract
underwriting activity in 2000 and to interest on an IRS tax refund received in
1999. Other expenses, which were incurred by TPG and MSC, increased to $59.5
million in 2001 compared to $33.9 million in 2000 and $24.8 million in 1999.
These increases were due to the increased expenses related to international
expansion and diversification efforts for both 2001 and 2000, and to the
increased expenses associated with higher contract underwriting activity in
2001.
Corporate
Investment income - Our consolidated net investment income, excluding realized
investment gains and losses, was $150.0 million in 2001, a 26% increase from
2000. This increase was due primarily to the cash flows our insurance operations
contributed to the investment portfolio growth, and to the investment income on
the proceeds from the $360.0 million Convertible Debentures offering in July
2001. Our consolidated net investment income, excluding realized investment
gains and losses, was $119.2 million in 2000, a 25% increase from 1999, largely
due to the growth in our investment portfolio. The pre-tax current book yield
was 5.9% in 2001, 5.9% in 2000 and 6.0% in 1999.
Net realized investment gains & losses - Net realized investment gains of $0.01
million for 2001 included a realized loss of $0.8 million resulted from
termination of an interest rate swap associated with the repayment of a bank
loan obtained to finance the PMI Ltd acquisition. Net realized investment gains
were $0.4 million in 2000 and $0.5 million in 1999.
Interest expense - We incurred $14.1 million of interest expense in 2001
compared to $10.2 million in 2000, due to the interest expense and accrual on
higher average debt outstanding during 2001 including the $360.0 million
Convertible Debentures that bear an interest rate of 2.5% per annum.
Approximately $130 million of the net proceeds from the Convertible Debentures
offering were used to repay and extinguish portions of our higher interest rate
debt. The interest expense for 2000 increased by $1.7 million over 1999, due to
a full year of interest incurred on the bank loan.
Taxes - Our effective tax rate was 30.1% in 2001 compared to 30.4% in 2000 and
29.5% in 1999. Our effective tax rate fluctuates from year to year primarily due
to the proportion of tax-exempt earnings relative to total pre-tax income.
Additionally, variations in the effective tax rate are due to changes in
statutory tax rates of countries in which foreign subsidiaries generate taxable
profits, and to fluctuations in the taxable earnings of those foreign
subsidiaries relative to total taxable earnings as a whole.
LIQUIDITY AND CAPITAL RESOURCES
TPG's principal sources of funds are dividends from two of its subsidiaries, PMI
and APTIC, investment income, and funds that may be raised from time to time in
the capital markets. PMI generates substantial cash flow from premiums written
on its insurance business and from investment returns on its investment
portfolio.
PMI's ability to pay dividends to TPG is affected by state insurance laws,
credit agreements, credit rating agencies and the discretion of insurance
regulatory authorities. The laws of Arizona, the state of PMI's domicile for
insurance regulatory purposes, provide that PMI may pay out of any available
surplus account without prior approval of the Director of the Arizona Department
of Insurance dividends during any twelve-month period an amount not to exceed
the lesser of 10% of policyholders' surplus as of the preceding year end or the
last calendar year's investment income. In addition to Arizona, other states may
limit or restrict PMI's ability to pay shareholder dividends. For example,
California, New York and Illinois prohibit mortgage insurers from declaring
dividends except from undivided profits remaining on hand over and above the
aggregate of their paid-in capital, paid-in surplus and contingency reserves.
Under Arizona law, based on the amount of its policyholders' surplus, PMI would
be able to pay dividends of approximately $16.0 million in 2002 without prior
approval of the Director of the Arizona Department of Insurance. In 2001, PMI
paid an extraordinary dividend of $50.0 million to TPG, which was approved by
the Arizona Department of Insurance.
The laws of Florida limit the payment of dividends by APTIC to TPG in any one
year to 10% of available and accumulated surplus derived from realized net
operating profits and net realized capital gains. As with PMI, the various
credit rating agencies and insurance regulatory authorities have broad
discretion to affect the payment of dividends to TPG by APTIC. Under Florida
law, APTIC would be able to pay dividends of $3.0 million in 2002 without prior
permission from the Florida Department of Insurance. APTIC declared and paid a
cash dividend of $2.5 million to TPG in 2001.
TPG's principal uses of funds are the payments of dividends to shareholders,
common stock repurchases, investments and acquisitions, and interest payments.
Our board of directors authorized a stock repurchase program in the amount of
$100.0 million in 1998. No common stock was repurchased during 2001, and $45.3
million remained available under the 1998 authorization as of December 31, 2001.
TPG had $335.5 million of available funds at December 31, 2001, an increase from
the December 31, 2000 balance of $108.3 million, due primarily to the $360.0
million Convertible Debentures offering in July 2001.
We believe that we have sufficient cash to meet all of our short- and
medium-term obligations, and that we maintain adequate liquidity to support our
operations. Our investment portfolio holds primarily investment grade securities
comprised of readily marketable fixed income and equity securities. As of
December 31, 2001, the fair value of our consolidated investment portfolio,
excluding investments in affiliates, increased to $2.4 billion from $1.9 billion
at year-end 2000.
We manage our capital resources based on our cash flow, total capital and rating
agency requirements. In July 2001, we issued $360.0 million of 2.50% Senior
Convertible Debentures in a private offering. We used the proceeds for working
capital and other general corporate purposes, as well as to repay and extinguish
portions of our long-term debt. Approximately $130 million of the net proceeds
were used to repay an outstanding bank loan in the amount of $35.7 million with
Bank of America, to repurchase $37.1 million of the $100.0 million 6.75% Senior
Notes, resulting in an extraordinary loss of $2.9 million, net of tax, and to
retire $51.5 million of the $100.0 million 8.309% Capital Securities, resulting
in an extraordinary loss of $1.9 million, net of tax.
We have a bank credit line in the amount of $25.0 million with Bank of America.
The agreement has recently been extended to December 30, 2002. There are no
outstanding borrowings under the credit line. This financial instrument contains
certain financial covenants and restrictions, including risk-to-capital ratios,
and minimum capital and dividend restrictions.
As of December 31, 2001, our total shareholders' equity was $1.8 billion. Our
long-term debt and other capital securities outstanding at December 31, 2001 was
$471.5 million, which was comprised of the following:
. $360.0 million 2.50% Senior Convertible Debentures due July 15, 2021. We
may not redeem the Debentures prior to July 15, 2006;
. $63.0 million 6.75% Notes due November 15, 2006; and
. $48.5 million 8.309% Capital Securities mature on February 1, 2027. The
Capital Securities are redeemable after February 1, 2007.
As of December 31, 2001, a schedule of our contractual obligations and
commercial commitments is as follows:
Payments Due by Period
----------------------------------------------------------
Less than After five
(In millions) Total one year 1 - 3 years 4 - 5 years years
- --------------------------------------------------------------------------------
Long-term Debt $423 -- -- $63 $360
Capital Securities $ 49 -- -- -- $ 49
Operating Leases $ 34 $12 $18 $ 3 $ 1
The 2.50% Senior Convertible Debentures included in our long-term debt are
redeemable at our option beginning in 2006. The holders of the Debentures may
require us to repurchase the Debentures on July 15, 2004, 2006, 2008, 2011 or
2016, and in certain other circumstances, at a price equal to the principal
amount thereof plus any accrued and unpaid interest, including contingent
interest and additional interest, if any, to the date of purchase. We may chose
to pay the purchase price in cash, common stock, or a combination of cash and
shares of common stock. If we elect to pay all or a portion of the purchase
price in common stock, the shares of common stock will be valued at 97.5% of the
average sale price for the twenty trading days ending on the third day prior to
the repurchase date. Holders of the Debentures may convert their Debentures
prior to stated maturity under certain circumstances. For additional information
about the terms of the Debentures, including the circumstances under which
contingent interest will be payable, see the Company's Current Report on Form
8-K, filed with the SEC on July 18, 2001, including the exhibits attached
thereto.
Included in the operating leases is the lease agreement for our current
corporate offices in San Francisco. We are scheduled to move to a new
headquarters location in Walnut Creek, California, in 2002, which we currently
intend to acquire on an unencumbered basis. Charges associated with the lease
abandonment and relocation costs will be reflected in our results in 2002.
Our consolidated reserves for losses and loss adjustment expenses with respect
to claim losses increased from December 31, 2000 by $19.5 million to $314.6
million at December 31, 2001, due primarily to an increase in the reserve
balances for the primary insurance books of business as a result of higher
levels of defaults.
PMI's claims-paying ability ratings from certain national rating agencies have
been based in part on the third party reinsurance arrangements and on various
capital support commitments from Allstate Insurance Company, or Allstate, PMI's
former parent company. Under the terms of a runoff support agreement
with Allstate, in the event (i) PMI's risk-to-capital ratio exceeds 23 to 1,
(ii) PMI's statutory policyholder surplus is less than $15.0 million, or (iii) a
third party beneficiary brings a claim under the runoff support agreement, then
Allstate may, at its option, in satisfaction of certain obligations it may have
under such agreement (a) pay to PMI (or to TPG for contribution to PMI) an
amount equal to claims relating to policies written prior to termination of the
Allstate support arrangements which are not paid by PMI or (b) pay such claims
directly to the policyholder. In the event Allstate makes any payment
contemplated by the runoff support agreement (which possibility we believe is
remote and, in the event unexpected losses or unforeseen events cause the
risk-to-capital ratio to increase, there are several courses of action available
to us to maintain PMI's risk-to-capital ratio below 23 to 1), Allstate will be
entitled to receive, at its option, subordinated debt or preferred stock of PMI
or TPG, as applicable, in return.
In 1997, PMI entered into a capital support commitment to Duff & Phelps Credit
Rating Co. ("Fitch"), under which it agreed to contribute to APTIC amounts
necessary to maintain APTIC's capital and surplus at a level no less than 100%
of Fitch's risk adjusted capital requirements to attain a Fitch claims paying
ability rating of not less than "AA-" at the end of each year. PMI also entered
into a cancellation agreement with APTIC that provides that, in the event PMI
provides notice of its intent to cancel the capital support commitment, APTIC
will immediately submit a request to Fitch to be rated on a stand-alone basis
and sign an agreement canceling APTIC's rights under the capital support
commitment.
In 2001, PMI executed a capital support agreement, superseding a prior capital
support agreement, whereby it agreed to contribute funds, under specified
conditions, to maintain CMG's risk-to-capital at or below 18.0 to 1. PMI's
obligation under the agreement is limited to an aggregate amount of $37.7
million, exclusive of capital contributions made prior to April 10, 2001. On
December 31, 2001, CMG's risk-to capital ratio was 14.8 to 1.
PMI has entered into various capital support agreements with its European and
Australian subsidiaries for ratings agency purposes that could require PMI to
make additional capital contributions to those subsidiaries. In a capital
support agreement with its Australian subsidiary, PMI Ltd, PMI agreed to
maintain PMI Ltd's net assets, as defined by Australian insurance law, at a
prudent level of capital but, in any event, not less than 2% of PMI Ltd's net
aggregate risk, as that term is defined by the agreement, plus AUD$50,000,000.
For rating agency purposes, PMI has agreed that the support required by the
phrase, a "prudent level of capital," is all amounts necessary to maintain PMI
Ltd's stand-alone financial strength rating at not less than "A." In addition,
PMI agreed to provide funds to PMI Ltd to ensure that PMI Ltd is able to meet
its obligations under its insurance policies. The agreement continues
indefinitely but may be terminated by mutual agreement of PMI and PMI Ltd at any
time, subject to not adversely affecting the interests of PMI Ltd policyholders.
In a capital support agreement with its Australian subsidiary, PMI Indemnity,
PMI agreed to maintain PMI Indemnity's net assets at a prudent level of capital
but, in any event, not less than 2% of PMI Indemnity's net aggregate risk. For
rating agency purposes, PMI has agreed that the support required by the phrase,
a "prudent level of capital," is all amounts necessary to maintain PMI
Indemnity's stand-alone financial strength rating at not less than "A-." PMI
also agreed to provide funds to PMI Indemnity to ensure that it is able to meet
its obligations under its insurance policies. The agreement with PMI Indemnity
continues indefinitely but may be terminated upon terms similar to those
contained in the PMI Ltd capital support agreement.
Under the terms of PMI's capital support agreement with PMI Europe, PMI agreed
to provide funds, as necessary, to ensure that PMI Europe is able to meet its
obligations in respect of all contracts of reinsurance when such obligations are
due and to maintain PMI Europe's minimum capital at an amount sufficient to
maintain its S&P and Moody's ratings at "AA-" and "Aa3." The agreement may be
terminated or amended by written agreement of PMI and PMI Europe, but no
amendment that shall
adversely affect insureds shall be effective as to insurance contracts entered
into prior to such amendment. TPG guarantees the obligations of PMI under its
capital support agreements with PMI Ltd, PMI Indemnity and PMI Europe.
On February 20, 2002, the Office of Federal Housing Enterprise Oversight
finalized a risk-based capital rule that treats credit enhancements issued by
private mortgage insurance companies with claims-paying ability ratings of "AAA"
more favorably than those issued by mortgage insurance companies with "AA"
ratings. The rule also provides capital guidelines for the GSEs in connection
with their use of other types of credit protection counter parties in addition
to mortgage insurers. We are currently rated "AA+" by Standard & Poor's, but do
not have a "AAA" rating and may need to obtain such a rating as a result of the
rule. To obtain a claims-paying ability rating of "AAA" we may need to dedicate
significant capital to the mortgage insurance business that we might use in
other ways, and we would also have additional costs that we would not otherwise
incur. Two of our direct competitors have "AAA" claims-paying ratings, with the
remainder being rated "AA." While we are currently considering various options
to address the rule, we cannot be sure either that we will be able to implement
any of these options in a timely manner, or if these options implemented, will
be effective to address the capital differential contained in the rule. If we
are unable to address the capital differential contained in the rule in a timely
manner, or at all, our business could be seriously harmed. It is not clear at
this point whether the final ruling will result in the GSEs increasing their use
of either AAA-rated mortgage insurers instead of AA-rated entities or credit
counterparties other than mortgage insurers.
PMI's ratio of net risk in force to statutory capital, or statutory
risk-to-capital ratio, at December 31, 2001 was 13.0 to 1 compared to 14.1 to 1
at December 31, 2000.
The holding company's consolidated ratio of earnings to fixed charges for the
year ended December 31, 2001, was 18.1. For purposes of the ratio of earnings to
fixed charges, "earnings" represent income from continuing operations before
income taxes plus fixed charges. "Fixed charges" represent interest expense plus
that portion of rent expense that, in our opinion, approximates the interest
factor included in rent expense plus distributions on Preferred Capital
Securities. As of the date of this report, we have no preferred stock
outstanding.
CRITICAL ACCOUNTING POLICIES
The "Management's Discussion and Analysis of Financial Condition and Results of
Operation," as well as disclosures included elsewhere in this Annual Report on
Form 10-K, are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosure of contingencies.
Actual results may differ significantly from these estimates under different
assumptions or conditions. We believe that the following critical accounting
policies involved the more significant judgments and estimates used in the
preparation of our financial statements.
Revenue Recognition - We generate a significant portion of our revenues from
mortgage insurance premiums paid by lenders and investors, on either a monthly,
annual or single payment basis. Monthly premiums are earned as coverage is
provided. Annual premiums are earned on a monthly pro rated basis over the year
of coverage. Single premiums are initially deferred as unearned premiums and
earned over the expected policy terms. The earning cycle for single premium
products is based on a range of seven- to eight-year cycle, which reflects the
timing and the severity of default or claims event for a policy year, and rates
used to determine the earnings are estimates based on the expiration of
corresponding risk. Earning pattern calculation is an estimation process and,
accordingly, we review our premium earning cycle regularly and any adjustments
to the estimates are reflected in the current period's operating results.
Reserves For Losses and Loss Adjustment Expenses - In establishing losses and
loss adjustment expenses ("LAE") reserves, we review information that is company
specific and industry related, as well as general economic conditions. Losses
and LAE reserves are determined by the estimates of ultimate claim rates and
average claim sizes for notices of default received and the estimated number of
defaults not reported prior to the close of an accounting period. These
estimates are based on assumptions primarily derived from analysis of historical
default and recovery experience. Significant assumptions used in the estimation
process, including expected claim rates, average claim sizes, claim severity,
and expected costs to settle claims, could have significant effects on the
reserve balances. We regularly evaluate the life cycle of claims based on our
historical experience and other available market data. We do not rely on a
single estimate to determine our loss reserves. To ensure the reasonableness of
the best estimates, we developed scenarios using generally recognized actuarial
projection methodologies that result in a range of possible losses and LAE
reserves. Each scenario in the loss reserve model is assigned different
weightings to actual claims experience in prior years to project the current
liability. Our best estimate was at slightly above the midpoint of this range
for 2001, which represented the most reasonable estimate based on our analysis
and assessment of current economic conditions. We monitor the reasonableness of
the judgments made in our prior year estimation process and adjust our current
year assumptions as appropriate. However, the loss reserving process is complex
and subjective and, therefore, the ultimate liability may vary significantly
from our estimates.
Deferred Policy Acquisition Costs - Our policy acquisition costs are related to
the issuance of primary mortgage insurance policies, including acquiring,
underwriting and processing new business, as well as sales related expenses. We
defer policy acquisition costs when incurred and amortize these costs over a
two-year period, which is based on estimated gross profits in order to match
costs and revenues. We review our estimation process on a regular basis and any
adjustments made to the estimates are reflected in the current period's
operating results.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The fair value of certain investments in our investment portfolio are interest
rate sensitive and are subject to change based on potential interest rate
movements. The result of a 100 basis points increase in interest rates would be
a 5.6% decrease in the value of our investment portfolio, while the result of a
100 basis points decrease in interest rates would be a 4.7% increase in the
value of our investment portfolio. As of December 31, 2001, the effective
duration of our investment portfolio was 5.9 years.
At December 31, 2001, $288.6 million of our invested assets were held by PMI
Australia and were denominated in Australian dollars, which has experienced
devaluation during 2001 compared to 2000 and 1999. At December 31 2001, $77.9
million of our invested assets were held by PMI Europe of which $61.3 million
were denominated in Euros, which has experienced appreciation in values during
2001.
INVESTMENT CONSIDERATIONS
General economic factors may adversely affect our loss experience and the demand
for mortgage insurance.
Losses result from events, such as unemployment, that reduce a borrower's
ability to continue to make mortgage payments. The amount of the loss, if any,
depends in part on whether the home of a borrower who defaults on a mortgage can
be sold for an amount that will cover unpaid principal and interest and the
expenses of the sale. Favorable economic conditions generally reduce the
likelihood that borrowers will lack sufficient income to pay their mortgages and
also favorably affect the value of homes, reducing and in some cases even
eliminating a loss from a mortgage default. We believe that our loss experience
could materially increase as a result of:
. national or regional economic recessions;
. declining values of homes;
. higher unemployment rates;
. deteriorating borrower credit;
. interest rate volatility;
. shortages of electric power in California or other states; or
. combinations of these factors
These factors could also materially reduce the demand for housing and,
consequently, the demand for mortgage insurance.
The United States has been experiencing an economic downturn. If this economic
downturn continues or worsens, our loss experience could suffer and demand for
mortgage insurance could decline.
If interest rates decline, home values increase or mortgage insurance
cancellation requirements change, the length of time that our policies remain in
force and our revenues could decline.
A significant percentage of the premiums we earn each year is generated from
insurance policies that we have written in previous years. As a result, the
length of time insurance remains in force is an important determinant of our
revenues. The policy owner or servicer of the loan may cancel insurance coverage
at any time. In addition, the Homeowners Protection Act of 1998 provides for the
automatic termination or cancellation of mortgage insurance upon a borrower's
request if specified conditions are satisfied. Factors that tend to reduce the
length of time our insurance remains in force include:
. current mortgage interest rates falling below the rates on the
mortgages underlying our insurance in force, which frequently
results in borrowers refinancing their mortgages and canceling their
existing mortgage insurance;
. the rate of appreciation in home values experienced by the homes
underlying the mortgages of the insurance in force, which can result
in the cancellation of mortgage insurance; and
. changes in the mortgage insurance cancellation policies of mortgage
lenders and investors.
Although we have a history of expanding our business during periods of low
interest rates, the resulting increase of new insurance written may not be
adequate to compensate us for our loss of insurance in force arising from policy
cancellations.
If the volume of low down payment home mortgage originations declines, the
amount of insurance that we write could also decline, which could result in a
decline in our future revenue.
The factors that affect the volume of low down payment mortgage originations
include:
. the level of home mortgage interest rates;
. the health of the domestic economy as well as conditions in regional
and local economies;
. consumer confidence, which may be adversely affected by economic
instability, war or terrorist events such as the attacks on the
World Trade Center and the Pentagon;
. housing affordability;
. population trends, including the rate of household formation;
. the rate of home price appreciation, which in times of heavy
refinancing affects whether refinance loans have loan-to-value
ratios that require private mortgage insurance; and
. government housing policy encouraging loans to first-time
homebuyers.
A decline in the volume of low down payment housing could reduce the demand for
private mortgage insurance and, therefore, our revenues.
We cannot cancel mortgage insurance policies or adjust renewal premiums to
protect from unanticipated claims, which could harm our financial performance.
We cannot cancel the mortgage insurance coverage that we provide. In addition,
we generally establish renewal premium rates for the life of the mortgage
insurance policy when the policy is issued. As a result, the impact of
unanticipated claims generally cannot be offset by premium increases on policies
in force or limited by nonrenewal of insurance coverage. The premiums we charge
may not be adequate to compensate us for the risks and costs associated with the
insurance coverage we provide to our customers.
The risk-based capital rule issued by the Office of Federal Housing Enterprise
Oversight could require us to obtain a claims-paying ability rating of "AAA" and
could cause our business to suffer.
On February 20, 2002, the Office of Federal Housing Enterprise Oversight
finalized a risk-based capital rule that treats credit enhancements issued by
private mortgage insurance companies with claims-paying ability ratings of "AAA"
more favorably than those issued by mortgage insurance companies with "AA"
ratings. The rule also provides capital guidelines for the GSEs in connection
with their use of other types of credit protection counterparties in addition to
mortgage insurers. We have a "AA+" rating and may need to obtain a "AAA" rating
as a result of the rule. To obtain a claims-paying ability rating of "AAA" we
may need to dedicate significant capital to the mortgage insurance business that
we might use in other ways and we would also have additional costs that we would
not otherwise incur. Two of our direct competitors have "AAA" claims paying
ratings, with the balance being rated "AA." While we are currently considering
options to address the rule, we cannot be sure that we will be able to implement
any of the options that we have under consideration to address the risk-based
capital rule in a timely manner, or at all, or that these options, if
implemented, will be effective to address the capital differential contained in
the rule. If we are unable to address the capital differential contained in the
rule in a timely manner, or at all, our business could be seriously harmed. It
is not clear at this point whether the finalized rule will result in the GSEs
increasing their use of either AAA-rated mortgage insurers instead of AA-rated
entities or credit counterparties other than mortgage insurers. Changes in the
preferences of Fannie Mae and Freddie Mac, or the GSEs, for private mortgage
insurance to other forms of credit enhancement,
or a tiering of mortgage insurers based on their credit rating, as a result of
the OFHEO rule could harm our financial condition and results of operations.
Because we compete with private mortgage insurers, governmental agencies and
others in an industry that is highly competitive, our revenues and profits could
decline substantially as we respond to competition or if we lose market share.
The principal sources of our direct and indirect competition include:
. other private mortgage insurers, some of which are subsidiaries of
well capitalized, diversified public companies with direct or
indirect capital reserves that provide them with potentially greater
resources than we have;
. federal and state governmental and quasi-governmental agencies,
principally the Federal Housing Administration, or FHA, and to a
lesser degree the Veterans Administration, or VA;
. mortgage lenders that choose not to insure against borrower default,
self-insure through affiliates, or offer residential mortgage
products that do not require mortgage insurance; and
. captive reinsurance subsidiaries of national banks, savings
institutions and bank holding companies and other mortgage lenders.
We cannot be sure that we will be able to compete successfully with our direct
or indirect competitors. If we are unable to compete successfully, our business
will suffer.
If mortgage lenders and investors select alternatives to private mortgage
insurance, the amount of insurance that we write could decline significantly,
which could reduce our revenues and profits.
Alternatives to private mortgage insurance include:
. government mortgage insurance programs, including those of the FHA
and the VA;
. member institutions providing credit enhancement on loans sold to a
Federal Home Loan Bank;
. investors holding mortgages in their portfolios and self-insuring;
. mortgage lenders maintaining lender recourse or participation with
respect to loans sold to the GSEs;
. investors using credit enhancements other than private mortgage
insurance or using other credit enhancements in conjunction with
reduced levels of private mortgage insurance coverage; and
. mortgage lenders structuring mortgage originations to avoid private
mortgage insurance, such as a first mortgage with an 80%
loan-to-value ratio and a second mortgage with a 10% loan-to-value
ratio, which is referred to as an 80-10-10 loan, rather than a first
mortgage with a 90% loan-to-value ratio. The loan-to-value ratio is
the ratio of the original loan amount to the value of the property.
These alternatives, or new alternatives to private mortgage insurance that may
develop, could reduce the demand for private mortgage insurance and cause our
revenues and profitability to decline.
The OFHEO risk-based capital rule may allow large financial entities such as
banks, financial guarantors, insurance companies, and brokerage firms to provide
or arrange for products that may efficiently substitute for some of the capital
relief provided to the GSEs by private mortgage insurance. Many of
these entities have significantly more capital than we have and a few have "AAA"
ratings. The ability of these companies to offer or arrange for the products
described above will be dependent upon, among other things, how the OFHEO
risk-based capital rule is interpreted and administered and the willingness of
the GSEs to utilize such forms of credit enhancement. Our financial condition
and results of operations could be harmed if the GSEs were to use these products
in lieu of mortgage insurance.
Legislation and regulatory changes may reduce demand for private mortgage
insurance, which could harm our business.
Increases in the maximum loan amount or other features of the FHA mortgage
insurance program can reduce the demand for private mortgage insurance.
Legislative and regulatory changes have caused, and may cause in the future,
demand for private mortgage insurance to decrease and this could harm our
financial condition and results of operations.
As a result of the enactment of The Gramm-Leach-Bliley Act, we expect to
experience increased competition from mortgage insurance companies owned by
large, well capitalized financial services companies, which could significantly
harm our business.
The Gramm-Leach-Bliley Act allows bank holding companies to engage in a
substantially broader range of activities, including insurance underwriting,
than those companies could previously engage in and allows insurers and other
financial service companies to acquire banks. Bank holding companies are now
permitted to form insurance subsidiaries that issue insurance products,
including mortgage insurance, directly to consumers. We expect that, over time,
consumers will have the ability to shop for their insurance, banking and
investment needs at one financial services company. We believe that this new law
may lead to increased competition in the mortgage insurance industry by
facilitating the development of new savings and investment products, resulting
in mortgage lenders offering mortgage insurance directly to home borrowers
rather than through captive reinsurance arrangements with us and encouraging
large, well-capitalized financial service companies to enter the mortgage
insurance business.
We depend on a small number of customers and our business and financial
performance could suffer if we were to lose the business of a major mortgage
lender.
We are dependent on a small number of customers. Our top ten customers were
responsible for 38% of our new insurance written as of December 31, 2001. The
concentration of business with our customers may increase as a result of mergers
or other factors. These customers may reduce the amount of business currently
given to us or cease doing business with us altogether. Our master policies and
related lender agreements do not, and by law cannot, require our lenders to do
business with us. The loss of business from any major customer could seriously
harm our business and results of operations.
We acquire a significant percentage of our new business through negotiated bulk
transactions with a limited number of parties. Negotiated transactions are
transactions in which we insure a large group of loans or commit to insure new
loans on agreed-upon terms. Our business could be harmed if these investors
substitute other types of credit enhancement for private mortgage insurance.
We could lose premium revenue if Fannie Mae or Freddie Mac continue to reduce
the level of private mortgage insurance coverage required for low down payment
mortgages.
Fannie Mae and Freddie Mac are the beneficiaries on a substantial majority of
the insurance policies we issue as a result of their purchases of home loans
from lenders or investors. Fannie Mae and Freddie Mac offer programs that
require less mortgage insurance coverage on mortgages approved by their
automated underwriting systems. Fannie Mae and Freddie Mac might further reduce
coverage requirements. If the
reduction in required levels of mortgage insurance becomes widely accepted by
mortgage lenders, our premium revenue would decline and our financial condition
and results of operations could suffer.
New products introduced by Fannie Mae or Freddie Mac, if widely accepted, could
harm our profitability.
Fannie Mae and Freddie Mac have separately introduced new products for which
they will, upon receipt from lenders of loans with primary mortgage insurance,
restructure the mortgage insurance coverage by reducing the amount of primary
insurance coverage and adding a second layer of insurance coverage, usually in
the form of pool insurance. Pool insurance is a type of mortgage insurance that
covers all or a percentage of a loss on individual mortgage loans held within a
group or pool of loans up to an agreed aggregate limit for the pool. Under these
programs, Fannie Mae and Freddie Mac may provide services to the mortgage
insurer and the mortgage insurer may be required to pay fees to Fannie Mae or
Freddie Mac for the reduced insurance coverage or the services provided. These
new products may prove to be less profitable than PMI's traditional mortgage
insurance business. If these products prove to be less profitable than PMI's
traditional mortgage insurance business, and become widely accepted, our
financial condition and operating results could seriously suffer.
Efforts by Fannie Mae and Freddie Mac to reduce the need for private mortgage
insurance could reduce our revenues.
Freddie Mac has made several announcements that it would pursue a permanent
charter amendment that would allow it to utilize alternative forms of default
loss protection or otherwise forego the use of private mortgage insurance on
higher loan-to-value mortgages. Such a result could severely harm our financial
condition and results of operation. In October 2000, Fannie Mae announced its
intention to increase its share of revenue associated with the management of
mortgage credit risk and interest rate risk during the next three years by
retaining mortgage credit risk previously borne by a number of other parties,
including mortgage insurers. Part of any attempt by Fannie Mae to increase its
share of revenue associated with mortgage credit risk could include a reduction
in the use or level of mortgage insurance, which could reduce our revenue.
Lobbying activities by large mortgage lenders calling for expanded federal
oversight and legislation relating to the role of Fannie Mae and Freddie Mac in
the secondary mortgage market could damage our relationships with those mortgage
lenders, Fannie Mae and Freddie Mac.
Together with Fannie Mae, Freddie Mac and mortgage lenders, we jointly develop
and make available various products and programs. These arrangements involve the
purchase of our mortgage insurance products and frequently feature cooperative
arrangements between the three parties. In 1999, a coalition of financial
services and housing related trade associations, including the Mortgage
Insurance Companies of America and several large mortgage lenders, formed FM
Watch, a lobbying organization that supports expanded federal oversight and
legislation relating to the role of Fannie Mae and Freddie Mac in the secondary
mortgage market. Fannie Mae and Freddie Mac have criticized, and lobbied
against, FM Watch. These lobbying activities could, among other things, polarize
Fannie Mae, Freddie Mac and members of FM Watch as well as our customers and us.
As a result of this polarization, our relationships with Fannie Mae and Freddie
Mac may limit our opportunities to do business with some mortgage lenders,
particularly the large mortgage lenders that have formed FM Watch. Conversely,
our relationships with these large mortgage lenders may limit our ability to do
business with Fannie Mae and Freddie Mac. Either of these outcomes could
seriously harm our financial condition and results of operations.
If we are unable to introduce and successfully market new products and programs,
our competitive position could suffer.
From time to time we introduce new mortgage insurance products or programs. Our
competitive position and financial performance could suffer if we experience
delays in introducing competitive new products and programs or if these products
or programs are less profitable than our existing products and programs.
Our settlement in the Baynham litigation contains a three year injunction,
terminating on December 31, 2003. The injunction relates, in part, to the terms
upon which we offer certain products and services, including contract
underwriting, reinsurance agreements with reinsurance affiliates of lenders and
mortgage insurance restructuring transactions. Some, but not all, of our
competitors in the mortgage insurance industry have agreed to abide by the terms
of the injunction. Our compliance with the injunction could inhibit our ability
to compete with respect to the offering of new products and structures and this
could have a material adverse effect upon our financial condition and results of
operations.
Mortgage lenders increasingly require us to reinsure a portion of the mortgage
insurance default risk on mortgages that they originate with their captive
mortgage reinsurance companies, which will reduce our net premiums written.
Our customers have indicated an increasing demand for captive mortgage
reinsurance arrangements. Under these arrangements, a reinsurance company, which
is usually an affiliate of the mortgage lender, assumes a portion of the
mortgage insurance default risk on mortgage loans originated by the lender in
exchange for a portion of the insurance premiums. An increasing percentage of
our new insurance written is being generated by customers with captive
reinsurance companies, and we expect that this trend will continue. An increase
in captive mortgage reinsurance arrangements will decrease our net premiums
written, which may negatively impact the yield that we obtain on net premiums
earned for customers with captive mortgage reinsurance arrangements. If we do
not provide our customers with acceptable risk-sharing structured transactions,
including potentially increasing levels of premium cessions in captive mortgage
reinsurance arrangements, our competitive position may suffer.
Our primary risk in force consists of mortgage loans with high loan-to-value
ratios, which generally result in more claims than mortgage loans with lower
loan-to-value ratios.
At December 31, 2001:
. 43% of our primary risk in force consisted of mortgages with
loan-to-value ratios greater than 90% but less than or equal to 95%,
which we refer to as 95s. Risk in force is the dollar amount equal
to the product of each individual insured mortgage loan's current
principal balance and the percentage specified in the insurance
policy of the claim amount that would be payable if a claim were
made. In our experience, 95s have claims frequency rates
approximately one and a half times that of mortgages with
loan-to-value ratios greater than 85% but less than or equal to 90%,
which we refer to as 90s.
. 6% of our primary risk in force consisted of mortgages with
loan-to-value ratios greater than 95% but less than or equal to 97%,
which we refer to as 97s. In our experience 97s have higher claims
frequency rates than 95s. We also insure mortgages with
loan-to-value ratios greater than 97%, which we believe have claims
frequency rates higher than 97s.
. 9% of our primary risk in force consisted of adjustable rate
mortgages, which we refer to as ARMs. In our experience ARMs,
although priced higher, have claims frequency rates that exceed the
rates associated with our book of business as a whole.
The premiums we charge for mortgage insurance on non-traditional loans, and the
associated investment income, may not be adequate to compensate us for future
losses from these products.
Our new insurance written includes Alternative A and Alternative A- loans and
less than A loans, which we refer to as non-traditional loans. Non-traditional
loans represented approximately 19% of our primary new insurance written in
2001. Loan characteristics, credit quality, loss development, pricing structures
and persistency, which is the percentage of insurance policies at the beginning
of a period that remain in force at the end of the period, on non-traditional
loans can be significantly different than our traditional prime business. In
addition, non-traditional loans generally do not meet the standard underwriting
guidelines of Fannie Mae and Freddie Mac. We expect higher default rates, which
is the percentage of insured loans in force that are in default, for
non-traditional loans. We cannot be sure that this book of business will
generate the same returns as our standard business or that the premiums that we
charge on non-traditional loans will adequately offset the associated risk.
Paying a significant number of claims under the pool insurance we write could
harm our financial performance.
We offer pool insurance that is generally used as an additional credit
enhancement for secondary market mortgage transactions. Pool insurance provides
coverage for conforming and non-conforming loans, and is generally considered
riskier than primary insurance. The premiums that we charge for pool insurance
may not adequately compensate us if we experience higher delinquency and default
rates than we anticipate at the time we set the premiums for the policies. If we
are required to pay a significant number of claims under our pool insurance,
then our financial condition and results of operations could be seriously
harmed.
The concentration of primary insurance in force in relatively few states could
increase claims and losses and harm our financial performance.
In addition to being affected by nationwide economic conditions, we could be
particularly affected by economic downturns in specific regions of the United
States where a large portion of our business is concentrated. As of December 31,
2001:
. 13% of our primary risk in force was on mortgages for homes located
in California, where the percentage of insured loans in force that
were in default, or default rate, on our policies was 2.6% on that
date;
. 9% of our primary risk in force was on mortgages for homes located
in Florida, where the default rate on our policies was 3.03% on that
date; and
. 7% of our primary risk in force was on mortgages for homes located
in Texas, where the default rate on our policies was 2.86% on that
date.
This compares with a nationwide default rate on our policies of 2.86% as of
December 31, 2001. Continued and prolonged adverse economic conditions in any of
these states could result in high levels of claims and losses. In addition,
refinancing of mortgage loans can have the effect of concentrating our insurance
in force in economically weaker areas, because mortgages in areas experiencing
appreciation of home values are less likely to require mortgage insurance at the
time of refinancing than are mortgages in areas experiencing limited or no
appreciation of home values.
We delegate underwriting authority to mortgage lenders that may cause us to
insure unacceptably risky mortgage loans, which could increase claims and
losses.
The majority of our new insurance written is underwritten pursuant to a
delegated underwriting program. Once a mortgage lender is accepted into our
delegated underwriting program, that mortgage lender may determine whether
mortgage loans meet our program guidelines and may commit us to issue mortgage
insurance. We expect to continue offering delegated underwriting to approve
lenders and may expand the availability of delegated underwriting to additional
customers. If an approved lender commits us to insure a mortgage loan, we may
not refuse to insure, or rescind coverage on, that loan even if we reevaluate
that loan's risk profile or the lender failed to follow our delegated
underwriting guidelines, except in very limited circumstances. In addition, our
ability to take action against an approved lender that fails to follow our
program guidelines and requirements is limited by access to data that would be
needed to assess the lender's compliance with those guidelines and requirements.
Therefore, an approved lender could cause us to insure a material amount of
mortgage loans with unacceptable risk profiles prior to our termination of the
lender's delegated underwriting authority.
In addition, mortgage insurers, such as PMI, issue mortgage insurance on
mortgage loans determined by the GSEs to be eligible for purchase by the GSEs.
As a result, the GSEs' underwriting standards which determine what loans are
eligible for purchase affect the quality of the risk insured by mortgage
insurers and the availability of mortgage loans. Any broadening by the GSEs of
their underwriting standards could cause us to insure riskier mortgage loans,
which could increase our claims and losses.
We expect our loss experience to increase as our policies continue to age.
The majority of claims under private mortgage insurance policies have
historically occurred during the third through the sixth years after issuance of
the policies. As of December 31, 2001, approximately 82% of our risk in force
was written after December 31, 1997. This means that less than half of our risk
in force has reached the beginning of the expected peak claims period. As a
result, our loss experience is expected to increase significantly as our
policies continue to age. If the claim frequency, which is the percentage of
loans insured that have resulted in a paid claim, on our risk in force
significantly exceeds the claim frequency that was assumed in setting our
premium rates, our financial condition and results of operations and cash flows
would be seriously harmed.
Our loss reserves may be insufficient to cover claims paid and loss-related
expenses incurred.
We establish loss reserves to recognize the liability for unpaid losses related
to insurance in force on mortgages that are in default. These loss reserves are
based upon our estimates of the claim rate and average claim amounts, as well as
the estimated costs, including legal and other fees, of settling claims. These
estimates are regularly reviewed and updated using currently available
information. Any adjustments, which may be material, resulting from these
reviews are reflected in our then current consolidated results of operations.
Our reserves may not be adequate to cover ultimate loss development on incurred
defaults. Our financial condition and results of operations could be seriously
harmed if our reserve estimates are insufficient to cover the actual related
claims paid and loss-related expenses incurred.
If we fail to properly underwrite mortgage loans under our contract underwriting
services, we may be required to assume the cost of repurchasing those loans.
We provide contract underwriting services for a fee. These services help enable
our customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting to us. As a part of
our contract underwriting services, we provide monetary and other remedies to
our customers in the event that we fail to properly underwrite a mortgage loan.
Such remedies may include:
. the purchase of additional or "deeper" mortgage insurance;
. assumption of some or all of the costs of repurchasing insured and
uninsured loans from the GSEs and other investors; or
. issuance of indemnifications to customers in the event that the
loans default for varying reasons including, but not limited to,
underwriting errors.
Generally, the scope of these remedies is in addition to those contained in
PMI's master primary insurance policies. Worsening economic conditions or other
factors that could lead to increases in PMI's default rate could also cause the
number and severity of the remedies that must be offered by MSC to increase.
Such an increase could have a material effect on our financial condition. There
are limitations on the number of available underwriting personnel and heavy
price competition among mortgage insurance companies. Our inability to recruit
and maintain a sufficient number of qualified underwriters or any significant
increase in the cost we incur to satisfy our underwriting services obligations
could harm our financial condition and results of operations.
If our claims-paying ability is downgraded, then mortgage lenders and the
mortgage securitization market may not purchase mortgages or mortgage-backed
securities insured by us, which could materially harm our financial performance.
The claims-paying ability of PMI Mortgage Insurance Co., our largest wholly
owned subsidiary, which we refer to as "PMI", is currently rated "AA+"
(excellent) by Standard and Poor's, "Aa2" (excellent) by Moody's and "AA+" (very
strong) by Fitch. These ratings may be revised or withdrawn at any time by one
or more of the rating agencies. These ratings are based on factors relevant to
PMI's policyholders and are not applicable to our common stock or outstanding
debt. The rating agencies could lower or withdraw our ratings at any time as a
result of a number of factors, including:
. underwriting or investment losses;
. the necessity to make capital contributions to our subsidiaries
pursuant to capital support agreements;
. other adverse developments in PMI's financial condition or results
of operations; or
. changes in the views of rating agencies.
If PMI's claims-paying ability rating falls below "AA-" from Standard and Poor's
or "Aa3" from Moody's, then investors, including Fannie Mae and Freddie Mac,
will not purchase mortgages insured by us, which would seriously harm our
financial condition and results of operations.
Our ongoing ability to pay dividends to our stockholders and meet our
obligations primarily depends upon the receipt of dividends and returns of
capital from our insurance subsidiaries and our investment income.
Our principal sources of funds are dividends from our subsidiaries, investment
income and funds that may be raised from time to time in the capital markets.
Factors that may affect our ability to maintain and meet our capital and
liquidity needs include:
. the level and severity of claims experienced by our insurance
subsidiaries;
. the performance of the financial markets;
. standards and factors used by various credit rating agencies;
. financial covenants in our credit agreements; and
. standards imposed by state insurance regulators relating to the
payment of dividends by insurance companies.
Any significant change in these factors could prevent us from being able to
maintain the capital resources required to meet our business needs.
An increase in PMI's risk-to-capital ratio could prevent it from writing new
insurance, which would seriously harm our financial performance.
The State of Arizona, PMI's state of domicile for insurance regulatory purposes,
and other states limit the amount of insurance risk that may be written by PMI,
based on a variety of financial factors, primarily the ratio of net risk in
force to statutory capital, or the risk-to-capital ratio.
Other factors affecting PMI's risk-to-capital ratio include:
. limitations under the runoff support agreement with Allstate
Insurance Company, or Allstate, our former parent company, which
prohibit PMI from paying any dividends if, after the payment of the
dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1;
. our credit agreement; and
. capital requirements necessary to maintain our credit rating and
PMI's claims-paying ability ratings.
Generally, the methodology used by the rating agencies to assign credit or
claims-paying ability ratings permits less capital leverage than under statutory
or other requirements. Accordingly, we may be required to meet capital
requirements that are higher than statutory or other capital requirements to
satisfy rating agency requirements.
PMI has several alternatives available to help control its risk-to-capital
ratio, including:
. obtaining capital contributions from The PMI Group;
. obtaining third party credit enhancements; and
. reducing the amount of new business written.
We may not be able to raise additional funds, or to do so on a timely basis, in
order to make a capital contribution to PMI. In addition, third party credit
enhancements may not be available to PMI or, if available, may not be available
on satisfactory terms. A material reduction in PMI's statutory capital, whether
resulting from underwriting or investment losses or otherwise, or a
disproportionate increase in risk in force, could increase its risk-to-capital
ratio. An increase in PMI's risk-to-capital ratio could limit its ability to
write new business, impair PMI's ability to pay dividends to The PMI Group and
seriously harm our financial condition and results of operations.
Our international insurance subsidiaries subject us to numerous risks associated
with international operations.
We have subsidiaries in Australia and Europe and may commit significant
resources to expand our international operations. Accordingly, we are subject to
a number of risks associated with international business activities. These risks
include:
. the need for regulatory and third party approvals;
. challenges attracting and retaining key foreign-based employees,
customers and business partners in international markets;
. economic downturns in the foreign mortgage origination markets
targeted, particularly the economies of Australia and Europe;
. interest rate volatility in a variety of countries;
. unexpected changes in foreign regulations and laws;
. burdens of complying with a wide variety of foreign laws;
. potentially adverse tax consequences;
. restrictions on the repatriation of earnings;
. foreign currency exchange rate fluctuations;
. potential increases in the level of defaults and claims on policies
insured by foreign-based subsidiaries;
. the need to integrate our domestic insurance subsidiaries' risk
management technology systems and products with those of our foreign
operations;
. the need to successfully develop and market products appropriate to
the foreign market, including the development and marketing of
credit enhancement products to European lenders and mortgage
securitizations;
. risks related to global economic turbulence; and
. political instability.
In September 2001, we completed our acquisition of the Australian mortgage
insurance company, CGU Lenders Mortgage Insurance Limited (renamed PMI Indemnity
Limited). We are integrating PMI Indemnity Limited's operations into our
existing Australian subsidiary and the success of our acquisition of PMI
Indemnity Limited will be dependent upon the success of this integration, among
other factors.
The performance of our strategic investments could harm our financial results.
At December 31, 2001, we had investments in affiliates of $204.9 million. The
performance of our strategic investments in affiliates could be harmed by:
. changes in the real estate, mortgage lending, mortgage servicing,
title and financial guaranty markets;
. future movements in interest rates;
. those operations' future financial condition and performance;
. the ability of those entities to execute future business plans; and
. our dependence upon management to operate those companies in which
we do not own a controlling share.
In addition, our ability to engage in additional strategic investments is
subject to the availability of capital and maintenance of our claims-paying
ability ratings by rating agencies.
Our inability to keep pace with the technological demands of our customers or
with the technology-related products and services offered by our competitors
could significantly harm our business and financial performance.
Participants in the mortgage lending and mortgage insurance industries
increasingly rely on e-commerce and other technology to provide and expand their
products and services. An increasing number of our customers require that we
provide our products and services electronically via the Internet or electronic
data transmission, and the percentage of our new insurance written delivered
electronically is increasing. We expect this trend to continue and, accordingly,
believe that it is essential that we continue to invest substantial resources on
maintaining electronic connectivity with our customers and, more generally, on
e-commerce and technology. Our business will suffer if we do not satisfy all
technological demands of our customers and keep pace with the technological
capabilities of our competitors.
If we are not reimbursed by our insurance carriers for costs incurred by us in
connection with our settlement of the Baynham litigation, we will be required to
take an additional charge against earnings.
To account for our settlement of the Baynham litigation, we took an after-tax
charge against fourth quarter 2000 earnings of $3.7 million, and incurred an
additional $1.0 million charge, net of tax, in the third quarter of 2001.
These charges represent our estimate of the cost of settlement less our estimate
of insurance payments we will receive from our insurance carriers as
reimbursement for costs incurred by us in connection with our defense and
settlement of the action. We have participated in non-binding mediation with our
insurance carriers with respect to the amount of the payments to be reimbursed
to us without achieving settlement and now must commence litigation to obtain
reimbursement from our carriers. If we do not realize our estimated amount of
insurance proceeds, we will be required to take an additional charge against
earnings and this could harm our results of operations.
Consolidated Statements of Operations
The PMI Group Inc. and Subsidiaries
Years Ended December 31,
(Dollars in thousands except per share data) 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------
Revenues Premiums earned $ 754,771 $634,362 $558,623
Investment income 149,987 119,199 95,142
Net realized investment gains 11 432 509
Other 32,194 8,579 15,850
--------- -------- --------
Total revenues 936,963 762,572 670,124
--------- -------- --------
Losses and Losses and loss adjustment expenses 118,048 103,079 112,682
Expenses Amortization of deferred policy acquisition costs 81,782 77,337 80,252
Other underwriting and operating expenses 268,415 189,771 170,239
Interest expense 14,148 10,210 8,554
Distributions on preferred capital securities 7,604 8,309 8,311
--------- -------- --------
Total losses and expenses 489,997 388,706 380,038
--------- -------- --------
Income before income taxes and extraordinary item 446,966 373,866 290,086
Income taxes 134,949 113,654 85,620
--------- -------- --------
Income before extraordinary item 312,017 260,212 204,466
Extraordinary loss on early extinguishment of debt,
net of income tax benefit of $2,588 4,805 -- --
--------- -------- --------
Net income $ 307,212 $260,212 $204,466
========= ======== ========
Per Share Data Basic:
Income before extraordinary item $ 7.02 $ 5.88 $ 4.55
Extraordinary loss, net of income tax benefit (0.11) -- --
--------- -------- --------
Basic net income $ 6.91 $ 5.88 $ 4.55
========= ======== ========
Diluted:
Income before extraordinary item $ 6.88 $ 5.78 $ 4.52
Extraordinary loss, net of income tax benefit (0.10) -- --
--------- -------- --------
Diluted net income $ 6.78 $ 5.78 $ 4.52
========= ======== ========
See accompanying notes to consolidated financial statements.
Consolidated Balance Sheets
The PMI Group, Inc. and Subsidiaries
As of December 31,
(Dollars in thousands except per share data) 2001 2000
- -----------------------------------------------------------------------------------------------------------------
Assets Investments:
Available for sale, at fair value:
Fixed income securities
(amortized cost: $2,010,114; $1,536,291) $ 2,078,875 $ 1,613,330
Equity securities:
Common (cost: $53,015; $53,315) 69,264 81,726
Preferred (cost: $89,192; $108,743) 92,266 111,743
Common stock of affiliates, at underlying book value 204,886 131,849
Short-term investments, at fair value 137,469 139,577
----------- -----------
Total investments 2,582,760 2,078,225
Cash 21,735 21,969
Accrued investment income 35,480 23,494
Premiums receivable 57,510 41,362
Reinsurance receivable and prepaid premiums 47,079 42,117
Reinsurance recoverable 6,068 9,211
Deferred policy acquisition costs 77,903 67,009
Property and equipment, net 68,188 53,475
Other assets 93,229 55,795
----------- -----------
Total assets $ 2,989,952 $ 2,392,657
=========== ===========
Liabilities Reserves for losses and loss adjustment expenses $ 314,590 $ 295,089
Unearned premiums 208,580 170,866
Long-term debt 422,950 136,819
Reinsurance payable 31,201 26,581
Deferred income taxes 63,852 74,981
Other liabilities and accrued expenses 113,591 89,110
----------- -----------
Total liabilities 1,154,764 793,446
----------- -----------
Commitments and contingencies:
Company-obligated mandatorily redeemable preferred capital
securities of subsidiary trust holding solely junior
subordinated deferrable interest debenture of the Company 48,500 100,000
Shareholders' Preferred stock - $0.01 par value; 5,000,000 shares authorized,
Equity and none issued or outstanding -- --
Common stock - $0.01 par value; 125,000,000 shares authorized,
and 52,793,777 shares issued 528 528
Additional paid-in capital 267,762 267,762
Accumulated other comprehensive income 40,791 62,501
Retained earnings 1,811,839 1,511,751
Treasury stock, at cost (8,212,475 and 8,436,761 shares) (334,232) (343,331)
----------- -----------
Total shareholders' equity 1,786,688 1,499,211
----------- -----------
Total liabilities and shareholders' equity $ 2,989,952 $ 2,392,657
=========== ===========
See accompanying notes to consolidated financial statements.
Consolidated Statements of Shareholders' Equity
The PMI Group, Inc. and Subsidiaries
Years Ended December 31,
(Dollars in thousands) 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
Common Balance, beginning of year $ 528 $ 528 $ 352
Stock 3 for 2 stock split in the form of a stock dividend -- -- 176
----------- ----------- -----------
Balance, end of year 528 528 528
----------- ----------- -----------
Additional Balance, beginning of year 267,762 265,828 265,040
Paid-in 3 for 2 stock split in the form of a stock dividend -- -- (176)
Capital Stock grants and exercise of stock options -- 1,934 964
----------- ----------- -----------
Balance, end of year 267,762 267,762 265,828
----------- ----------- -----------
Accumulated Balance, beginning of year 62,501 20,186 74,462
Other Change in unrealized gains (losses) on investments,
Comprehensive net of tax (benefit) of ($6,830), $28,176, and
Income ($28,629) (11,331) 50,294 (54,276)
Change in currency translation (10,379) (7,979) --
----------- ----------- -----------
Other comprehensive income (loss), net of tax (21,710) 42,315 (54,276)
----------- ----------- -----------
Balance, end of year 40,791 62,501 20,186
----------- ----------- -----------
Retained Balance, beginning of year 1,511,751 1,258,617 1,060,724
Earnings Net income 307,212 260,212 204,466
Dividends declared (7,124) (7,078) (6,573)
----------- ----------- -----------
Balance, end of year 1,811,839 1,511,751 1,258,617
----------- ----------- -----------
Treasury Balance, beginning of year (343,331) (327,891) (303,063)
Stock Repurchase of common stock -- (24,017) (27,469)
Issuance of treasury stock 9,099 8,577 2,641
----------- ----------- -----------
Balance, end of year (334,232) (343,331) (327,891)
----------- ----------- -----------
Total shareholders' equity $ 1,786,688 $ 1,499,211 $ 1,217,268
=========== =========== ===========
Comprehensive Net income $ 307,212 $ 260,212 $ 204,466
Income Other comprehensive income (loss), net of tax (21,710) 42,315 (54,276)
----------- ----------- -----------
Comprehensive income $ 285,502 $ 302,527 $ 150,190
=========== =========== ===========
See accompanying notes to consolidated financial statements.
Consolidated Statements of Cash Flows
The PMI Group, Inc. and Subsidiaries
Years Ended December 31,
(Dollars in thousands) 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
Cash Net income $ 307,212 $ 260,212 $ 204,466
Flows Adjustments to reconcile net income to net cash provided by
From operating activities:
Operating Extraordinary loss on early extinguishment of debt 7,393 -- --
Activities Net realized capital gains (11) (432) (509)
Equity in earnings of affiliates (18,153) (11,643) (7,061)
Depreciation and amortization 13,107 24,092 13,243
Deferred income taxes (4,804) (28,834) 7,539
Changes in:
Accrued investment income (11,986) (1,436) (1,903)
Deferred policy acquisition costs (6,397) 2,570 (7,973)
Premiums receivable (16,148) (10,703) (6,292)
Reinsurance receivable 942 (1,673) 62,764
Reinsurance recoverable 3,143 2,224 (4,653)
Reserves for losses and loss adjustment expenses 14,628 13,089 18,649
Unearned premiums (213) (11,223) 13,526
Income taxes payable 8,608 10,391 (3,834)
Other 3,702 (22,734) 27,769
--------- --------- ---------
Net cash provided by operating activities 301,023 223,900 315,729
--------- --------- ---------
Cash Proceeds from sales and maturities of fixed income securities 321,036 193,141 231,673
Flows Proceeds from sales of equity securities 119,090 53,370 42,647
From Investment purchases:
Investing Fixed income securities (718,561) (267,346) (332,046)
Activities Equity securities (104,775) (145,258) (31,940)
Net (increase) decrease in short-term investments 1,168 5,516 (84,508)
Investments in affiliates (54,841) (26,827) (25,634)
Acquisitions of wholly-owned subsidiaries (60,166) -- (100,872)
Capital expenditures (26,408) (20,070) (12,528)
--------- --------- ---------
Net cash used in investing activities (523,457) (207,474) (313,208)
--------- --------- ---------
Cash Proceeds from issuance of long-term debt 351,900 -- 45,825
Flows Repayments of long-term debt (75,706) -- --
From Extinguishment of preferred Capital Securities (55,969) -- --
Financing Repurchases of common stock -- (24,017) (27,469)
Activities Issuance of treasury stock 9,099 8,577 2,641
Dividends paid to shareholders (7,124) (7,093) (5,199)
--------- --------- ---------
Net cash provided by (used in) financing activities 222,200 (22,533) 15,798
--------- --------- ---------
Net increase (decrease) in cash (234) (6,107) 18,319
Cash at beginning of year 21,969 28,076 9,757
--------- --------- ---------
Cash at end of year $ 21,735 $ 21,969 $ 28,076
========= ========= =========
See accompanying notes to consolidated financial statements.
NOTE 1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of The
PMI Group, Inc. ("TPG"), a Delaware corporation; its direct and indirect
wholly-owned subsidiaries, PMI Mortgage Insurance Co. ("PMI"), an Arizona
corporation; American Pioneer Title Insurance Company ("APTIC"), a Florida
corporation; PMI Mortgage Insurance Ltd ("PMI Ltd"), an Australian mortgage
insurance company; PMI Mortgage Insurance Company Limited ("PMI Europe"), an
Irish corporation; and other insurance, reinsurance and non-insurance
subsidiaries. TPG and its subsidiaries are collectively referred to as the
"Company". The Company has equity interests in CMG Mortgage Insurance Company
("CMG"), which conducts residential mortgage insurance business; Fairbanks
Capital Holding Corp. ("Fairbanks"), a special servicer of single-family
residential mortgages; and two financial guaranty reinsurance companies based in
Bermuda, RAM Holdings Ltd. and Ram Holdings II Ltd., collectively referred to as
"Ram Re". The Company's percentage ownership of CMG, Fairbanks, and Ram Re are
50%, 45.7% and 24.9% respectively, and accordingly, they are accounted for on
the equity method of accounting in the Company's consolidated financial
statements. All material intercompany transactions and balances have been
eliminated in consolidation.
NOTE 2. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - The Company, through its subsidiaries, primarily writes residential
mortgage guaranty insurance, or primary mortgage insurance, and mortgage pool
insurance. In addition, the Company writes title insurance through its title
insurance subsidiary, APTIC. Primary insurance and pool insurance provide
protection to mortgage lenders against losses in the event of borrower default
and assist lenders and investors in selling mortgage loans in the secondary
market. Title insurance protects the mortgagors and lenders against losses
resulting from title defects, liens, and encumbrances in existence as of the
effective date of the policy. Significant accounting policies are as follows:
Basis of Accounting - The financial statements have been prepared on the basis
of accounting principles generally accepted in the United States ("GAAP"), which
vary from statutory accounting practices prescribed or permitted by insurance
regulatory authorities. The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements, as well as the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
Investments - The Company has designated its entire portfolio of fixed income
and equity securities as available-for-sale. These securities are recorded at
fair value with unrealized gains and losses, net of deferred income taxes, and
accounted for as a component of accumulated other comprehensive income in
shareholders' equity. The Company evaluates its investments regularly to
determine whether there are declines in value and whether any such declines meet
the definition of other-than-temporary impairment in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Market value of a security below cost
or amortized cost for two consecutive quarters is a potential indicator of an
other-than-temporary impairment. When the Company determines a security has
suffered an other-than-temporary impairment, the impairment loss is recognized,
to the extent of the decline, as a realized investment loss in the current
period's earnings.
The Company's short-term investments have maturities of less than twelve months
when purchased and are carried at fair value. Investments in 20% to 50% owned
affiliates are accounted for on the equity method of accounting, and investments
in less than 20% owned affiliates are accounted for on the cost method of
accounting. The Company reports the equity earnings of its unconsolidated
affiliates, Fairbanks on a one-month lag and Ram Re on a quarter lag basis. The
investment in Fairbanks includes a
goodwill component of approximately $27 million. Realized gains and losses on
sales of investments are determined on a specific-identification basis.
Investment income consists primarily of interest and dividends. Interest income
is recognized on an accrual basis and dividend income is recorded on the date of
declaration.
Property and Equipment - Property and equipment, including software, are carried
at cost and are depreciated using the straight-line method over the estimated
useful lives of the assets, ranging from three to ten years. Accumulated
depreciation on property and equipment was $70.6 million as of December 31,
2001, $59.3 million as of December 31, 2000 and $51.4 million as of December 31,
1999.
Revenue Recognition - Primary mortgage insurance policies are contracts that are
non-cancelable by the insurer, are renewable at a fixed price at the insured's
option, and provide payment of premiums on a monthly, annual or single basis.
Upon renewal by the insured, the Company is not able to re-underwrite or
re-price its policies. SFAS No. 60, Accounting and Reporting for Insurance
Enterprises, specifically excludes mortgage guaranty insurance from its guidance
relating to the earning of insurance premiums. Premiums written on a monthly
basis are earned as coverage is provided. Monthly premiums accounted for
approximately 63% of gross premiums written in 2001, compared with 66% in 2000
and 61% in 1999. Premiums written on an annual premium basis are amortized on a
monthly pro rata basis over the year of coverage. Premiums written on policies
covering more than one year, or single premium policies, are initially deferred
as unearned premiums and earned over the expected life of the policy, a range of
seven to eight years. Rates used to determine the earning of single premiums are
estimates based on the expiration of risk. Accordingly, the unearned premiums
represent the portion of premiums written that is applicable to the estimated
unexpired risk of insured policies.
In 2001, the Company refined the loss reserve estimation process of its
international operations to be based upon a default model consistent with U.S.
subsidiaries. In connection with the refinement in the provisioning policy and
premium earning estimates, the Company updated the assumptions used to determine
the rates of premiums earned and shortened the duration of the expected policy
life of single premium products, which resulted in an acceleration of earnings
in the first two years. The new methodology and estimates are consistent with
those applied to the U.S. operations.
Title insurance premiums are recognized as revenue on the effective date of the
title insurance policy. Fee income of the non-insurance subsidiaries is earned
as the services are provided including contract underwriting. Contract
underwriting revenue is recorded in other income.
Deferred Policy Acquisition Costs - The Company defers certain costs in its
mortgage insurance operations relating to the acquisition of new insurance and
amortizes these costs against related premium revenue in order to match costs
and revenues. These costs are primarily associated with the acquisition,
underwriting and processing of new business, including contract underwriting and
sales related activities. To the extent the Company is compensated by customers
for contract underwriting, those underwriting costs are not deferred. Costs
related to the issuance of mortgage insurance are initially deferred and
reported as deferred policy acquisition costs ("DPAC"). SFAS 60 specifically
excludes mortgage guaranty insurance from its guidance relating to the
amortization of DPAC. Amortization of these costs for each underwriting year
book of business is charged against revenue in proportion to estimated gross
profits over a two-year period. The estimates for each underwriting year are
updated regularly to reflect actual experience and any changes to key
assumptions such as persistency or loss development.
DPAC is summarized as follows:
(Dollars in thousands) 2001 2000 1999
- ------------------------------------------------------------------------------------
Beginning DPAC balance $ 67,009 $ 69,579 $ 61,605
Policy acquisition costs incurred and deferred 88,179 74,767 88,226
Amortization of deferred costs (81,782) (77,337) (80,252)
Acquisitions of wholly-owned subsidiaries 4,497 -- --
-------- -------- --------
Ending DPAC balance $ 77,903 $ 67,009 $ 69,579
======== ======== ========
Income Taxes - The Company accounts for income taxes using the liability method
in accordance with SFAS No. 109, Accounting for Income Taxes. The liability
method measures the expected future tax consequences of temporary differences at
the enacted tax rates applicable for the period in which the deferred asset or
liability is expected to be realized or settled. Temporary differences are
differences between the tax basis of an asset or liability and its reported
amount in the financial statements that will result in taxable or deductible
amounts in future years.
Special Purpose Entities - Certain insurance transactions entered into by PMI
Europe require the use of foreign Special Purpose Entities ("SPEs"). These SPEs
are wholly-owned subsidiaries of the Company, and accordingly, are consolidated
in the Company's financial statements. The Company is not affiliated with any
SPEs that qualify for off-balance sheet treatment.
Derivatives - Derivative financial instruments are reported at fair value.
Changes in the fair value of derivatives are recorded each period in earnings or
other comprehensive income, depending on whether the derivative is designated
and effective as part of a hedged transaction, and on the type of hedge
transaction. Gains or losses on derivative instruments reported in other
comprehensive income are reclassified to earnings in the period which earnings
are affected by the underlying hedged item, and the ineffective portion of
hedges are recognized in earnings in the current period.
The Company's use of derivative financial instruments is generally limited to
reducing its exposure to interest rate risk and currency exchange risk by
utilizing interest rate and currency swap agreements that are accounted for as
hedges. Hedge accounting requires a high correlation between changes in fair
value or cash flows of the derivative instrument and the specific item being
hedged, both at inception and throughout the life of the hedge. In 1999, the
Company entered into an interest rate swap to hedge interest rate risk
associated with the debt obtained to finance the PMI Ltd acquisition. This
interest rate swap was terminated in July 2001 when the Company repaid the
associated debt, and the termination of the swap resulted in a realized loss of
$0.8 million. The Company did not have any derivative instruments as of December
31, 2001.
Foreign currency translation - The financial statements of foreign subsidiaries
have been translated into U.S. dollars in accordance with SFAS No. 52, Foreign
Currency Translation. Assets and liabilities denominated in non-U.S. dollar
currencies are translated into U.S. dollar equivalents using either the year-end
spot exchange rates or historical rates. Revenues and expenses are translated
mostly at weighted-average exchange rates. The effects of translating operations
with a functional currency other than the reporting currency are reported as a
component of accumulated other comprehensive income included in shareholders'
equity.
Earnings Per Share - Basic earnings per share ("EPS") excludes dilution and is
based on net income available to common shareholders and the weighted-average
common shares that are outstanding during the period. Diluted EPS is based on
net income available to common shareholders and the weighted-average of dilutive
common shares outstanding during the period. Weighted-average dilutive common
shares reflect the potential increase of common shares if outstanding securities
were converted into
common stock, or if contracts to issue common stock, including stock options
issued by the Company that have a dilutive impact, were exercised. Net income
available to common shareholders is the same for computing basic and diluted
EPS. Weighted-average common shares outstanding for the years ended December 31,
2001, 2000 and 1999 are as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Weighted-Average Shares Outstanding
For basic EPS 44,443,748 44,253,619 44,893,250
For diluted EPS 45,333,984 45,018,501 45,244,060
Stock-Based Compensation - The Company accounts for stock-based compensation to
employees and directors using the intrinsic value method prescribed in
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued
to Employees, and its related interpretations. Under APB 25, compensation cost
for stock-based awards is measured as the excess, if any, of the market price of
the underlying stock on the grant date over the employees' exercise price of the
stock options. As all options have been granted with an exercise price equal to
the fair value at the date of the grants, no compensation expense has been
recognized for the Company's stock option program. SFAS No. 123, Accounting for
Stock-Based Compensation, requires the pro-forma disclosure of net income and
earnings per share using the fair value method, and provides that the employers
may continue to account for the stock-based compensation under APB 25. The
Company adopted the pro-forma disclosure requirements of SFAS 123 and details
are disclosed in Note 16, Incentive Plans.
Reclassifications - Certain items in the prior period's financial statements
have been reclassified to conform to the current period's presentation.
NOTE 3. NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, and No. 142, Goodwill and Other Intangible Assets,
effective for fiscal years beginning after December 15, 2001. Under SFAS 141,
the use of the pooling-of-interest method is no longer permitted for all
business combinations initiated after June 30, 2001, and the purchase method of
accounting is required. Under SFAS 142, goodwill and intangible assets deemed to
have an indefinite useful life will no longer be amortized but will be subject
to an annual review for impairment.
The Company adopted SFAS 142 effective January 1, 2002, and wrote off the
remaining balance of the negative goodwill, recorded in connection with the
purchase of PMI Ltd in 1999, of $7.6 million as a change in accounting method.
NOTE 4. ACQUISITIONS
In September 2001, the Company completed its acquisition of CGU Lenders Mortgage
Insurance Limited (renamed PMI Indemnity Limited), an Australian mortgage
insurance company. The purchase price of this acquisition remains subject to
post-closing adjustments, but is expected to be approximately $41 million. The
acquisition was accounted for under the purchase method of accounting and there
was no related goodwill. PMI Indemnity Limited's operations are being merged
into the Company's existing Australian subsidiary, and its financial results
were included in the Company's fourth quarter results of operations.
In December 1999, the Company acquired all of the outstanding common stock of
Pinebrook Mortgage Insurance Company ("Pinebrook"), which was a wholly-owned
subsidiary of Allstate Insurance Company
("Allstate"), for $22.6 million in cash. The purchase price approximated the
book value of Pinebrook, which did not differ significantly from fair value.
This transaction was accounted for under the purchase method of accounting.
In August 1999, the Company acquired all of the outstanding common stock of PMI
Ltd for approximately $78.3 million. The acquisition was accounted for under the
purchase method of accounting. The excess of the estimated fair value of net
assets acquired over the purchase price of approximately $22 million was
recorded as negative goodwill to be amortized over eight years. The remaining
balance of this negative goodwill has been written off upon the Company's
adoption of SFAS 142 effective January 1, 2002.
The pro-forma unaudited results of operations for the year ended December 31,
1999, assuming the purchase of PMI Ltd had been consummated as of January 1,
1999, are as follows:
(Dollars in thousands, except per share amounts) 1999
- --------------------------------------------------------------------------------
Revenues $692,585
Net income 220,679
Basic net income per common share 4.92
Diluted net income per common share 4.87
NOTE 5. INVESTMENTS
Fair Values and Net Unrealized Gains and Losses on Investments - The cost or
amortized cost, estimated fair value, based on quoted market prices, and net
unrealized gains and losses on investments are shown in the table below:
Cost or Gross Unrealized Net
Amortized Fair ---------------------- Unrealized
(Dollars in thousands) Cost Value Gains (Losses) Gains/(Losses)
- ------------------------------------------------------------------------------------------------------------------------
December 31, 2001:
Fixed income securities
U.S. government and agencies $ 73,127 $ 72,249 $ 1,774 $ (2,652) $ (878)
Mortgage-backed securities 112,301 113,666 1,386 (21) 1,365
Municipal bonds 1,418,805 1,487,335 77,325 (8,795) 68,530
Corporate bonds 405,881 405,625 5,427 (5,683) (256)
---------- ---------- -------- -------- --------
Total fixed income securities 2,010,114 2,078,875 85,912 (17,151) 68,761
Equity securities
Common stocks 53,015 69,264 19,553 (3,304) 16,249
Preferred stocks 89,192 92,266 3,741 (667) 3,074
---------- ---------- -------- -------- --------
Total equity securities 142,207 161,530 23,294 (3,971) 19,323
Investments in affiliates 203,883 204,886 1,059 (56) 1,003
Short-term investments 135,058 137,469 2,417 (6) 2,411
---------- ---------- -------- -------- --------
Total $2,491,262 $2,582,760 $112,682 $(21,184) 91,498
========== ========== ======== ========
Deferred income taxes (32,349)
--------
Unrealized gains, net of deferred taxes $ 59,149
========
December 31, 2000:
Fixed income securities
U.S. government and agencies $ 42,189 $ 43,512 $ 2,173 $ (850) $ 1,323
Mortgage-backed securities 59,399 59,576 331 (154) 177
Municipal bonds 1,268,775 1,349,160 82,692 (2,307) 80,385
Corporate bonds 165,928 161,082 2,400 (7,246) (4,846)
---------- ---------- -------- -------- --------
Total fixed income securities 1,536,291 1,613,330 87,596 (10,557) 77,039
Equity securities
Common stocks 53,315 81,726 32,543 (4,132) 28,411
Preferred stocks 108,743 111,743 3,216 (216) 3,000
---------- ---------- -------- -------- --------
Total equity securities 162,058 193,469 35,759 (4,348) 31,411
Investments in affiliates 130,747 131,849 1,102 -- 1,102
Short-term investments 139,470 139,577 113 (6) 107
---------- ---------- -------- -------- --------
Total $1,968,566 $2,078,225 $124,570 $(14,911) 109,659
========== ========== ======== ========
Deferred income taxes (39,179)
--------
Unrealized gains, net of deferred taxes $ 70,480
========
The difference between the cost and fair value of the investments in affiliates
reflects the Company's shares of net unrealized gains and losses on the
affiliates' investment portfolio. The stated fair value does not represent the
fair value of the affiliates' common stock held by the Company.
Included in the Company's short-term investments is commercial paper with a face
value of $10.0 million issued by Pacific Gas and Electric Company ("PG&E"),
which is currently in default. In the second quarter of 2001, the Company
determined that the investment's $3.2 million decline in market value was an
other-than-temporary impairment as prescribed in SFAS 115, and recognized a
realized loss of $3.2 million. Subsequently, the Company recorded an
unrealized gain of $2.4 million due to the increase in the fair value of this
investment during the second half of 2001.
Scheduled Maturities - The following table set forth the amortized cost and fair
value of fixed income securities by contractual maturity at December 31, 2001:
Amortized Fair
(Dollars in thousands) Cost Value
- --------------------------------------------------------------------------------
Due in one year or less $ 54,675 $ 54,800
Due after one year through five years 316,837 319,087
Due after five years through ten years 354,588 358,884
Due after ten years 1,171,713 1,232,438
Mortgage-backed securities 112,301 113,666
---------- ----------
Total fixed income securities $2,010,114 $2,078,875
========== ==========
Actual maturities may differ from those scheduled as the result of calls or
prepayments by the issuers prior to the maturity.
Investment Income - Investment income consists of:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Fixed income securities $ 109,425 $ 94,794 $ 82,256
Equity securities 10,785 4,841 2,400
Investments in affiliates 18,153 11,643 7,061
Short-term investments 13,055 9,223 4,793
--------- --------- --------
Investment income before expenses 151,418 120,501 96,510
Investment expense (1,431) (1,302) (1,368)
--------- --------- --------
Net investment income $ 149,987 $ 119,199 $ 95,142
========= ========= ========
Realized Investment Gains and Losses - Net realized gains and losses on
investments are composed of:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Fixed income securities
Gross gains $ 11,129 $ 1,657 $ 535
Gross losses (1,722) (9,734) (3,610)
-------- -------- -------
Net gains (losses) 9,407 (8,077) (3,075)
Equity securities:
Gross gains 12,503 17,768 7,210
Gross losses (18,698) (9,474) (3,636)
-------- -------- -------
Net gains (losses) (6,195) 8,294 3,574
Short-term investments
Gross gains -- 453 10
Gross losses (3,201) (238) --
-------- -------- -------
Net gains (losses) (3,201) 215 10
-------- -------- -------
Net realized gains before income taxes 11 432 509
Income taxes (4) (151) (178)
-------- -------- -------
Total realized gains after income taxes $ 7 $ 281 $ 331
======== ======== =======
Unrealized Investment Gains and Losses - The change in net unrealized gains and
losses consists of:
(Dollars in thousands) 2001 2000 1999
- ---------------------------------------------------------------------------------------------------
Fixed income securities $ (6,559) $ 53,948 $(61,376)
Equity securities (7,048) (5,586) 8,758
Investments in affiliates (101) 1,905 (1,662)
Short-term investments 2,377 27 4
-------- -------- --------
Change in unrealized gains (losses), net of deferred taxes (11,331) 50,294 (54,276)
Realized gains, net of income taxes 7 281 331
-------- -------- --------
Total $(11,324) $ 50,575 $(53,945)
======== ======== ========
Investment Concentrations and Other Items - The Company maintains a diversified
portfolio of municipal bonds. The following states represent the largest
concentrations in the municipal bond portfolio, expressed as a percentage of the
carrying value of all municipal bond holdings. Holdings in states that exceed 5%
of the municipal bond portfolio at December 31, for the respective years are
presented below:
2001 2000
- --------------------------------------------------------------------------------
Illinois 16.5% 14.1%
Texas 12.8 12.6
Washington 10.8 11.2
New York 8.8 9.7
Massachusetts 7.7 7.5
District of Columbia 5.7 4.2
At December 31, 2001, fixed income and short-term securities with a market value
of $19.6 million were on deposit with regulatory authorities as required by law.
NOTE 6. LOSSES AND LOSS ADJUSTMENT EXPENSES RESERVES
The reserves for losses and loss adjustment expenses ("LAE") are the estimated
claim settlement on notices of default that have been received by the Company,
as well as loan defaults that have been incurred but have not been reported by
the lenders. SFAS 60 specifically excludes mortgage guaranty insurance from its
guidance relating to the reserves for losses. Consistent with industry
accounting practices, the Company does not establish loss reserves for future
claims on insured loans that are not currently in default. The Company
establishes loss reserves on a case-by-case basis when insured loans are
identified as currently in default using estimated claim rates and average claim
sizes for each report year, net of salvage recoverable. The Company also
reserves for defaults that have been incurred but have not been reported to the
Company prior to the close of an accounting period, using estimated claim rates
and claim sizes for the estimated number of defaults not reported.
The Company's reserving process is based upon the assumptions of past
experience, adjusted for the anticipated effect of current economic conditions
and projected future economic trends, including the real estate market, housing
values, unemployment rates and their effect on recent claim rates and claim
severity. Therefore, the reserves are necessarily based on estimates and the
ultimate liability may vary from such estimates. Management regularly reviews
the evaluation of the loss reserves utilizing current information and updates
the assumptions in the estimation process accordingly. Any resulting adjustments
are reflected in the current period's earnings. Management believes that the
reserves for losses and loss adjustment expenses at December 31, 2001 were
appropriately established on an aggregate basis and were adequate to cover the
ultimate net cost of settling reported and unreported claims.
The following table provides a reconciliation of the beginning and ending
reserves for losses and loss adjustment expenses for each of the last three
years:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------------------------
Balance at January 1 $ 295,089 $ 282,000 $ 215,259
Reinsurance recoverable (9,211) (11,435) (6,782)
--------- --------- ---------
Net balance at January 1 285,878 270,565 208,477
Losses and loss adjustment expenses incurred (principally
with respect to defaults occurring in)
Current year 242,493 191,904 159,293
Prior years (124,445) (88,825) (46,611)
--------- --------- ---------
Total incurred 118,048 103,079 112,682
Losses and loss adjustment expenses payments (principally
with respect to defaults occurring in)
Current year (8,723) (4,825) (1,798)
Prior years (91,554) (82,941) (96,890)
--------- --------- ---------
Total payments (100,277) (87,766) (98,688)
Acquisitions of wholly-own subsidiaries 4,873 -- 48,094
--------- --------- ---------
Net balance at December 31 308,522 285,878 270,565
Reinsurance recoverable 6,068 9,211 11,435
--------- --------- ---------
Balance at December 31 $ 314,590 $ 295,089 $ 282,000
========= ========= =========
The increase in 2001 losses and loss adjustment expenses incurred was due, in
part, to the economic downturn in 2001 and corresponding increases in claims
paid. Primary insurance default inventory increased from 18,093 at December 31,
2000 to 25,907 at December 31, 2001. The default rate was
2.86% at year-end 2001 compared to 2.21% at year-end 2000. Generally it takes
approximately twelve months from the receipt of a default notice to result in a
claim payment; therefore, most losses paid related to default notices received
in prior years. The provision for losses and loss adjustment expenses for
default events in prior years decreased by $124.4 million in 2001 and $88.8
million in 2000, due primarily to the impact of favorable real estate market and
home prices on lost mitigation activities.
NOTE 7. INCOME TAXES
The components of income tax expense are as follows:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Current $ 40,969 $ 37,565 $ 6,942
Deferred 91,392 76,089 78,678
-------- -------- -------
Total income tax expense $132,361 $113,654 $85,620
======== ======== =======
The components of the income tax expense for 2001 included a foreign provision
for current tax expense of $15.1 million and a deferred tax benefit of $1.0
million primarily related to PMI Australia and PMI Europe. The Company paid
income taxes of $11.6 million in 2001, $12.5 million in 2000 and $10.5 million
in 1999.
Section 832(e) of the Internal Revenue Code permits mortgage guaranty insurers
to deduct, within certain limitations, additions to statutory contingency
reserves. This provision allows mortgage guaranty insurers to increase statutory
unassigned surplus through the purchase of non-interest bearing "tax and loss
bonds" from the federal government. The tax and loss bonds purchased are limited
to the tax benefit of the deduction for additions to the contingency reserves.
The Company purchased tax and loss bonds of $99.0 million in 2001, $103.4
million in 2000 and $73.5 million in 1999.
The components of the deferred income tax assets and liabilities at December 31
are as follows:
(Dollars in thousands) 2001 2000
- --------------------------------------------------------------------------------
Deferred tax assets:
Discount on loss reserves $ 8,658 $ 6,597
Unearned premium reserves 179 1,265
Alternative minimum tax credit carryforward 57,289 49,414
Pension costs and deferred compensation 9,221 6,302
Other assets 14,866 8,625
-------- --------
Total deferred tax assets 90,213 72,203
Deferred tax liabilities:
Statutory contingency reserves 63,626 61,905
Deferred policy acquisition costs 23,218 22,154
Unrealized gains on investments 33,944 36,976
Equity earnings of unconsolidated affiliates 10,723 6,640
Other liabilities 22,554 19,509
-------- --------
Total deferred tax liabilities 154,065 147,184
-------- --------
Net deferred tax liability $ 63,852 $ 74,981
======== ========
A reconciliation of the statutory federal income tax rate to the effective tax
rate reported on income before income taxes is shown in the following table:
2001 2000 1999
- --------------------------------------------------------------------------------
Statutory federal income tax rate 35.0% 35.0% 35.0%
Tax-exempt interest (5.2) (6.0) (6.8)
State income tax 0.4 0.4 0.5
Foreign income tax (1.0) (0.3) 0.2
Other 0.9 1.3 0.6
------ ------ ------
Effective income tax rate 30.1% 30.4% 29.5%
====== ====== ======
NOTE 8. BUSINESS SEGMENTS
The Company's reportable operating segments include U.S. Mortgage Insurance,
International Mortgage Insurance and Title Insurance. The Other segment includes
the income and expenses of TPG, PMI Mortgage Services Co. and an inactive
broker-dealer.
Transactions between segments are not significant. The Company evaluates
performance primarily based on segment net income. The following tables present
information for reported segment income or loss and segment assets as of and for
the periods indicated:
Year Ended December 31, 2001
U.S. International
Mortgage Mortgage Title Consolidated
(Dollars in thousands) Insurance Insurance Insurance Other Total
- -------------------------------------------------------------------------------------------------------------------------
Premiums earned, investment income
and other income $ 650,685 $ 73,889 $ 162,528 $ 49,861 $ 936,963
Losses and loss adjustment expenses (102,856) (9,287) (5,905) -- (118,048)
Other underwriting and operating expenses (137,207) (11,515) (141,929) (59,546) (350,197)
Interest expense (46) (1,533) -- (20,173) (21,752)
----------- --------- --------- --------- -----------
Income (loss) before income taxes 410,576 51,554 14,694 (29,858) 446,966
Income (tax) benefit (127,521) (13,798) (5,294) 11,665 (134,949)
Extraordinary loss on early extinguishment
of debt, net of income tax benefit -- -- -- (4,805) (4,805)
----------- --------- --------- --------- -----------
Net income (loss) $ 283,054 $ 37,756 $ 9,400 $ (22,998) $ 307,212
=========== ========= ========= ========= ===========
Total assets $ 2,087,600 $ 415,518 $ 63,662 $ 423,172 $ 2,989,952
=========== ========= ========= ========= ===========
Year Ended December 31, 2000
U.S. International
Mortgage Mortgage Title Consolidated
(Dollars in thousands) Insurance Insurance Insurance Other Total
- -------------------------------------------------------------------------------------------------------------------------
Premiums earned, investment income
and other income $ 599,850 $ 38,517 $ 105,907 $ 18,298 $ 762,572
Losses and loss adjustment expenses (95,308) (5,684) (2,087) -- (103,079)
Other underwriting and operating expenses (131,700) (7,220) (94,302) (33,885) (267,108)
Interest expense (19) (2,705) -- (15,795) (18,519)
----------- --------- --------- --------- -----------
Income (loss) before income tax expense 372,823 22,908 9,518 (31,382) 373,866
Income tax benefit (expense) (114,234) (6,501) (3,274) 10,355 (113,654)
----------- --------- --------- --------- -----------
Net income (loss) $ 258,588 $ 16,407 $ 6,244 $ (21,027) $ 260,212
=========== ========= ========= ========= ===========
Total assets $ 2,052,814 $ 174,006 $ 53,275 $ 112,562 $ 2,392,657
=========== ========= ========= ========= ===========
Year Ended December 31, 1999
U.S. International
Mortgage Mortgage Title Consolidated
(Dollars in thousands) Insurance Insurance Insurance Other Total
- -------------------------------------------------------------------------------------------------------------------------
Premiums earned, investment income
and other income $ 531,824 $ 15,902 $ 101,778 $ 20,620 $ 670,124
Losses and loss adjustment expenses (110,465) (1,213) (1,004) -- (112,682)
Other underwriting and operating expenses (134,264) (3,168) (88,244) (24,815) (250,491)
Interest expense (3) (1,307) -- (15,555) (16,865)
----------- --------- --------- --------- -----------
Income (loss) before income tax expense 287,092 10,214 12,530 (19,750) 290,086
Income tax benefit (expense) (88,628) (3,469) (4,422) 10,899 (85,620)
----------- --------- --------- --------- -----------
Net income (loss) $ 198,464 $ 6,745 $ 8,108 $ (8,851) $ 204,466
=========== ========= ========= ========= ===========
Total assets $ 1,764,125 $ 182,586 $ 46,484 $ 107,567 $ 2,100,762
=========== ========= ========= ========= ===========
Included in the results of international mortgage insurance are the results of
the Australian and European operations. We commenced operations in Europe in
February 2001. The Australian operating results for 2000 reflect eleven months
of activity of PMI Ltd due to the one-month lag reporting period, whereas 2001
results reflect thirteen months of activity as we began to report our foreign
subsidiaries on the same calendar month as U.S. operations. The Australian
operating results for 2001 also includes four months of PMI Indemnity Limited's
activity. The 1999 results represent operations from the date of acquisition of
PMI Ltd in August 1999.
NOTE 9. LONG-TERM DEBT
Senior Convertible Debentures - In July 2001, the Company issued $360.0 million
of 2.50% Senior Convertible Debentures in a private offering to qualified
institutional buyers, and subsequently filed a shelf registration statement for
the resale of the Debentures and the common stock of TPG issuable upon
conversion of the Debentures. The Company has used a portion of the net proceeds
of $351.9 million for the repayment or retirement of existing indebtedness and
for general corporate purposes. The Debentures are due on July 15, 2021 and bear
interest at a rate of 2.50% per annum. The Company pays interest on the
Debentures on January 15 and July 15 of each year, beginning January 15, 2002,
and additional contingent interest under certain circumstances. The Debentures
may be convertible at the registered holders' option, prior to stated maturity,
into shares of the Company's common stock at an initial conversion price of
$88.31 per share, subject to adjustments in specified circumstances. The Company
may redeem some or all of the Debentures on or after July 15, 2006 for a price
equal to the principal amount of the Debentures plus any accrued and unpaid
interest. The holders may put the Debentures to the Company on July 15, 2004,
2006, 2008, 2111 and 2116. Upon a change of control of the Company, holders may
also require the Company, subject to certain conditions, to repurchase all or a
portion of the Debentures. The Company may repurchase the Debentures with cash,
common stock, or a combination of cash and shares of common stock.
Bank Loan - In August 1999, the Company entered into a credit agreement with
Bank of America, N.A. ("Bank"). The Company borrowed $45.8 million (AUD $70.5
million) at a six-month adjustable interest rate which equals the Australia Bank
Bill Buying Rate plus a specified margin that is dependent on the TPG's senior
debt rating ("Loan"). The proceeds of the Loan were used to finance the
acquisition of PMI Ltd. Concurrently, the Company entered into an interest rate
swap transaction ("Swap") with the Bank. The Swap effectively fixed the interest
rate on the Loan to 7.0%. The net interest effect of the Swap is reported as an
adjustment to interest expense. Effective January 1, 2001, upon adoption of SAFS
No. 133, Accounting for Derivative Instruments and Hedging Activities, the
Company recorded a $1.0 million liability for the fair value of the Swap in the
consolidated balance sheet. In July 2001, the Company repaid the Loan in the
amount of $35.7 million (AUD $70.5 million). Correspondingly, the
Company terminated the Swap, resulting in a realized loss of $0.8 million. The
Company made interest payments on the Loan of $1.5 million in 2001 and $3.0
million in 2000. No interest payments were made during 1999.
Senior Notes - In November 1996, the Company issued unsecured debt securities in
the face amount of $100.0 million ("Notes"). The Notes mature and are payable on
November 15, 2006 and are not redeemable prior to maturity. No sinking fund is
required or provided for prior to maturity. Interest on the Notes is 6.75% and
is payable semiannually. In 2001, the Company repurchased $37.1 million of the
Notes, resulting in an extraordinary loss of $1.9 million, net of tax. The
Company made interest payments on the Notes of $6.5 million in 2001, $6.8
million in 2000 and 1999.
NOTE 10. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL SECURITIES
OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST
DEBENTURE OF THE COMPANY
In February 1997, TPG, through a wholly-owned trust, privately issued $100.0
million of 8.309% preferred Capital Securities, Series A (the "Capital
Securities"). The Capital Securities are redeemable after February 1, 2007 at a
premium or upon occurrence of certain tax events and mature on February 1, 2027.
The net proceeds of $99.0 million were used for general corporate purposes,
including common stock repurchases and additions to the investment portfolio.
The Capital Securities were issued by PMI Capital I ("Issuer Trust"). The sole
asset of the Issuer Trust consists of $103.1 million principal amount of a
junior subordinated debenture issued by TPG to the Issuer Trust. The
subordinated debenture bears interest at the rate of 8.309% per annum and
matures on February 1, 2027. The amounts due to the Issuer Trust under the
subordinated debenture and the related transactions have been eliminated in the
Company's consolidated financial statements. Distributions on the Capital
Securities occur on February 1 and August 1 of each year. The obligations of TPG
under the subordinated debenture and a related guarantee and expense agreement
constitute a full and unconditional guarantee by TPG of the Issuer Trust's
obligations under the Capital Securities. The Capital Securities are subject to
mandatory redemption under certain circumstances. In 2001, the Company retired
$51.5 million of the Capital Securities. The early extinguishment of a portion
of this debt resulted in an extraordinary loss of $2.9 million, net of tax. The
Company made distribution payments of $7.6 million in 2001, and $8.3 million in
2000 and 1999.
NOTE 11. FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets and incurs various financial liabilities. The estimated fair value of the
liabilities indicated below has been determined by quoted market price.
As of December 31, 2001 As of December 31, 2000
----------------------- -----------------------
Carrying Estimated Carrying Estimated
(Dollars in thousands) Value Fair Value Value Fair Value
- ---------------------------------------------------------------------------------------
2.50% Senior Convertible Debentures $360,000 $383,400 $ -- $ --
6.75% Notes 62,950 66,814 99,609 99,859
8.309% Capital Securities 48,500 51,161 99,109 94,992
7.0% Bank Loan -- -- 37,210 39,000
The estimated fair value is based on available market information and
appropriate valuation methodologies. However, considerable judgment is required
in interpreting market data to develop the estimates of fair value and,
accordingly, the estimates presented herein are not necessarily indicative of
the amounts that could be realized in a current market exchange.
A number of the Company's significant assets and liabilities, including deferred
policy acquisition costs, property and equipment, loss reserves, unearned
premiums and deferred income taxes are not considered financial instruments.
NOTE 12. COMMITMENTS AND CONTINGENCIES
Leases - The Company leases certain office facilities and equipment. Minimum
rental payments under non-cancelable operating leases with a remaining term of
more than one year as of December 31, 2001 are as follows:
(Dollars in thousands) Lease Commitments
- --------------------------------------------------------------------------------
Years ending December 31:
2002 $11,864
2003 9,859
2004 7,821
2005 2,050
2006 1,429
Thereafter 1,408
-------
Total $34,431
=======
The Company renewed its corporate headquarters lease for 5 years in 1999. In
December 2000, the Company executed a purchase agreement for a seven-story
commercial building to serve as the new executive offices. The total purchase
price was $74.0 million in cash, with an initial deposit of $4.5 million paid on
December 29, 2000 and the final progress payment due at closing, which is
expected to be in 2002. The Company has made payments of $16.5 million to date
and has incurred $3.7 million of other costs and fees relating to the
construction of the building, which were included in other assets.
Rent expense for all leases was $12.8 million for 2001, $11.3 million for 2000
and $9.6 million for 1999.
Legal Proceedings - On December 15, 2000, the Company announced that PMI entered
into an agreement with the plaintiffs to settle the putative class action
litigation captioned Baynham et al. v. PMI Mortgage Insurance Company. PMI
denied all facts and allegations in the lawsuit that alleged violations of
Section 8 of the Real Estate Settlement Procedures Act ("RESPA") and other
related claims.
To account for the settlement, PMI took an pre-tax charge against fourth quarter
2000 earnings of $5.7 million, which is the estimated settlement less
anticipated insurance recovery. In the third quarter of 2001, the Company
incurred an additional pre-tax charge of $1.5 million, due to the write off of a
portion of the insurance recovery as a result of the insolvency of one of the
Company's insurance carriers. The charges are based upon the estimate of the
cost of settlement less the estimate of insurance payments the Company will
receive from its insurance carriers as reimbursement for costs incurred in
connection with its defense and settlement of the action. The Company
participated in non-binding mediation with its insurance carriers with respect
to the amount of reimbursement without achieving settlement. There can be no
assurance that the Company's estimate of the amount of insurance proceeds will
be realized and such an event could have an adverse effect on the Company's
results of operations.
Various other legal actions and regulatory reviews are currently pending that
involve the Company and specific aspects of its conduct of business. In the
opinion of management, the ultimate liability in one or more of these actions is
not expected to have a material effect on the financial condition or results of
operations of the Company.
NOTE 13. REINSURANCE
PMI uses reinsurance to reduce net risk in force, to optimize capital
allocation, and to comply with a statutory provision adopted by several states
that limits the maximum mortgage insurance coverage to 25% for any single risk.
The Company's reinsurance agreements typically provide for a recovery of a
proportionate level of claim expenses from reinsurers, and reinsurance
recoverable is recorded as assets. As with all reinsurance contracts, the
Company remains liable to its policyholders if the reinsurers are unable to
satisfy their obligations under the agreements. Reinsurance recoverable and
estimates are based on the Company's actuarial analysis of the applicable
business. Amounts the Company will ultimately recover could differ materially
from amounts recorded in reinsurance recoverable. Reinsurance transactions are
recorded in accordance with the provisions of the reinsurance agreements and the
accounting guidance provided in SFAB No. 113, Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts. Reinsurance
recoverable on paid losses was $6.1 million at December 31, 2001, $9.2 million
at December 31, 2000 and $11.4 million at December 31, 1999. Prepaid reinsurance
premiums were $1.6 million in 2001, $1.8 million in 2000 and $1.7 million in
1999.
The majority of the Company's existing reinsurance contracts are captive
reinsurance arrangements. Captive reinsurance is a reinsurance product in which
a portion of the risk insured by PMI is reinsured with the mortgage originator
or investor through an affiliated entity. Ceded premiums for U.S. captive
reinsurance accounted for 81% of total ceded premiums written in 2001 compared
to 77% in 2000 and 56% in 1999.
In December 1993, PMI ceased writing capital markets pool business ("Old Pool"),
except for honoring certain commitments in existence prior to the
discontinuation of this business. Concurrently, PMI entered into a reinsurance
agreement with Forestview Mortgage Insurance Co. ("Forestview"), a wholly owned
subsidiary of Allstate, to cede all future Old Pool premiums and net losses from
PMI to Forestview. In July of 1999, PMI and Forestview received regulatory
approval of a Recapture Agreement executed in March 1999 to commute the Old Pool
reinsurance agreement retroactive to January 1, 1999. The Recapture Agreement
also included the commutation of an insignificant second lien primary insurance
agreement between the parties.
During 1999, PMI entered into a reinsurance agreement with three reinsurers to
provide coverage for a ten-year period in the event of excessive losses on PMI's
pool business. PMI paid the reinsurers a one-time premium of $16.4 million. This
agreement does not transfer risk as prescribed in SFAS 113, and therefore, is
being reported in accordance with SOP 98-7, Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Risk. The expense
attributable to the expiration of coverage provided under the contract was $2.1
million in 2001, $2.2 million in 2000 and $1.9 million in 1999.
The effects of reinsurance on premiums written, premiums earned and losses and
loss adjustment expenses of the Company's operations for the years ended
December 31 are as follows:
(Dollars in thousands) 2001 2000 1999
- -----------------------------------------------------------------------------------------
Premiums written
Direct $ 821,968 $ 676,777 $ 597,551
Assumed 1,745 2,209 8,999
Ceded (65,874) (39,924) (35,296)
--------- --------- ---------
Net premiums written $ 757,839 $ 639,062 $ 571,254
========= ========= =========
Premiums earned
Direct $ 818,946 $ 671,602 $ 586,590
Assumed 3,954 1,800 6,445
Ceded (68,129) (39,040) (34,412)
--------- --------- ---------
Net premiums earned $ 754,771 $ 634,362 $ 558,623
========= ========= =========
Losses and loss adjustment expenses
Direct $ 119,134 $ 106,301 $ 115,180
Assumed 684 (643) 3,109
Ceded (1,770) (2,579) (5,607)
--------- --------- ---------
Net losses and loss adjustment expenses $ 118,048 $ 103,079 $ 112,682
========= ========= =========
NOTE 14. DIVIDENDS AND SHAREHOLDERS' EQUITY
Dividends - Under Arizona State insurance law, PMI may pay out of any available
surplus account without prior approval of the Director of the Arizona Department
of Insurance dividends during any twelve-month period not to exceed the lesser
of 10% of policyholders' surplus as of the preceding year end, or the last
calendar year's investment income. Other state insurance laws restrict the
payment of dividends from the unassigned surplus account only. The laws of
Florida limit the payment of dividends by APTIC to TPG in any one year to 10% of
available and accumulated surplus derived from net operating profits and net
realized investment gains. In addition to the dividend restrictions by state
laws, the Company's credit agreements limit the payment of dividends by PMI,
insurance regulatory authorities have the ability, directly or indirectly, to
limit the payment of dividends to TPG by PMI or by APTIC. In 2001, APTIC
declared and paid a cash dividend of $2.5 million to TPG, substantially the full
amount of the dividend that can be paid in 2001 without prior permission from
the Florida Department of Insurance. In 2001, PMI paid a cash dividend of $50.0
million to TPG, which was approved by the Arizona Department of Insurance.
Preferred Stock - The Company's restated certificate of incorporation authorizes
the Board of Directors to issue up to 5,000,000 shares of preferred stock of TPG
in classes or series and to set the designations, preferences, qualifications,
limitations or restrictions of any class or series with respect to the rate and
nature of dividends, the price and terms and conditions on which shares may be
redeemed, the amount payable in the event of voluntary or involuntary
liquidation, the terms and conditions for conversion or exchange into any other
class or series of the stock, voting rights and other terms. The Company may
issue, without the approval of the holders of common stock, preferred stock that
has voting, dividend or liquidation rights superior to the common stock, which
may adversely affect the rights of holders of common stock.
Pursuant to the Runoff Support Agreement described in Note 18, the Company has
agreed that, in the event that Allstate makes a payment contemplated by the
Allstate Support Agreements or the Runoff Support Agreement, Allstate will have
the right to receive preferred stock of TPG or PMI with a
liquidation preference equal to the amount of such payment. Such preferred stock
will rank senior in right of payment to the issuer's common stock and, so long
as such preferred stock is outstanding, the issuer thereof will be prohibited
from paying any dividends or making any other distributions on its common stock.
NOTE 15. BENEFIT PLANS
After one year of service, full-time and part-time employees of the Company
participate in The PMI Group, Inc. Retirement Plan ("Plan"), a noncontributory
defined benefit plan. The Plan has been funded by the Company to the fullest
extent permitted by federal income tax rules and regulations. In addition,
certain employees whose earnings exceed $170,000 per year participate in The PMI
Group, Inc. Supplemental Employee Retirement Plan, a noncontributory defined
benefit plan. Benefits under both plans are based upon the employees' length of
service, average annual compensation and estimated social security retirement
benefits.
The Company provides certain health care and life insurance benefits for retired
employees, referred to as the "OPEB Plan". Generally, qualified employees may
become eligible for these benefits if they retire in accordance with the
Company's established retirement policy and are continuously insured under the
Company's group plans or other approved plans for ten or more years prior to
retirement. The Company shares the cost of the retiree medical benefits with
retirees based on years of service, and the Company's share is subject to a 5%
limit on annual medical cost inflation after retirement. The Company has the
right to modify or terminate these plans.
The following table presents certain information with respect to the Company's
benefit plans as of December 31:
Pension Benefits Other Benefits
---------------------------------- -------------------------------
(Dollars in thousands, except percentages) 2001 2000 1999 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation at January 1 $ 34,624 $ 25,537 $ 18,376 $ 4,814 $ 3,952 $ 4,219
Service cost 6,130 5,955 5,443 529 574 578
Interest cost 3,098 2,725 1,710 373 410 320
Actuarial loss (gain) 935 1,614 1,046 (266) (92) (1,139)
Benefits paid (803) (1,207) (1,038) (55) (30) (26)
-------- -------- -------- ------- ------- -------
Benefit obligation at December 31 43,984 34,624 25,537 5,395 4,814 3,952
-------- -------- -------- ------- ------- -------
Change in plan assets
Fair value of plan assets at January 1 17,136 13,894 8,877 -- -- --
Actual return (loss) on plan assets (2,494) 1,296 2,397 -- -- --
Company contribution 5,864 3,155 3,658 55 30 26
Benefits paid (803) (1,209) (1,038) (55) (30) (26)
-------- -------- -------- ------- ------- -------
Fair value of plan assets at December 31 19,703 17,136 13,894 -- -- --
-------- -------- -------- ------- ------- -------
Funded status
Funded (under funded) status of plan
at December 31 (24,281) (17,488) (11,643) (5,396) (4,814) (3,952)
Unrecognized actuarial loss (gain) 9,129 4,357 2,891 (1,708) (1,532) (1,460)
Unrecognized prior service cost -- -- -- 205 225 245
-------- -------- -------- ------- ------- -------
Accrued and recognized benefit cost $(15,152) $(13,131) $ (8,752) $(6,899) $(6,121) $(5,167)
======== ======== ======== ======= ======= =======
Components of net periodic benefit cost
Service cost $ 6,130 $ 5,955 $ 5,443 $ 529 $ 574 $578
Interest cost 3,098 2,725 1,710 373 411 320
Expected return on assets (1,495) (1,363) (893) -- -- --
Prior service cost amortization -- -- -- -- 20 20
Actuarial loss (gain) recognized 205 216 234 19 (20) --
Additional cost 305 -- -- (90) -- --
------- ------- ------- ----- ----- ----
Net periodic benefit cost $ 8,243 $ 7,533 $ 6,494 $ 831 $ 985 $918
======= ======= ======= ===== ===== ====
Weighted-average assumptions
Discount rate 7.50% 7.75% 8.00% 7.50% 7.75% 8.00%
Expected return on plan assets 8.50% 8.50% 8.50% N/A N/A N/A
Rate of compensation increase 5.50% 5.50% 5.50% N/A N/A N/A
Health care cost trend on covered charges N/A N/A N/A 6.00% 6.00% 6.00%
Sensitivity of retiree welfare results. Assumed health care cost trend rates
have a significant effect on the amounts reported for the health care plans. A
one-percentage-point change in assumed health care cost trend rates would have
the following effects:
One-Percentage- One-Percentage-
(In thousands) Point Increase Point Decrease
- -----------------------------------------------------------------------------------------------
Effect on total of service and interest cost components $ 200 $155
Effect on accumulated post-retirement benefit obligation 1,048 821
Savings and Profit Sharing Plans. All full-time, part-time and certain temporary
employees of the Company are eligible to participate in The PMI Group, Inc.
Savings and Profit-Sharing Plan ("401(k) Plan"). Eligible employees who
participate in the 401(k) Plan receive, within certain limits, matching Company
contributions. Costs relating to the 401(k) Plan were $2.7 million for 2001,
$2.4 million for 2000 and $2.2 million for 1999. Contract underwriters are
covered under The PMI Group, Inc. Alternate 401(k) Plan, under which there are
no matching Company contributions.
NOTE 16. INCENTIVE PLANS
Equity Incentive Plan - In 2001, the shareholders approved the amendment of The
PMI Group, Inc. Equity Incentive Plan ("Equity Incentive Plan") and The PMI
Group, Inc. Stock Plan for Non-Employee Directors ("Directors Plan"), to reflect
the merger of the Directors Plan into the Equity Incentive Plan. Pursuant to the
merger, the director awards are now made under the Equity Incentive Plan on
substantially the same terms and conditions as were in effect under the Director
Plan before the plan merger date. The Equity Incentive Plan provides for awards
of both non-qualified stock options and incentive stock options, stock
appreciation rights, restricted stock subject to forfeiture and restrictions on
transfer, and performance awards entitling the recipient to receive cash or
common stock in the future following the attainment of performance goals
determined by the Board of Directors. Generally, options are granted with an
exercise price equal to the market value on the date of grant, expire ten years
from the grant date and have a three-year vesting period. The directors' award
program provides that each director who is not an employee of the Company
receives an annual grant of up to 450 shares of common stock and receives 3,750
shares of stock options annually, after an initial option of up to 6,000 shares.
The shares are granted on June 1 of each year or as soon as administratively
practicable after each anniversary of the director's commencement of service.
The following is a summary of the stock option activity in the Equity Incentive
Plan during 2001, 2000 and 1999:
2001 2000 1999
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Option Exercise Price Under Option Exercise Price Under Option Exercise Price
- -----------------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of year 2,078,103 $36.31 1,756,041 $34.41 1,318,388 $36.13
Granted 751,745 60.52 646,667 39.12 587,256 29.54
Exercised (159,039) 33.54 (243,021) 30.63 (102,776) 25.19
Forfeited (42,559) 51.96 (81,584) 34.65 (46,827) 42.18
--------- --------- ---------
Outstanding at end of year 2,628,250 43.15 2,078,103 36.31 1,756,041 34.41
========= ========= =========
Exercisable at year-end 1,141,123 $34.94 827,541 $33.20 746,398 $31.00
Weighted-average fair
market value of options
granted during the year -- $60.52 -- $39.12 -- $29.54
Reserved for future grants 4,498,810 -- 1,738,350 -- 2,353,469 --
Note: As of December 31, 2001, exercise price for options outstanding ranged
from $19.66 to $70.88. The weighted-average remaining contractual life of three
options was 7.3 years.
The fair value of stock-based compensation to employees is calculated using the
option pricing models that are developed to estimate the fair value of freely
tradable and fully transferable options without vesting restrictions, which
differ from the Company's stock option program. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect calculated value. The fair value of each
stock option grant is estimated on the date of the grant using the Black-Scholes
option pricing model with the following weighted-average assumptions:
2001 2000 1999
- --------------------------------------------------------------------------------
Dividend yield 0.28% 0.30% 0.35%
Expected volatility 36.92% 35.08% 29.66%
Risk-free interest rate 4.50% 6.14% 5.53%
SFAS 123 requires the pro-forma disclosure of net income and earnings per share
using the fair value method. If the computed fair values of the 2001, 2000 and
1999 awards had been amortized to expense over the vesting period of the awards,
the Company's net income, basic net income per share and diluted net income per
share would have been reduced to the pro-forma amounts indicated below:
(Dollars in thousands, except per share amounts) 2001 2000 1999
- --------------------------------------------------------------------------------
Net income:
As reported $307,212 $260,212 $204,466
Pro-forma 298,444 255,811 201,503
Basic earnings per share:
As reported $ 6.91 $ 5.88 $ 4.55
Pro-forma 6.72 5.78 4.49
Diluted earnings per share:
As reported $ 6.78 $ 5.78 $ 4.52
Pro-forma 6.58 5.68 4.45
Equity Stock Purchase Plan - In 1999, the Company adopted The PMI Group, Inc.
Employee Stock Purchase Plan ("ESPP"). The ESPP allows eligible employees to
purchase shares of the Company's stock
at 15% discount of fair market value of the stock at the beginning or ending of
each six-month enrollment period, whichever is lower. Under the ESPP, the
Company sold approximately 26,693 shares in 2001, 23,638 shares in 2000 and
13,578 shares in 1999. The Company applies APB 25 in accounting for the ESPP.
The pro-forma effect on the Company's net income and earnings per share had
compensation cost been determined under SFAS 123 was deemed immaterial in 2001.
NOTE 17. STATUTORY ACCOUNTING
The Company's domestic insurance subsidiaries prepare statutory financial
statements in accordance with the accounting practices prescribed or permitted
by their respective state's Department of Insurance, which is a comprehensive
basis of accounting other than GAAP.
The National Association of Insurance Commissioners ("NAIC") revised the NAIC
Accounting Practices and Procedures Manual in a process referred to as
Codification. The revised manual was adopted by the respective states effective
January 1, 2001. The Company prepares its statutory financial statements in
conformity with accounting practices prescribed or permitted by the State of
Arizona. Effective January 1, 2001, the State of Arizona required that insurance
companies domiciled in the State of Arizona prepare their statutory basis
financial statements in accordance with the NAIC Accounting Practices and
Procedures Manual - Version effective January 1, 2001 subject to any deviations
prescribed or permitted by the State of Arizona insurance commissioner.
Accounting changes adopted to conform to the provisions of the NAIC Accounting
Practices and Procedures Manual are reported as changes in accounting
principles. The cumulative effect of changes in accounting principles is
reported as an adjustment to unassigned funds, or surplus, at the end of the
period in which the change in accounting principle occurs. The cumulative effect
is the difference between the amount of capital and surplus at the beginning of
the period and the amount of capital and surplus that would have been reported
at that date if the new accounting principles had been applied retroactively for
all prior periods. As a result of these changes, the Company reported an
increase in statutory unassigned funds of $6.2 million as of January 1, 2001.
The statutory net income, statutory surplus and contingency reserve liability of
PMI as of and for the years ended December 31 are as follows:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Statutory net income $ 318,989 $ 276,946 $ 270,301
Statutory surplus 190,813 159,528 134,133
Contingency reserve liability 1,709,896 1,457,991 1,238,140
Under the insurance laws of the State of Arizona and several other states,
mortgage insurers are required to establish a special contingency reserve from
unassigned funds, with annual additions equal to 50% of premiums earned for that
year. This reserve is required to be maintained for a period of 120 months to
protect against the effects of adverse economic cycles. After 120 months, the
reserve is released to unassigned funds. In the event an insurer's loss ratio in
any calendar year exceeds 35%, however, the insurer may withdraw from its
contingency reserve an amount equal to the excess portion of such losses. The
Company has not withdrawn from the contingency reserve since the year ended
1997.
The differences between the statutory net income and equity presented above and
the consolidated net income and equity presented on a GAAP basis primarily
reflect the differences between GAAP and statutory accounting practices as well
as the results of operations and equity of other subsidiaries of the Company.
NOTE 18. CAPITAL SUPPORT AGREEMENTS
PMI's claims-paying ratings from certain national rating agencies have been
based on various capital support commitments from Allstate ("Allstate Support
Agreements"). On October 27, 1994, the Allstate Support Agreements were
terminated with respect to policies issued after October 27, 1994, but continue
in modified form (as so modified, the "Runoff Support Agreement") for policies
written prior to such termination. Under the terms of the Runoff Support
Agreement, Allstate may, at its option, either directly pay or cause to be paid,
claims relating to policies written during the terms of the respective Allstate
Support Agreements if PMI fails to pay such claims or, in lieu thereof, make
contributions directly to PMI or TPG. In the event any amounts are paid or
contributed, which possibility management believes is remote; Allstate would
receive subordinated debt or preferred stock of PMI or TPG in return. No payment
obligations have arisen under the Runoff Support Agreement. The Runoff Support
Agreement provides PMI with additional capital support for rating agency
purposes.
The Runoff Support Agreement contains certain covenants, including covenants
that (i) PMI will write no new business after its risk-to-capital ratio equals
or exceeds 23 to 1; (ii) PMI will pay no dividends if, after the payment of any
such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; and
(iii) on the date that any of the following events occur: (a) PMI's
risk-to-capital ratio exceeds 24.5 to 1, (b) Allstate shall have paid any claims
relating to PMI policies directly to a policyholder or by paying an amount equal
to such claims to PMI, or to TPG for contribution to PMI, pursuant to the Runoff
Support Agreement, or (c) any regulatory order is issued restricting or
prohibiting PMI from making full or timely payments under policies, PMI will
transfer substantially all of its assets in excess of $50.0 million to a trust
account established for the payment of claims.
In 1997, PMI entered into a capital support commitment to Duff & Phelps Credit
Rating Co. ("Fitch"), under which it agreed to contribute to APTIC amounts
necessary to maintain APTIC's capital and surplus at a level no less than 100%
of Fitch's risk adjusted capital requirements to attain a Fitch claims paying
ability rating of not less than "AA-" at the end of each year. PMI also entered
a cancellation agreement with APTIC that provides that, in the event PMI
provides notice of its intent to cancel the capital support commitment, APTIC
will immediately submit a request to Fitch to be rated on a stand-alone basis
and sign an agreement canceling APTIC's rights under the capital support
commitment.
In 2001, PMI executed a capital support agreement whereby it agreed to
contribute funds, under specified conditions, to maintain CMG's risk-to-capital
at or below 18.0 to 1. PMI's obligation under the agreement is limited to an
aggregate amount of $37.7 million, exclusive of capital contributions made prior
to April 10, 2001. A 1999 CMG capital support agreement was superceded by
execution of the new agreement. On December 31, 2001, CMG's risk-to capital
ratio was 14.8 to 1.
PMI has entered into capital support agreements with its European and Australian
subsidiaries that could require PMI to make additional capital contributions to
those subsidiaries in order to maintain their credit ratings. With respect to
the European and Australian subsidiaries, the Company guarantees the performance
of PMI's capital support agreements.
As of December 31, 2001, the Company was in compliance with all covenants
included in its capital support agreements.
NOTE 19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
A summary of selected quarterly results follows:
First Quarter Second Quarter Third Quarter Fourth Quarter
------------------- ------------------- ------------------- -------------------
2001 2000 2001 2000 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)
Revenues $204,573 $179,418 $216,621 $187,893 $236,817 $195,046 $278,952 $200,211
Net income $ 71,531 $ 59,990 $ 75,197 $ 64,979 $ 78,344 $ 69,256 $ 82,140 $ 65,983
Basic EPS $ 1.61 $ 1.36 $ 1.69 $ 1.47 $ 1.76 $ 1.57 $ 1.84 $ 1.49
Diluted EPS $ 1.59 $ 1.34 $ 1.66 $ 1.45 $ 1.72 $ 1.53 $ 1.81 $ 1.46
Earnings per share is computed independently for the quarters presented.
Therefore, the sum of the quarterly earnings per share amounts may not equal the
total computed for the year.
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
The PMI Group, Inc.
We have audited the accompanying consolidated balance sheets of The PMI Group,
Inc. and subsidiaries (the Company) as of December 31, 2001 and 2000, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the two years then ended. Our audits also included the financial
statement schedules as of and for each of the two years ended December 31, 2001
listed in the index at item 14(a). These financial statements and schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedules based on our audits. The
financial statements of the Company for the year ended December 31, 1999 were
audited by other auditors whose report dated January 20, 2000, expressed an
unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The PMI Group,
Inc. and subsidiaries at December 31, 2001 and 2000, and the consolidated
results of their operations and their cash flows for each of the years then
ended, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedules as of
and for each of the two years ended December 31, 2001, when considered in
relation to the basic financial statements taken as a whole, present fairly in
all material respects the information set forth therein.
/s/ Ernst & Young LLP
Los Angeles, California
January 21, 2002
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of The PMI Group, Inc.:
We have audited the accompanying consolidated statements of operations, cash
flows, and shareholders' equity of The PMI Group, Inc. and subsidiaries for the
year ended December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of the operations, cash flows and shareholders'
equity of The PMI Group, Inc. and subsidiaries for the year ended December 31,
1999, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Deloitte & Touche LLP
San Francisco, California
January 20, 2000