EXHIBIT 13.1
I N D E X T O F I N A N C I A L S
32 Five Year Summary of Financial Data
33 Management's Discussion and Analysis of Financial
Condition and Results of Operations
42 Consolidated Statements of Operations
43 Consolidated Balance Sheets
44 Consolidated Statements of Shareholders' Equity
45 Consolidated Statements of Cash Flows
47 Notes to Consolidated Financial Statements
61 Report of Management
61 Report of Independent Auditors
31
F I V E Y E A R S U M M A R Y O F F I N A N C I A L D A T A
(In thousands, except per share data) 1996 1995 1994 1993 1992
---- ---- ---- ---- ----
SUMMARY OF CONSOLIDATED OPERATIONS:
Net premiums written $ 403,020 $ 314,021 $ 277,747 $ 291,089 $ 208,602
=========== =========== =========== =========== ===========
Premiums earned $ 412,738 $ 328,756 $ 296,345 $ 268,554 $ 173,039
Investment income, less
investment expense 67,442 62,041 56,774 45,733 40,847
Realized capital gains
and losses 14,296 11,934 3,064 1,229 686
Other income 6,948 2,309 3,802 -- --
----------- ----------- ----------- ----------- -----------
Total revenues 501,424 405,040 359,985 315,516 214,572
Total losses and expenses 279,318 224,499 221,434 202,543 119,912
----------- ----------- ----------- ----------- -----------
Income from continuing operations
before income taxes 222,106 180,541 138,551 112,973 94,660
Income tax expense
(benefit)* 64,188 45,310 32,419 24,305 (10,911)
----------- ----------- ----------- ----------- -----------
Income from continuing
operations* 157,918 135,231 106,132 88,668 105,571
Income (loss) from discontinued
operations -- -- -- (28,863) 6,726
----------- ----------- ----------- ----------- -----------
Net income $ 157,918 $ 135,231 $ 106,132 $ 59,805 $ 112,297
=========== =========== =========== =========== ===========
MORTGAGE INSURANCE OPERATING RATIOS:
Loss ratio 41.9% 38.5% 40.5% 41.4% 33.2%
Expense ratio 18.4% 24.9% 30.1% 28.2% 27.0%
----- ----- ----- ----- -----
Combined ratio 60.3% 63.4% 70.6% 69.6% 60.2%
===== ===== ===== ===== =====
CONSOLIDATED BALANCE SHEET DATA:
Total assets $ 1,509,919 $ 1,304,440 $ 1,097,421 $ 985,129 $ 815,136
Reserve for losses and
loss adjustment expenses $ 199,774 $ 192,087 $ 173,885 $ 135,471 $ 94,002
Long-term obligations $ 99,342 -- -- -- --
Shareholders' equity $ 986,862 $ 870,503 $ 687,178 $ 575,300 $ 513,583
PER SHARE DATA:
Income from continuing
operations $ 4.51 $ 3.85 $ 3.03 $ 2.53 $ 3.02
Income (loss) from
discontinued operations -- -- -- (0.82) 0.19
----------- ----------- ----------- ----------- -----------
Net income $ 4.51 $ 3.85 $ 3.03 $ 1.71 $ 3.21
=========== =========== =========== =========== ===========
Shareholders' equity $ 28.60 $ 24.87 $ 19.63 $ 16.44 $ 14.67
Cash dividends declared $ 0.20 $ 0.15 -- -- --
PMI OPERATING AND STATUTORY DATA:
Number of policies in force 700,084 657,800 612,806 543,924 428,745
Default rate 2.19% 1.98% 1.88% 1.81% 2.03%
Persistency 83.3% 86.4% 83.6% 70.0% 74.6%
Direct primary insurance
in force (in millions) $ 77,312 $ 71,430 $ 65,982 $ 56,991 $ 43,698
Direct primary risk in
force (in millions) $ 17,336 $ 15,130 $ 13,243 $ 11,267 $ 8,676
Statutory capital $ 988,475 $ 824,156 $ 659,402 $ 494,621 $ 456,931
Risk-to-capital ratio 15.9:1 15.8:1 17.7:1 20.8:1 19.0:1
Total PMI employees 586 578 586 632 529
* During 1991, the Company increased its tax liabilities and income tax expenses 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 reevaluated its tax balances and reduced
its tax liabilities and income tax expense by $30.9 million.
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF CONSOLIDATED OPERATIONS
1996 VERSUS 1995
Consolidated net income in 1996 was $157.9 million, a 16.8% increase over net
income of $135.2 million in 1995. The increase was attributable to increases
primarily in premiums earned and secondarily in investment income (including
capital gains) of 25.5% and 10.5%, respectively, partially offset by increases
primarily in losses and loss adjustment expenses and secondarily in underwriting
and other expenses (including interest expense) of 35.1% and 13.7%,
respectively. Premiums earned increased primarily from the ongoing mortgage
insurance operations, secondarily from a one time impact of a cancellation of a
quota share treaty with its primary reinsurers, and also from the title
insurance operations. Earnings per share were $4.51 in 1996 compared with $3.85
in 1995, a 17.1% increase. Excluding capital gains, earnings per share were
$4.24 in 1996 compared with $3.63 in 1995, a 16.8% increase. Revenues in 1996
were $501.4 million, a 23.8% increase over revenues of $405.0 million in 1995.
PMI Mortgage Insurance Co.'s ("PMI") new insurance written ("NIW") totaled $17.9
billion in 1996 compared with $14.5 billion in 1995, a 23.4% increase. The
increase in NIW resulted primarily from the number of new mortgage insurance
policies issued increasing by 19.5%, to 142,900 policies in 1996 from 119,600
policies in 1995, and secondarily from an increase in the average loan size to
$125,100 from $120,900. NIW net of quota share reinsurance increased by 39.3% to
$17.0 billion in 1996 from $12.2 billion in 1995. This increase was affected by
three factors: first, the increase in gross NIW; second, effective for new
policies written in 1996, PMI reduced its percentage of quota share cessions
from approximately 15% in 1995 to 5% in 1996; third, effective December 31, 1996
PMI terminated and commuted its reinsurance agreement with its primary
reinsurers, Centre Reinsurance Company of New York and Centre Reinsurance
International Company, collectively referred to as "Centre Re". The impact of
the Centre Re commutation is described below.
One of the factors contributing to the increase in new policies issued was
growth in market share in 1996 compared with 1995. PMI's market share of NIW
increased to 14.1% during 1996 from 13.2% in 1995. On a combined basis with CMG
Mortgage Insurance Company ("CMG"), market share increased to 14.7% in 1996
compared with 13.5% in 1995. CMG is a 45% owned affiliate of PMI and is
accounted for on the equity method in the Company's consolidated financial
statements. A second factor was the growth in the total number of insurable loan
originations in the mortgage insurance industry in 1996 compared with 1995,
which was caused by increases in the purchase market and refinancing activity
primarily in the first half of 1996. Refinancing as a percentage of PMI's NIW
increased by 5.4 percentage points, to 16.9% in 1996 from 11.5% in 1995.
Consistent with the industry, PMI experienced a significantly higher level of
refinance business in the first half of 1996 as compared with the second half of
1996.
PMI (excluding CMG) experienced a drop in market share of NIW from the third
quarter of 1996 to the fourth quarter of 1996, from 14.7% to 13.7%. It is
management's conclusion that this drop in market share was due to increases in
product competition, including the availability of a pool insurance product not
offered by PMI. During the first quarter of 1997, competitive pressures
continued to adversely impact market share, and management expects this trend to
continue into the second quarter of 1997. See Cautionary Statement.
PMI's persistency rate (percentage of insurance remaining in force from one year
prior) decreased 3.1 percentage points during 1996, and stands at 83.3% as of
December 31, 1996 compared with 86.4% as of December 31, 1995. The persistency
rate leveled off in the second quarter of 1996 and experienced slight but
consistent
33
improvements in the third and fourth quarters. This trend is consistent with
PMI's refinancing activity during 1996. Insurance in force grew at a rate of
8.3% during 1996 to a total of $77.3 billion at December 31, 1996 compared with
$71.4 billion at December 31, 1995. The higher level of NIW in 1996 compared
with 1995, coupled with the slight rebound in persistency during the second half
of 1996, slightly improved the 1996 growth rate of insurance in force to 8.3%
over the 1995 rate of 8.2%.
Mortgage insurance net premiums written were $349.8 million in 1996 compared
with $273.7 million 1995, an increase of 27.8%. The increase is attributable
primarily to the increase in NIW over the 1995 level, secondarily to the Centre
Re commutation, and also to higher average premiums resulting from the
increasing shift to deep coverage loans, higher average loan sizes and the
growth of insurance in force. New premiums written decreased by 15.6% to $21.6
million in 1996 from $25.6 million in 1995, while renewal premiums increased by
22.3% to $345.1 million in 1996 from $282.1 million in 1995. The decrease in new
premiums written during 1996 resulted primarily from the continuing shift to the
monthly premium product from an annual premium product. The monthly premium plan
as a percentage of NIW represented 95.1% of NIW in 1996 compared with 85.2% in
1995, and 96.6% in the fourth quarter of 1996 compared with 91.0% in the
corresponding period of 1995.
The increase in average premiums was caused by a continuing shift to mortgages
with loan-to-value ratios greater than 90% and equal to or less than 95% ("95s")
with increased insurance coverage, partially offset by a decrease in the use of
adjustable rate mortgages (ARMs). 95s with 30% coverage increased to 41.8% of
NIW in 1996 compared with 34.7% in 1995. Similarly, mortgages with loan-to-value
ratios greater than 85% and equal to or less than 90% ("90s") with 25% coverage
increased to 41.7% in 1996 compared with 32.9% in 1995. ARMs decreased to 13.4%
of NIW in 1996 compared with 21.3% in 1995.
Refunded premiums increased by 24.0% in 1996 to $15.5 million from $12.5 million
in 1995. This was due primarily to the increase in policy cancellations related
to the growth in mortgage refinancing volume during the first half of 1996.
Mortgage insurance ceded premiums were $1.3 million in 1996 compared with $21.5
million in 1995, while PMI's ceded premiums written as a percentage of net new,
renewal and refunded premiums decreased to 0.2% in 1996 compared with 9.2% in
1995. The reduction of ceding percentages in 1996 was due primarily to the
Centre Re commutation and secondarily to a larger portion of premiums remaining
with the Company through the use of Residential Guaranty Co. ("RGC"), a
subsidiary of The PMI Group, Inc. ("TPG"), as a reinsurer.
Mortgage insurance premiums earned increased 24.6% to $359.5 million in 1996
from $288.5 million in 1995. This increase is due primarily to the increase in
NIW over the 1995 level, secondarily to the Centre Re commutation, and also to
the growth in insurance in force in 1996 over 1995, the impact of higher premium
rates resulting from the shift to increased insurance coverage products and
higher average loan sizes.
The Company's net investment income in 1996 was $67.4 million compared with
$62.0 million in 1995, an increase of 8.7%. The increase was primarily
attributable to the growth in the average amount of invested assets, which
resulted from cash flows generated by operating activities, partially offset by
a decrease in the average investment yield (pretax) to 6.1% in 1996 from 6.5% in
1995. Realized capital gains (net of losses) reported an increase over 1995, up
20.2% to $14.3 million in 1996 from $11.9 million in 1995.
Mortgage insurance losses and loss adjustment expenses increased to $150.6
million in 1996 from $111.0 million in 1995, an increase of 35.7%. This increase
was due primarily to the growth and maturation of insurance in force,
secondarily to the Centre Re commutation, and also to increased claim amounts
associated with the higher coverage percentages, higher loan sizes and an
increase in the default rate.
The majority of claims under PMI policies have historically occurred during the
third through the sixth years after issuance of the policies. Insurance written
by PMI from the period January 1, 1991 through December 31, 1994
34
represents 55.4% of PMI's insurance in force at December 31, 1996, with the 1993
book of business alone representing 22.5%. This substantial volume of PMI's
business is in its expected peak claim period. Consistent with increasing
coverage percentages and increasing mortgage principal amounts, claim amounts
have risen in recent years. Claims paid in 1996 were $130.1 million compared
with $93.7 million in 1995. Also, PMI has been experiencing an acceleration in
its claim payment process. This acceleration is a result of Fannie Mae's and
Freddie Mac's loss mitigation efforts to make earlier determinations regarding
delinquent loans and to accelerate the loan foreclosure and claim process.
Management believes that this is only an acceleration of the timing of payments,
and will not increase the expected number of claims ultimately paid by PMI.
Policies written in California accounted for approximately 73% and 67% of the
total dollar amount of claims paid in 1996 and 1995, respectively. Although
management expects that during 1997 California will continue to account for the
majority of total claims paid, management also anticipates that California
claims paid as a percentage of total claims paid will begin to decline
consistent with the decline in default rates on PMI's California policies
discussed below. Accordingly, management anticipates the average claim size to
decrease over the long term.
In addition to claim increases, PMI's default rate has increased to 2.19% at
December 31, 1996 from the December 31, 1995 rate of 1.98%. This increase was
primarily caused by a growth in the inventory level of notices of delinquency
due primarily to the maturation of PMI's 1992 and 1993 books of business.
Management expects this trend to continue in 1997. See Cautionary Statement.
Default rates on PMI's California policies decreased to 3.81% at December 31,
1996, from 4.08% at December 31, 1995. Policies written in southern California
in the years 1989 through 1993, which are in the historically highest claim
period, are also generally believed to have been written at the high point of
southern California real estate prices. The California economy continues to
recover more slowly than anticipated when the policies were issued. Accordingly,
California default rates for each of the policy years since 1989 may continue to
experience an average default rate higher than the national average default
rate. However, the default rates for California experienced year over year
improvements in the third and fourth quarters of 1996, and management expects
this trend to continue in 1997. See Cautionary Statement.
Mortgage insurance underwriting and other expenses decreased to $64.4 million in
1996 from $68.0 million in 1995, or 5.3%. This decrease, in contrast to the
growth rate in NIW, is primarily the result of management's focus on controlling
expenses and the expense ratio, and secondarily to the Centre Re commutation.
The mortgage insurance loss ratio increased to 41.9% in 1996 compared with 38.5%
in 1995 due to the increase in losses and loss adjustment expenses discussed
above. The expense ratio reported an improvement over 1995, dropping to 18.4% in
1996 from 24.9% in 1995, resulting in a combined ratio of 60.3% in 1996, 3.1
percentage points better than the 1995 ratio of 63.4%. The impact of the Centre
Re commutation was to decrease the stated mortgage insurance expense ratio for
1996 by approximately two percentage points and to increase the loss ratio by a
corresponding amount. The net impact of the Centre Re commutation was immaterial
to the mortgage insurance combined ratio for the year ending December 31, 1996.
Title insurance premiums earned increased 32.0% to $53.2 million in 1996
compared with $40.3 million in 1995. This improvement was due to expansion
efforts of the title business, as well as the overall improvement in the volume
of residential mortgage originations. Underwriting and other expenses increased
31.5% to $48.0 million in 1996 compared to $36.5 million in 1995. This increase
is directly attributable to the increase in premiums earned. The title insurance
combined ratio decreased to 93.5% in 1996 from 95.4% in 1995. The title
insurance industry expense ratios are much higher than those experienced in the
mortgage insurance industry primarily because the commission rates paid to title
agencies and attorneys are substantially higher than those paid to mortgage
insurance sales agents.
35
Other income, primarily revenues generated by PMI Mortgage Services Co. ("MSC"),
increased to $6.9 million in 1996 from $2.3 million in 1995. This growth is
primarily due to increased mortgage services operations resulting from higher
refinancing activity and expansion of its contract underwriting services.
The Company's effective tax rate was 28.9% in 1996 compared to 25.1% in 1995.
The benefits of tax-preference investment income and other permanent differences
reduced the effective rates below the statutory rate of 35% during both periods.
The increase in the effective rate in 1996 over 1995 was due to a greater
portion of operating income generated from insurance operations rather than
tax-free bond income, the state tax effect of PMI's $25.0 million cash dividend
and transfer of American Pioneer Title Insurance Company ("APTIC") to TPG, and a
shift in the mix of the investment portfolio to a greater portion of taxable
fixed-income bonds.
1995 VERSUS 1994
Net income in 1995 was $135.2 million, a 27.4% increase over 1994 net income of
$106.1 million. The increase was primarily attributable to increases in premiums
earned and investment income (including capital gains) of 10.9% and 23.6%,
respectively, and a decrease in operating expenses of 5.0%, partially offset by
an increase in losses and loss adjustment expenses of 8.6%. Earnings per share
were $3.85 for the year compared with $3.03 in 1994, a 27.1% increase. Excluding
capital gains, earnings per share were $3.63 in 1995 compared with $2.97 in
1994, a 22.2% increase. Revenues in 1995 were $405.0 million, a 12.5% increase
over revenues of $360.0 million in 1994.
New mortgage insurance written totaled $14.5 billion in 1995 compared with $18.4
billion in 1994, a 21.2% decrease. The decrease in NIW resulted from the number
of new mortgage insurance policies written declining by 23.3%, to 119,600
policies in 1995 from 156,000 policies in 1994. One of the factors contributing
to this decrease was the drop in refinancing activity in 1995 versus 1994.
Refinancings showed a significant decrease of 56.4% to 12,300 policies in 1995
from 28,200 policies in 1994. Refinancing as a percentage of NIW decreased by
6.8 points, to 11.5% in 1995 from 18.3% in 1994. The number of policies written
for new purchases also dropped in 1995 from the 1994 level, to 107,300 from
127,800, a 16.0% decline. Management believes that a second contributing factor
to the decline in total NIW was PMI's reluctance to aggressively participate in
a market which displayed a deteriorating trend in borrower credit quality
beginning in late 1994 and continuing into 1995. Consequently, PMI's market
share of NIW in 1995 declined to 13.2% compared to 14.0% in 1994.
PMI's persistency rate increased 2.8 points in 1995 over the 1994 rate, to 86.4%
from 83.6%. This increase is primarily attributable to the decrease in
refinancing activity in 1995. The increased persistency contributed to the
growth of insurance in force to $71.4 billion at December 31, 1995, from $66.0
billion at December 31, 1994. Growth in insurance in force continued during 1995
at a slower pace than the 1994 growth level, 8.2% in 1995 versus 15.8% in 1994,
primarily due to the decrease in NIW.
Mortgage insurance net premiums written in 1995 were $273.7 million, compared
with $232.3 million in 1994, an increase of 17.8%. The increase is primarily
attributable to higher renewal premiums due to improved persistency and to a
decline in ceded and refunded premiums, partially offset by a decline in new
premiums written. The decline in new premiums written in 1995 was due to the
decrease in NIW in 1995 from 1994, and the increasing usage of the monthly
premium plan in 1995. The increase in net premiums written is also attributable
to higher average premiums for NIW during 1995 compared with 1994. The higher
average premiums were caused by an increasing shift to 95s with deeper coverage,
partially offset by a decline in the use of ARMs. 95s with 30% coverage
increased to 34.7% of NIW in 1995 compared with 1.2% in 1994, while ARMs
decreased to 21.3% of NIW in 1995 compared with 29.7% in 1994. The deeper
coverage percentages are primarily a result of changes in Fannie Mae and Freddie
Mac coverage requirements effective in 1995. The new
36
deeper coverage percentages for 30 year loans include 30 percent coverage on 95s
and 25 percent coverage on 90s.
PMI's monthly premium plan experienced significant growth in popularity during
1995, its first full year in PMI's product line. The monthly plan represented
85.2% of NIW in 1995, up 48.2 points from the 1994 level of 37.0%. This trend
toward the monthly premium product has significantly impacted PMI's premium mix
from new to renewals. The monthly product spreads the receipt of premiums over
12 equal monthly payments (which initially reduces the amount of premiums
written), compared to the annual prepayment method (where the entire annual
premium is recorded as written at the effective date of the policy). For the
monthly premium plan, PMI recognizes only the first month's premium as new
premium written while subsequent monthly premium payments are recognized as
renewal premiums. Management believes that the monthly premium plan does not
significantly impact net premiums earned. The monthly premium products have been
priced to compensate for the different timing of cash flows (as compared to
annual premium products) and the related impact on investment income, and,
accordingly, will have no significant effect on the Company's results of
operations.
Refunded premiums in 1995 decreased by 15.0% to $12.5 million from $14.7 million
in 1994 due primarily to the decrease in refinancing volume during 1995. Ceded
premiums written as a percentage of net new, renewal and refunded premiums
decreased to 9.2% in 1995 compared to 10.4% in 1994.
Mortgage insurance premiums earned increased 15.0% to $288.5 million in 1995
from $250.9 million in 1994. This increase is due primarily to the growth in
insurance in force in 1995 over 1994 and the impact of higher premium rates from
the shift to deeper coverage products.
The Company's net investment income in 1995 was $62.0 million compared with
$56.8 million in 1994, an increase of 9.2%. The increase was primarily
attributable to the growth in the average amount of invested assets, which
resulted from positive cash flows generated by operating activities, partially
offset by a decrease in the effective yield. The average effective yield
(pretax) on the portfolio's invested value during 1995 decreased to 6.5% from
6.9% in 1994, primarily due to an increasing portion of the portfolio being
invested in lower yielding, tax-exempt municipal bonds. Realized capital gains
(net of losses) reported a significant increase over 1994, up $8.8 million to
$11.9 million in 1995 from $3.1 million in 1994. This increase is consistent
with the 1995 stock market performance.
Mortgage insurance losses and loss adjustment expenses increased to $111.0
million in 1995 from $101.6 million in 1994, an increase of 9.3%. This increase
was primarily the result of the growth in insurance in force in recent years and
the increased default rates and claim amounts in certain areas of the country,
particularly California.
Consistent with increasing coverage percentages and increasing mortgage
principal amounts, claim amounts have risen in recent years, while PMI's book of
business continues to mature into the higher-frequency claim period. Insurance
written by PMI in the period from January 1, 1990 through December 31, 1993
represented 51.6% of PMI's insurance in force at December 31, 1995. In addition,
PMI's default rate has increased over the 1994 level by 10 basis points, from
1.88% to 1.98% at December 31, 1995.
Mortgage insurance underwriting and other expenses decreased 2.7% to $68.0
million in 1995 from $69.9 million in 1994. This decrease is primarily the
result of the decrease in NIW in 1995.
The mortgage insurance loss ratio decreased to 38.5% in 1995 compared with 40.5%
in 1994 due, in part, to a $20.7 million decrease in prior year reserves
recorded in 1995. The expense ratio also reported an improvement over 1994,
dropping to 24.9% in 1995 from 30.1% in 1994, resulting in a combined ratio of
63.4% in 1995, 7.2 points better than the 1994 ratio of 70.6%.
37
Title insurance premiums earned decreased 11.2% to $40.3 million in 1995
compared with $45.4 million in 1994. Underwriting and other expenses decreased
9.9% to $36.5 million in 1995 compared to $40.5 million in 1994. These decreases
are attributable to an overall decline in the volume of residential mortgage
originations. The title insurance combined ratio increased slightly to 95.4% in
1995 from 94.1% in 1994.
Other income, primarily revenues generated by MSC, decreased to $2.3 million in
1995 from $3.8 million in 1994, a 39.5% decline. This decrease is primarily due
to reduced mortgage services operations resulting from lower refinancing
activity.
The Company's effective tax rate was 25.1% in 1995 compared to 23.4% in 1994.
The benefits of tax-preference investment income and other permanent differences
reduced the effective rates below the statutory rate of 35% during both periods.
The increase in the effective rate in 1995 over 1994 was primarily due to a
greater portion of operating income generated from insurance operations rather
than tax-free bond income.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Liquidity and capital resource considerations are different for TPG and PMI, its
principal insurance operating subsidiary, as discussed below.
TPG's principal sources of funds are dividends from its subsidiaries, PMI and
APTIC, cash and investment income thereon and funds that may be raised from time
to time in the capital markets. In February 1996, TPG executed two bank credit
agreements totaling $50.0 million. At December 31, 1996, there were no
outstanding borrowings under the agreements. In November 1996, TPG publicly
issued $100 million of 6.75% 10-year notes. Net proceeds to the Company, after
underwriters' discount, were $99.3 million. In February 1997, TPG privately
issued $100 million 8.309% capital securities. Such securities are redeemable
after February 2007 and in no event beyond February 2027, exclusive of certain
tax events. The net proceeds, totaling $99.0 million, will be used for general
corporate purposes, including common stock repurchases, acquisitions and
additions to the investment portfolio.
TPG's principal uses of funds are common stock repurchases, the payment of
dividends to shareholders, payment of operating expenses, funding of
acquisitions, additions to the investment portfolio and investments in
subsidiaries.
As of December 31, 1996, TPG had available approximately $103.6 million of
unrestricted funds. This amount has increased substantially from the December
31, 1995 amount due to the unused portion of the proceeds of the November debt
offering and receipt of the cash dividend from PMI, less the capital
contribution to RGC and funds used to repurchase common stock.
The principal sources of funds for PMI are premiums received on new and renewal
business, commissions on ceded business and reimbursement of losses from
reinsurers, and amounts earned from the investment of this cash flow. The
principal uses of funds by PMI are the payment of claims and related expenses,
reinsurance premiums, other operating expenses and dividends to TPG.
In the mortgage guaranty insurance industry, liquidity refers to the ability of
an enterprise to generate adequate amounts of cash from its normal operations,
including premiums received and investment income, in order to meet its
financial commitments, which are principally obligations under the insurance
policies it has written. Liquidity requirements are influenced significantly by
the level and severity of claims. PMI's claims-paying ability is currently rated
"AA+" (Very High) by Duff & Phelps Credit Rating Co., "AA+" (Very Strong) by
Fitch Investors Service, Inc., "Aa2" (Excellent) by Moody's Investors Service,
Inc. and "AA+" (Excellent) by Standard
38
and Poor's Rating Services. These ratings are subject to revisions or withdrawal
at any time by the assigning rating organization. The ratings by the
organizations are based upon factors relevant to PMI's policyholders and are not
applicable to the Company's common stock or outstanding debt. The Company's
operations generally do not require significant amounts of capital expenditures.
PMI generates substantial cash flows from operations as a result of premiums
being received in advance of the time when claim payments are required. Cash
flows generated from PMI's operating activities increased slightly to $96.7
million in 1996 from $93.2 million in 1995. These operating cash flows, along
with that portion of the investment portfolio that is held in cash and
highly-liquid securities, have historically met the liquidity requirements of
PMI, as evidenced by the growth in its investment portfolio. PMI's investment
portfolio, on a cost basis, was $1,054.8 million at December 31, 1996 compared
with $988.3 million at December 31, 1995.
Consolidated reserve for losses and loss adjustment expenses increased from
$192.1 million at December 31, 1995, to $199.8 million at December 31, 1996, an
increase of $7.7 million, or 4.0%. The change in consolidated reserve for losses
and loss adjustment expense consisted of increases resulting primarily from the
Centre Re commutation and secondarily from the maturation of PMI's book of
business, offset by a decrease due to the acceleration of claim payments.
Consolidated shareholders' equity increased from $870.5 million at December 31,
1995, to $986.9 million at December 31, 1996, an increase of $116.4 million, or
13.4%. This increase consisted of $157.9 million of net income and $1.6 million
of employee stock options exercised, offset by common stock repurchases of $30.1
million, dividends declared of $7.0 million and a decrease of $6.0 million in
net unrealized gains on investments available for sale (net of tax).
PMI's risk-to-capital ratio at December 31, 1996 was 15.9:1 compared to 15.8:1
at December 31, 1995. Had the Centre Re commutation not occurred, PMI's
risk-to-capital ratio would have been approximately 14.9:1 at December 31,
1996.
CAUTIONARY STATEMENT
Cautionary Statement for purposes of the Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995. The statements contained in this
document, including statements which are incorporated by reference, that are not
historical facts, and that relate to future plans, events or performance are
forward-looking statements. The Company's actual results may differ materially
from those expressed in any forward-looking statements made by the Company.
These forward-looking statements involve a number of risks or uncertainties
including, but not limited to, the factors set forth below.
Several factors such as economic recessions, falling housing values, rising
unemployment rates, deteriorating borrower credit, interest rate volatility,
legislation impacting borrowers' rights, or combinations of such factors might
affect the mortgage insurance industry in general and could materially and
adversely affect the Company's financial condition and results of operations.
Such economic events could materially and adversely impact the demand for
mortgage insurance, cause claims on policies issued by PMI to increase, and/or
cause a similar adverse increase in PMI's loss experience.
In addition to nationwide economic conditions, PMI could be particularly
affected by economic downturns in specific regions where a large portion of its
business is concentrated, particularly California where PMI has 22.0% of its
risk in force concentrated and where the default rate on all PMI policies in
force is 3.81% compared to 2.19% nationwide, as of December 31, 1996.
39
Several factors that may influence the amount of NIW by PMI include mortgage
insurance industry volumes of new business, the impact of competitive
underwriting criteria and products including mortgage pool insurance, the effect
of risk-sharing structured transactions, changes in the performance of the
financial markets, general economic conditions that affect the demand for or
acceptance of the Company's products, changes in government housing policy,
changes in the statutory charters, regulations and coverage requirements of
Government Sponsored Enterprises, banks and savings institutions, customer
consolidation and other risk factors listed from time to time in TPG's
Securities and Exchange Commission filings.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
POTENTIAL INCREASE IN CLAIMS
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured for the life of the loan. As a result,
the impact of increased claims from policies originated in a particular year
generally cannot be offset by premium increases on policies in force or
mitigated by nonrenewal of insurance coverage. There can be no assurance,
however, that the premiums charged will be adequate to compensate PMI for the
risks and costs associated with the coverage provided to its customers.
RECENT GROWTH; CHANGES IN COMPOSITION OF INSURANCE WRITTEN
The mortgage insurance industry has experienced a significant increase in NIW,
primarily as a result of historically low interest rates. Policies written by
PMI from January 1, 1991 through December 31, 1994 represent 55.4% of PMI's
insurance in force as of December 31, 1996. The majority of claims under PMI
policies have historically occurred during the third through the sixth years
after issuance of the policies. Thus, this substantial volume of PMI's business
is in its expected peak claims period, and management expects that the default
rate will rise in the future as such business continues through its expected
peak claims period. If actual claim frequency on such business significantly
exceeds expected claim frequency, the Company's financial condition and results
of operations could be materially and adversely affected.
The composition of PMI's NIW has included an increasing percentage of mortgages
with LTVs in excess of 90% and less than or equal to 95% ("95s"). At December
31, 1996, approximately 43.6% of PMI's risk in force consisted of 95s, which, in
PMI's experience, have had a claims frequency approximately twice that of
mortgages with LTVs equal to or less than 90% and over 85% ("90s"). PMI also
offers coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"),
which have even higher risk characteristics than 95s and greater uncertainty as
to pricing adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"),
which, although priced higher, have risk characteristics that exceed the risk
characteristics associated with PMI's book of business as a whole. Although PMI
charges higher premium rates for loans which are ARMs and/or 95s and even higher
rates for 97s, the premiums earned on such products, and the associated
investment income, may ultimately prove to be inadequate to compensate for
future losses from such products.
LOSS RESERVES
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amount, as well as the estimated costs, including legal and other fees, of
settling claims. Such reserves are based on estimates, which are regularly
reviewed and updated. There can be no assurance that PMI's reserves will prove
to be adequate to cover ultimate loss development on incurred defaults. The
Company's financial condition and results of operations could be materially and
adversely affected if PMI's reserve estimates are insufficient to cover the
actual related claims paid and expenses incurred.
40
COMPETITION; MARKET SHARE
Numerous factors bear on the relative position of the private mortgage insurance
industry versus government and quasi-governmental competition as well as the
competition of lending institutions which choose to remain uninsured or to
reinsure through affiliates. PMI's market share, as measured by NIW declined in
the fourth quarter of 1996, compared to the third quarter of 1996, due primarily
to PMI's decision not to offer mortage pool insurance. Management presently
anticipates that competitive pressures related to the availability of mortgage
pool insurance will continue to negatively impact market share during the first
half of 1997. The Company's financial condition and results of operation could
be materially and adversely affected by a continuing decline in its market
share.
TPG and PMI from time to time introduce new mortgage insurance products or
programs. The Company's financial condition and results of operations could be
materially and adversely affected if PMI or the Company experience delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products or programs
will be as profitable as the Company's existing products and programs.
FANNIE MAE AND FREDDIE MAC; STATE AND FEDERAL LEGISLATION
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. Any change
in PMI's existing eligibility status could have a material adverse effect on
the Company's financial condition and results of operations.
Proposals have been advanced which would allow Fannie Mae and Freddie Mac
greater flexibility in utilizing substitutes for private mortgage insurance.
The Company cannot predict whether any such proposals will be adopted or, if
adopted, whether such proposals would materially and adversely affect the
Company's financial condition and results of operations.
PMI must cancel mortgage insurance for a mortgage loan upon the request of the
insured. Fannie Mae and Freddie Mac have recently adopted guidelines which give
borrowers the right to request cancellation of mortgage insurance when specified
conditions are met. In addition, federal legislation has been introduced that
also addresses these issues and various states have enacted or proposed similar
legislation. Proposals concerning borrower notification of their cancellation
rights, cancellation criteria, or the point at which mortgage insurance premiums
may no longer be charged to borrowers, are still being formulated and remain
uncertain. Although it is expected that certain of these proposals will
eventually be enacted, the Company believes it is too early to ascertain their
impact.
RISK-TO-CAPITAL RATIO
Regulators specifically limit the amount of insurance risk that may be written
by PMI to a multiple of 25 times PMI's statutory capital (which includes the
contingency reserve). Other factors affecting PMI's risk-to-capital ratio
include: (i) regulatory review and oversight by the State of Arizona, PMI's
state of domicile for insurance regulatory purposes; (ii) limitations under the
Runoff Support Agreement discussed below, which prohibit PMI from paying any
dividends if, after the payment of any such dividend, PMI's risk-to-capital
ratio would equal or exceed 23 to 1, (iii) TPG's credit agreements, and (iv)
TPG's and PMI's credit or claims-paying ability ratings.
Significant losses could cause a material reduction in statutory capital,
causing an increase in the risk-to-capital ratio and thereby limit PMI's ability
to write new business. The inability to write new business could materially
adversely affect the Company's financial condition and results of operations.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATES
Historically, Allstate provided capital and other business support services to
PMI pursuant to a variety of contractual arrangements with PMI and TPG. Pursuant
to the Runoff Support Agreement with Allstate, if PMI's risk-to-capital ratio
exceeds 23 to 1, Allstate will have certain limited rights and obligations to
pay amounts with respect to claims under PMI policies in effect prior to the
effective date of the Runoff Support Agreement (or to contribute capital to TPG
or to PMI for such purpose). In 1993, PMI entered into a reinsurance agreement
with Forestview, a wholly-owned subsidiary of Allstate, whereby Forestview
agreed to reinsure all liabilities (net of amounts collected from third party
reinsurers) in connection with PMI's mortgage pool insurance business in
exchange for premiums received. In 1994, Forestview also agreed to assume PMI's
mortgage pool insurance business upon receipt of all required regulatory
approvals. Significant claims have been paid on the policies covered by the
reinsurance agreement which, amounts have been reimbursed by Forestview to PMI.
It is anticipated that additional significant claims will be paid in 1997 and
beyond.
Due to the complex nature of numerous arrangements between Allstate and the
Company, Allstate has the ability to influence the policies and affairs of the
Company. The failure of Allstate to maintain its contractual commitments to the
Company could have a material adverse impact on the Company's financial
condition and results of operations.
41
CONSOLIDATED STATEMENTS OF
O P E R A T I O N S
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) 1996 1995 1994
- ---------------------------------------------------------------------------- -------------- --------------- ---------------
REVENUES Premiums earned $ 412,738 $ 328,756 $ 296,345
Investment income, less investment expense 67,442 62,041 56,774
Realized capital gains, net 14,296 11,934 3,064
Other income 6,948 2,309 3,802
-------------- --------------- ---------------
TOTAL REVENUES 501,424 405,040 359,985
-------------- --------------- ---------------
LOSSES AND Losses and loss adjustment expenses 152,409 112,837 103,907
EXPENSES Underwriting and other operating expenses 126,002 111,662 117,527
Interest expense 907 -- --
-------------- --------------- ---------------
TOTAL LOSSES AND EXPENSES 279,318 224,499 221,434
-------------- --------------- ---------------
INCOME BEFORE INCOME TAXES 222,106 180,541 138,551
INCOME TAX EXPENSE 64,188 45,310 32,419
-------------- --------------- ---------------
NET INCOME $ 157,918 $ 135,231 $ 106,132
============== =============== ===============
INCOME PER
SHARE NET INCOME $ 4.51 $ 3.85 $ 3.03
============== =============== ===============
WEIGHTED AVERAGE SHARES OUTSTANDING 35,040 35,122 35,000
============== =============== ===============
See notes to consolidated financial statements
42
CONSOLIDATED
B A L A N C E S H E E T S
AS OF DECEMBER 31,
(DOLLARS IN THOUSANDS) 1996 1995
- ------------------------ ------------------------------------------------------------- --------------- ---------------------
ASSETS Investments
Available for sale, at market
Fixed income securities (amortized
cost $1,042,570 and $867,705) $ 1,085,514 $ 928,773
Equity securities
Common (cost $77,775 and $85,088) 112,583 110,843
Preferred (cost $305 and $438) 388 505
Common stock of affiliate, at underlying book value 11,385 10,541
Short-term investments 81,876 82,310
--------------- ---------------------
Total investments 1,291,746 1,132,972
Cash 6,592 3,654
Accrued investment income 19,439 18,367
Reinsurance recoverable and prepaid premiums 83,379 78,007
Receivable from affiliates 10,525 7,579
Receivable from Allstate 16,822 14,733
Deferred policy acquisition costs 31,633 22,986
Property and equipment, net 22,519 17,574
Other assets 27,264 8,568
--------------- ---------------------
TOTAL ASSETS $ 1,509,919 $ 1,304,440
=============== =====================
LIABILITIES Reserve for losses and loss adjustment expenses $ 199,774 $ 192,087
Unearned premiums 116,951 140,322
Long-term debt 99,342 --
Reinsurance balances payable 13,295 18,741
Deferred income taxes 50,786 52,130
Other liabilities and accrued expenses 42,909 30,657
--------------- ---------------------
TOTAL LIABILITIES 523,057 433,937
--------------- ---------------------
Commitments and contingent liabilities (Note 10) -- --
SHAREHOLDERS' Preferred stock - $.01 par value; 5,000,000 shares -- --
authorized
EQUITY Common stock - $.01 par value; 125,000,000 shares
authorized; 35,047,619 and 35,011,494 shares issued 350 350
Additional paid-in capital 258,059 256,507
Unrealized net gains on investments 50,709 56,761
Retained earnings 707,885 556,969
--------------- ---------------------
1,017,003 870,587
Less cost of treasury shares (537,800 and 2,000 shares
at cost) 30,141 84
--------------- ---------------------
TOTAL SHAREHOLDERS' EQUITY 986,862 870,503
--------------- ---------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,509,919 $ 1,304,440
=============== =====================
See notes to consolidated financial statements
43
CONSOLIDATED STATEMENTS OF
S H A R E H O L D E R S' E Q U I T Y
YEAR ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS) 1996 1995 1994
- ----------------------------------------------------------------------------------- ------------ ------------- -------------
PREFERRED Preferred stock - $.01 par value; 5,000,000 shares
STOCK authorized $ -- $ -- $ --
------------ ------------- -------------
COMMON Common stock - $.01 par value; 125,000,000 shares
STOCK authorized, 35,047,619, 35,011,494 and 35,000,000
shares issued 350 350 350
------------ ------------- -------------
ADDITIONAL Balance, beginning of year 256,507 256,163 198,163
PAID-IN Stock grants and exercise of stock options 1,552 344 --
CAPITAL Capital contributions from Allstate -- -- 58,000
------------ ------------- -------------
Balance, end of year 258,059 256,507 256,163
------------ ------------- -------------
UNREALIZED Balance, beginning of year 56,761 3,676 55,930
NET GAINS ON Change in unrealized net gains on investments (6,052) 53,085 (52,254)
------------ ------------- -------------
INVESTMENTS Balance, end of year 50,709 56,761 3,676
------------ ------------- -------------
RETAINED Balance, beginning of year 556,969 426,989 320,857
EARNINGS Net income 157,918 135,231 106,132
Dividends declared (7,002) (5,251) --
------------ ------------- -------------
Balance, end of year 707,885 556,969 426,989
------------ ------------- ------------
TREASURY Balance, beginning of year (84) -- --
STOCK Purchases of THE PMI Group, Inc. common stock (30,057) (84) --
------------ ------------- ------------
Balance, end or year (30,141) (84) --
------------ ------------- ------------
TOTAL SHAREHOLDERS' EQUITY $ 986,862 $ 870,503 $ 687,178
============ ============= ============
See notes to consolidated financial statements.
44
CONSOLIDATED STATEMENTS OF
C A S H F L O W S
YEAR ENDED DECEMBER 31,
(IN THOUSANDS} 1996 1995 1994
- ------------------------------------------------------------------------------------ ------------- ------------ -------------
CASH Net income $ 157,918 $ 135,231 $ 106,132
FLOWS Reconciliation of net income to net cash provided by operating
FROM activities
OPERATING Realized capital gains, net (14,296) (11,934) (3,064)
ACTIVITIES Equity in (earnings) loss of affiliate (192) 605 448
Depreciation and amortization 3,283 5,155 4,905
Changes in
Reserve for losses and loss adjustment expenses 7,687 18,202 38,414
Unearned premiums (23,371) (16,699) (20,644)
Deferred policy acquisition costs (8,647) 2,616 3,412
Accrued investment income (1,072) (1,265) (1,178)
Reinsurance balances payable (5,446) 6,126 (153)
Reinsurance recoverable and prepaid premiums (5,372) (17,328) (14,240)
Income taxes 1,915 12,549 6,309
Receivable from affiliates (2,946) 12,330 (11,868)
Receivable from/payable to Allstate (2,089) (47,111) 3,988
Other (5,566) 1,554 3,192
------------- ------------ -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 101,806 100,031 115,653
------------- ------------ -------------
CASH Proceeds from sales of equity securities 97,104 56,163 29,844
FLOWS Investment collections of fixed-income securities 32,595 67,697 60,784
FROM Proceeds from sales of fixed-income securities 211,945 -- --
INVESTING Investment purchases
ACTIVITIES Fixed-income securities (415,162) (168,641) (136,036)
Equity securities (77,634) (56,078) (43,042)
Net (increase) decrease in short-term investments 434 4,700 (72,164)
Purchase of common stock of affiliate -- -- (9,299)
Investment in affiliate (1,350) (1,848) --
Purchase of property and equipment (10,213) (6,368) (8,723)
------------- ------------ -------------
NET CASH USED IN INVESTING ACTIVITIES (162,281) (104,375) (178,636)
------------- ------------ -------------
CASH Issuance of long-term debt 99,337 -- --
FLOWS Proceeds from exercise of stock options 1,135 170 --
FROM Dividends paid to shareholders (7,002) (3,500) --
FINANCING Purchases of The PMI Group, Inc. common stock (30,057) (84) --
ACTIVITIES Capital contributions from Allstate -- -- 58,000
------------- ------------ -------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 63,413 (3,414) 58,000
------------- ------------ -------------
NET INCREASE (DECREASE) IN CASH 2,938 (7,758) (4,983)
CASH AT BEGINNING OF YEAR 3,654 11,412 16,395
------------- ------------ -------------
CASH AT END OF YEAR $ 6,592 $ 3,654 $ 11,412
============= ============ =============
See notes to consolidated financial statements
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
NOTE 1. BASIS OF PRESENTATION
BASIS OF PRESENTATION. The accompanying consolidated financial statements
include the accounts of The PMI Group, Inc. ("TPG"), its wholly owned
subsidiaries, PMI Mortgage Insurance Co. ("PMI"), Residential Guaranty Co.
("RGC"; formerly PMI Reinsurance Co.), American Pioneer Title Insurance Company
("APTIC") and PMI Mortgage Guaranty Co. ("PMG"), and PMI's wholly owned
subsidiaries PMI Mortgage Services Co. ("MSC") and PMI Securities Co.,
collectively referred to as the "Company". All material intercompany
transactions and balances have been eliminated in consolidation.
FORMATION OF COMPANY. TPG was incorporated in December 1993. After obtaining the
required regulatory approvals, on November 28, 1994, Allstate Insurance Company
("Allstate") contributed all of the outstanding common stock of PMI to TPG.
Allstate had previously been the direct owner of all of the common stock of PMI.
Allstate is a wholly owned subsidiary of The Allstate Corporation ("Allstate
Corp.").
On April 18, 1995, Allstate, which had been the sole shareholder of the Company,
sold 24.5 million shares of the Company's common stock, representing 70% of the
outstanding shares of common stock, for approximately $784.0 million (net of
related underwriting discount) in an underwritten public offering registered
under the Securities Act of 1933. Concurrent with the stock offering, Allstate
Corp. sold a new issue of 6.76% exchangeable notes due in 1998. The notes are
mandatorily exchangeable at maturity into substantially all of the remaining
outstanding shares of the common stock of the Company owned by Allstate after
completion of the public offering (subject to Allstate Corp.'s right to deliver
cash in lieu of such shares). As a result, Allstate Corp. will continue to own,
directly or indirectly, 30% of the Company's common stock until the notes are
exchanged, at which time Allstate's ownership could be significantly reduced or
eliminated.
In connection with the public offering of the Company's common stock, the
Company increased the number of shares of common stock outstanding to 35 million
through a stock split effected as a stock dividend on February 27, 1995.
Accordingly, earnings per share has been calculated based on 35 million shares
outstanding for 1994.
NOTE 2. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS. The Company, through PMI, primarily writes residential mortgage
guaranty insurance ("primary insurance"). In addition, the Company writes title
insurance through APTIC. Primary insurance provides protection to mortgage
lenders against losses in the event of borrower default and assists lenders in
selling mortgage loans in the secondary market. Title insurance protects the
insured party against losses resulting from title defects, liens and
encumbrances existing as of the effective date of the policy.
BASIS OF ACCOUNTING. The financial statements have been prepared on the basis of
generally accepted accounting principles ("GAAP") which vary from statutory
accounting practices prescribed or permitted by insurance regulatory authorities
(see Note 12). 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 and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
INVESTMENTS. The Company has designated its entire portfolio of fixed-income and
equity securities as available for sale. Such securities are carried at market
value with unrealized gains and losses, net of deferred income taxes, reported
as a separate component of shareholders' equity.
In September 1994, PMI acquired 45% of the common stock of CMG Mortgage
Insurance Company ("CMG") from CUNA Mutual Investment Corp. ("CMIC"). CMIC
continues to own the remaining 55% of the common stock of CMG. Such affiliated
investment is reported in accordance with the equity method of accounting.
Investment income consists primarily of interest and dividends. Interest is
recognized on an accrual basis and dividends are recorded on the date of
declaration. Realized capital gains and losses are determined on a
specific-identification basis.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
PROPERTY AND EQUIPMENT. Property and equipment (including software) is carried
at cost less accumulated depreciation. The Company provides for depreciation
utilizing the straight-line method over the estimated useful lives of the
assets, generally 3 to 10 years for equipment and 40 years for real property.
Accumulated depreciation on property and equipment was $28.0 million and $23.2
million at December 31, 1996 and 1995, respectively.
INSURANCE ACCOUNTING. Primary insurance policies are contracts that are
non-cancelable by the insurer, are renewable at a fixed price at the insured's
option, and provide for the payment of premiums on a single, annual or monthly
payment basis. Upon renewal by the insured, the Company is not able to re-
underwrite or re-price its policies. Premiums written on a single premium and an
annual premium basis are initially deferred as unearned premiums and earned over
the policy term. Premiums written on policies covering more than one year
(single premium plans) are amortized over the policy life in relation to the
expiration of risk. Premiums written on annual payment policies are earned on a
monthly pro-rata basis. Premiums written on monthly payment policies are earned
in the period to which they relate. 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.
Certain costs of acquiring insurance business, including compensation, premium
taxes and other underwriting expenses, are deferred, to the extent recoverable,
and amortized to expense as the related premiums are earned. Policy acquisition
costs amortized to expense in the years ended December 31, 1996, 1995 and 1994
were $48.3 million, $52.9 million and $48.1 million, respectively.
The reserve for losses and loss adjustment expenses is the estimated cost of
settling claims related to notices of default on insured loans that have been
reported to the Company as well as loan defaults that have occurred but have not
been reported. Estimates are based on an evaluation of claim rates, claim
amounts, and salvage recoverable. Reserves for title insurance claims are based
on estimates of the amounts required to settle such claims, including expenses
for defending claims for which notice has been received and an amount estimated
for claims not yet reported.
Management believes that the reserve for losses and loss adjustment expenses at
December 31, 1996 is appropriately established in the aggregate and is adequate
to cover the ultimate net cost of reported and unreported claims arising from
losses which had occurred by that date. The establishment of appropriate
reserves is an inherently uncertain process. Such reserves are necessarily based
on estimates and the ultimate net cost may vary from such estimates. These
estimates are regularly reviewed and updated using the most current information
available. Any resulting adjustments, which may be material, are reflected in
current operations.
INCOME TAXES. The Company accounts for income taxes using the liability method,
whereby deferred tax assets and liabilities are recorded based on the difference
between the financial statement and tax bases of assets and liabilities at the
currently enacted tax rates. The principal assets and liabilities giving rise to
such differences are presented in Note 6.
CONCENTRATION OF RISK. A substantial portion of PMI's business is generated
within the state of California. Of new insurance written for the year ended
December 31, 1996, California accounted for 20.7%. Also, at December 31, 1996,
California's book of business represented 22.0% of total risk in force.
STOCK-BASED COMPENSATION. The Company accounts for stock-based awards to
employees and directors using the intrinsic value method in accordance with
Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued
to Employees (see Note 11).
RECLASSIFICATION. Certain prior year amounts have been reclassified to conform
to current year presentation.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
NOTE 3. INVESTMENTS
MARKET VALUES. The amortized cost and estimated market values for fixed-income securities are shown below (in thousands):
GROSS UNREALIZED
AMORTIZED ---------------- MARKET
COST GAINS (LOSSES) VALUE
------------- ------------- ------------- --------------
At December 31, 1996
U. S. government and agencies $ 89,131 $ 588 $ (1,129) $ 88,590
Municipals 831,213 48,021 (4,233) 875,001
Corporate bonds 121,990 424 (749) 121,665
Redeemable preferred stock 236 22 -- 258
------------- ------------- ------------- --------------
Total $ 1,042,570 $ 49,055 $ (6,111) $ 1,085,514
============= ============= ============= ==============
At December 31, 1996
U. S. government and agencies $ 5,302 $ 877 $ -- $ 6,179
Municipals 861,634 61,256 (1,083) 921,807
Redeemable preferred stock 769 18 -- 787
------------- ------------- ------------- --------------
Total $ 867,705 $ 62,151 $ (1,083) $ 928,773
============= ============= ============= ==============
SCHEDULED MATURITIES. The scheduled maturities for fixed-income securities were as follows at December 31, 1996 (in thousands):
AMORTIZED MARKET
COST VALUE
------------- --------------
Due in one year or less $ 37,484 $ 38,017
Due after one year through five years 254,572 265,367
Due after five years through ten years 209,967 217,102
Due after ten years through twenty years 460,269 482,443
Due after twenty years 80,278 82,585
------------- --------------
Total $ 1,042,570 $ 1,085,514
============= ==============
Actual maturities may differ from those scheduled as a result of calls by the issuers prior to maturity.
INVESTMENT CONCENTRATION AND OTHER ITEMS. The Company maintains a diversified
portfolio of municipal bonds. At December 31, the following states represented
the largest concentrations in the portfolio (expressed as a percentage of the
carrying value of all municipal bond holdings).
Holdings in no other state exceed 5.0% of the portfolio at December 31 for the
respective years.
1996 1995
---- ----
Texas 17.3% 17.4%
Illinois 14.2 15.7
Washington 10.4 9.2
Indiana 10.0 10.0
California 9.4 7.2
Massachusetts 5.3 3.5
Pennsylvania 3.9 5.0
At December 31, 1996, fixed-income securities with a market value of $9.7
million were on deposit with regulatory authorities as required by law.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
UNREALIZED NET GAINS ON INVESTMENTS.
Unrealized net gains on investments included in shareholders' equity at December 31, 1996, are as follows (in thousands):
GROSS UNREALIZED NET
MARKET ------------------------ UNREALIZED
COST VALUE GAINS (LOSSES) GAINS
----------- ----------- --------- ---------- ----------
Fixed income securities $ 1,042,570 $ 1,085,514 $ 49,055 $ (6,111) $ 42,944
Common stocks 77,775 112,583 35,588 (779) 34,809
Preferred stocks 305 388 82 -- 82
Investment in affiliate 11,200 11,385 185 -- 185
----------- ----------- -------- --------- --------
Total $ 1,131,850 $ 1,209,870 $ 84,910 $ (6,890) 78,020
=========== =========== ======== ========= 27,311
Less deferred income taxes --------
Total $ 50,709
========
The difference between cost and market value of the investment in affiliate
reflects net unrealized gains on the affiliate's investment portfolio. The
stated market value does not necessarily represent the fair value of the
affiliate's common stock held by the Company.
The change in net unrealized gains, net of deferred income taxes, for fixed
income securities and equity securities are as follows (in thousands):
1996 1995 1994
---------- -------- ---------
Fixed income securities $ (11,777) $ 42,065 $ (49,976)
Equity securities 5,895 10,729 (2,278)
Investment in affiliate (170) 291 --
---------- -------- ---------
Total $ (6,052) $ 53,085 $ (52,254)
========== ======== =========
INVESTMENT INCOME. Investment income by investment type is as follows (in
thousands):
1996 1995 1994
-------- -------- --------
Fixed income securities $ 63,715 $ 56,259 $ 52,921
Equity securities 2,136 2,625 2,117
Common stock of affiliate 192 (605) (448)
Short-term 2,119 5,030 3,226
-------- -------- --------
Investment income, before expenses 68,162 63,309 57,816
Less investment expense 720 1,268 1,042
-------- -------- --------
Investment income, less investment expense $ 67,442 $ 62,041 $ 56,774
======== ======== ========
REALIZED CAPITAL GAINS AND LOSSES. Net realized capital gains on investments are
as follows (in thousands):
1996 1995 1994
-------- -------- --------
Fixed income securities $ 2,072 $ 1,381 $ 1,282
Equity securities 12,024 10,555 1,786
Short-term 200 (2) (4)
-------- -------- --------
Realized capital gains -- net, before taxes 14,296 11,934 3,064
Less income taxes 5,004 4,177 1,072
-------- -------- --------
Realized capital gains, net of taxes $ 9,292 $ 7,757 $ 1,992
======== ======== ========
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
Gross realized capital gains and losses on investments are as follows (in
thousands):
1996 1995 1994
---- ---- ----
Gross realized capital gains $ 19,842 $ 13,306 $ 4,793
Gross realized capital losses (5,546) (1,372) (1,729)
-------- -------- -------
Net realized capital gains $ 14,296 $ 11,934 $ 3,064
======== ======== =======
NOTE 4. LOSS RESERVES
The following table is a reconciliation of the beginning and ending reserve for
losses and loss adjustment expenses for each of the last three years (in
thousands):
1996 1995 1994
---- ---- ----
Balance, January 1 $ 192,087 $ 173,885 $ 135,471
Less reinsurance recoverable 17,899 17,569 12,649
------------- -------------- -------------
Net balance, January 1 174,188 156,316 122,822
------------- -------------- --------------
Losses and loss adjustment expenses, principally in respect
of defaults occurring in
Current year 161,740 133,536 121,464
Prior years (9,331) (20,699) (17,557)
------------- -------------- -------------
Total losses and loss adjustment expenses 152,409 112,837 103,907
------------- -------------- --------------
Losses and loss adjustment expense payments, principally
in respect of defaults occurring in
Current year 23,353 16,180 13,651
Prior years 108,757 78,785 56,762
------------- -------------- -------------
Total payments 132,110 94,965 70,413
------------- -------------- -------------
Net balance, December 31 194,487 174,188 156,316
Plus reinsurance recoverable 5,287 17,899 17,569
------------- -------------- -------------
Balance, December 31 $ 199,774 $ 192,087 $ 173,885
============= ============== ==============
As a result of changes in estimates of ultimate losses resulting from insured
events in prior years, the provision for losses and loss adjustment expenses
(net of reinsurance recoverable) decreased by $9.3 million, $20.7 million and
$17.6 million in 1996, 1995 and 1994, respectively, due primarily to
lower-than-anticipated losses in California. Such re-estimates were based on
management's analysis of various economic trends (including the real estate
market and unemployment rates) and their effect on recent claim rate and claim
severity experience.
NOTE 5. REINSURANCE
PMI cedes reinsurance to reduce net risk in force to meet regulatory
risk-to-capital requirements and to comply with the regulatory maximum policy
coverage percentage limitation of 25%. Certain of the Company's reinsurance
arrangements have adjustable features, including experience account refunds,
which depend on the loss experience of the underlying business. While such
estimates are based on the Company's actuarial analysis of the applicable
business, the amounts the Company will ultimately recover could differ
materially from amounts recorded in reinsurance recoverable. Reinsurance ceding
arrangements do not discharge the Company from its obligations as the primary
insurer.
Effective December 31, 1996 PMI terminated and commuted its reinsurance
agreement with Centre Reinsurance Company of New York and Centre Reinsurance
International Company. This commutation did not have a significant impact on the
Company's results of operations.
In December 1993, the Company decided to cease writing new business in its
mortgage pool insurance business segment (except for honoring certain
commitments in existence prior to the discontinuation of this business).
Concurrently, the Company entered into a reinsurance agreement with Forestview
Mortgage Insurance Co. ("Forestview"), a wholly owned subsidiary of Allstate, to
cede all future mortgage pool net premiums and net losses from PMI to
Forestview. As a result of
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
this ceding agreement, the pool business had no significant impact on the
Company's results of operations for the years ended December 31, 1996, 1995 and
1994. The Board of Directors of Allstate has resolved that Allstate will make
capital contributions to Forestview as necessary to maintain Forestview's
risk-to-capital ratio below 20.0 to 1. In accordance with accounting for
discontinued operations, pool insurance assets (unpaid losses recoverable and
paid claims receivable from reinsurers) and liabilities (loss reserves and
premiums payable) have been netted in the accompanying consolidated balance
sheets, resulting in a net receivable from reinsurers of $12.4 million and $4.8
million at December 31, 1996 and 1995, respectively. Gross pool reinsurance
recoverables and receivables from Forestview and other reinsurers are as follows
at December 31 (in thousands):
1996 1995
---- ----
Forestview $140,670 $123,768
Other reinsurers 39,322 53,135
------- -------
Total $179,992 $176,903
======= =======
Reinsurance recoverable on paid primary losses from non-affiliated reinsurers
was $5.3 million and $2.2 million at December 31, 1996 and 1995, respectively.
Prepaid primary reinsurance premiums from non-affiliated reinsurers were $3.8
million and $17.4 million at December 31, 1996 and 1995, respectively.
The effects of reinsurance on the primary premiums written, premiums earned and
losses and loss adjustment expenses of the Company's operations for the year
ending December 31 are as follows (in thousands):
1996 1995 1994
---- ---- ----
Premiums written
Direct $ 404,528 $ 335,632 $ 301,015
Assumed (901) 3,010 3,819
Ceded (607) (24,621) (27,087)
----------- ----------- ------------
Premiums written, net of reinsurance $ 403,020 $ 314,021 $ 277,747
=========== =========== ============
Premiums earned
Direct $ 425,831 $ 352,459 $ 321,477
Assumed 634 3,412 4,001
Ceded (13,727) (27,115) (29,133)
----------- ----------- ------------
Premiums earned, net of reinsurance $ 412,738 $ 328,756 $ 296,345
=========== =========== ============
Losses and loss adjustment expenses
Direct $ 157,203 $ 128,607 $ 117,672
Assumed (267) 499 778
Ceded (4,527) (16,269) (14,543)
----------- ----------- ------------
Losses and loss adjustment expenses, net of reinsurance $ 152,409 $ 112,837 $ 103,907
=========== =========== ============
In the first quarter of 1996 a quota share reinsurance assumption agreement with
Triad Guaranty Insurance Corporation was terminated.
NOTE 6. INCOME TAXES
The components of income tax expense are as follows (in thousands):
1996 1995 1994
---- ---- ----
Current $ 9,056 $ 10,513 $ 2,842
Deferred 55,132 34,797 29,577
---------------- --------------- ----------------
Total income tax expense $ 64,188 $ 45,310 $ 32,419
================ =============== ================
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
A reconciliation of the statutory federal income tax rate to the effective tax
rate reported on income from operations before taxes is as follows:
1996 1995 1994
---- ---- ----
Statutory federal income tax rate 35.0% 35.0% 35.0%
Tax-exempt income (7.1) (9.5) (11.9)
State income tax (net) 0.9 0.4 0.2
Other 0.1 (0.8) 0.1
--- ---- ---
Effective income tax rate 28.9% 25.1% 23.4%
==== ==== ====
On April 10, 1995 the Company and its subsidiaries separated from Allstate (See
Note 1). Effective April 11, 1995 the Company and its subsidiaries file a
consolidated income tax return. Prior to that date the Company was part of the
consolidated return of Sears, Roebuck and Co. ("Sears"), the former parent
company of Allstate Corp. The Company's share of consolidated federal income tax
liability prior to April 11, 1995 was determined under a tax sharing agreement
as part of the Sears tax group. Under the tax sharing agreement, the Company has
continuing rights and obligations to Allstate and Sears for the tax effect of
any changes in taxable income relating to the periods during which the Company
was part of the Sears tax group. At December 31, 1996 the Company had income
taxes receivable of $16.8 million from Allstate related to the filing of an
amended return for prior years.
Section 832(e) of the Internal Revenue Code permits mortgage guaranty insurers
to deduct, within certain limitations, additions to statutory contingency
reserves (see Note 12). This provision was enacted to enable 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 $50.4 million, $21.2 million and $19.3 million in 1996, 1995 and 1994,
respectively.
The Company paid income taxes of $8.2 million, $28.4 million and $9.4 million in
1996, 1995 and 1994, respectively. Included in these amounts are federal income
tax payments to Allstate under the tax sharing agreement of $0.7 million, $21.2
million and $8.6 million in 1996, 1995 and 1994, respectively.
The components of the deferred income tax assets and liabilities at December 31
are as follows (in thousands):
1996 1995
---- ----
Deferred tax assets
Discount on loss reserves $ 3,722 $ 3,831
Unearned premium reserves 8,187 9,823
Alternative minimum tax credit carryforward 10,453 10,026
Pension costs 2,586 1,724
Other assets 4,258 3,217
----------- -----------
Total deferred tax assets 29,206 28,621
----------- -----------
Deferred tax liabilities
Statutory contingency reserves (36,435) (30,405)
Policy acquisition costs (11,072) (8,045)
Unrealized net gains on investments (27,311) (30,577)
Reinsurance -- (7,751)
Other liabilities (5,174) (3,973)
----------- -----------
Total deferred tax liabilities (79,992) (80,751)
----------- -----------
Net deferred tax liability $ (50,786) $ (52,130)
=========== ===========
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
NOTE 7. FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets and incurs various financial liabilities. Carrying value approximates
fair value for all financial assets and liabilities at December 31, 1996 and
1995. A number of the Company's significant assets and liabilities, including
deferred policy acquisition costs, property and equipment, deferred income taxes
and loss reserves, are not considered financial instruments.
NOTE 8. BENEFIT PLANS
PENSION PLANS
As of April 18, 1995 all full-time employees and certain part-time employees of
the Company participate in The PMI Group, Inc. Retirement Plan (the "Plan"), a
noncontributory defined benefit plan. Also, employees earning in excess of
$150,000 per year participate in The PMI Group, Inc. Supplemental Employee
Retirement Plan ("SERP"), a noncontributory defined benefit plan. Prior to April
18, 1995 the Company participated in the Allstate retirement plan ("Allstate
Plan"), which was also a noncontributory defined benefit plan. Benefits under
all three plans are based upon the employee's length of service, average annual
compensation and estimated social security retirement benefits. Pension expense
of $0.6 million and $2.6 million for the years ended December 31, 1995, and
1994, respectively, was allocated to the Company from the Allstate Plan based
upon compensation. Information about the components of net periodic pension
expense and the Allstate Plan's funded status is not available on a separate
company basis.
The components of the net periodic cost of the Company's defined benefit pension
plans for the year ended December 31, 1996 and the period April 18, 1995,
through December 31, 1995, are as follows (in thousands):
1996 1995
- ----------------------------------------------------------------- ----------------- ----------------
Service cost $3,282 $2,003
Interest on projected benefit obligation 484 175
Actual return on plan assets (219) (4)
Net amortization and deferral 78 10
----------------- ----------------
Net periodic pension cost $3,625 $2,184
================= ================
The following lists the funded status of the pension plan as of December 31,
1996 and 1995 (in thousands):
1996 1995
- ----------------------------------------------------------------- ----------------- ----------------
Actuarial present value of benefit obligations
Vested $3,399 $1,991
Non-vested 1,370 842
----------------- ----------------
Accumulated benefit obligation $4,769 $2,833
================= ================
Projected benefit obligation $6,658 $3,596
Net assets available for benefits 2,896 1,097
----------------- ----------------
Projected benefit obligation in excess of plan assets 3,762 2,499
Unrecognized net gain (loss) 581 (67)
----------------- ----------------
Net pension liability $4,343 $2,432
================= ================
The Company has accrued for the $4.3 million pension obligation as of December
31, 1996. The discount rates used in determining the actuarial present value of
the projected benefit obligation and the pension expense were 7.5% and 7.0% for
1996 and 1995, respectively. The expected long-term rate of return on plan
assets and the assumed rate of compensation increase was 8.5% and 5.5%,
respectively, for both 1996 and 1995. Plan assets consist of fixed income and
equity securities.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
POST-RETIREMENT BENEFITS OTHER THAN PENSION
The Company provides certain health care and life insurance benefits for retired
employees ("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 10 or more years prior to retirement. The Company
shares the cost of the retiree medical benefits with retirees based on years of
service with the Company's share being subject to a 5% limit on annual medical
cost inflation after retirement. The Company's post-retirement benefit plans
currently are not funded. The Company has the right to modify or terminate these
plans.
The components of the net periodic post-retirement benefit cost of the Company's
OPEB Plan for the year ended December 31, 1996 and the period April 18, 1995,
through December 31, 1995, are as follows (in thousands):
1996 1995
---- ----
Service cost $ 438 $ 226
Interest on projected benefit obligation 235 124
------------ ------------
Net periodic post-retirement benefit cost $ 673 $ 350
============ ============
The following lists the funded status of the OPEB Plan as of December 31, 1996
and 1995 (in thousands):
1996 1995
---- ----
Actuarial present value of
benefit obligations
Active employees eligible to retire $ 216 $122
Active employees ineligible to retire 2,566 2,728
------------ -----
Total accumulated post-retirement benefit
obligation 2,782 2,850
Less unrecognized prior service cost 304 333
Unrecognized (gains) losses (535) 180
------------ ------------
Accrued post-retirement benefit obligation $ 3,013 $ 2,337
============ ===============
The discount rates for the beginning of the period were 7.0% and 7.5% for 1996
and 1995, respectively. The discount rates used at the end of the period were
7.5% and 7.0% in 1996 and 1995, respectively, which reflects the changes in
high-quality investment-grade bond yields over the periods. The assumed health
care trend rate used in measuring the accumulated post-retirement benefit
obligation is 10.5% grading down to 5.0% over nine years. The effect of a one
percentage point increase in the health care trend rate assumption would result
in an increase of 23% in the accumulated post-retirement benefit obligation from
$2.8 million to $3.4 million as of December 31, 1996.
SAVINGS AND PROFIT SHARING PLAN
As of April 18, 1995, employees of the Company were eligible to participate in
The PMI Group, Inc. Savings and Profit Sharing Plan ("PMI Plan") covering both
salaried and hourly employees. Eligible employees who participate in the PMI
Plan receive, within certain limits, matching Company contributions. Costs
relating to the PMI Plan amounted to $1.1 million and $0.8 million for 1996 and
1995, respectively.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
NOTE 9. DEBT AND CREDIT FACILITIES
LONG-TERM DEBT
On November 15, 1996, the Company issued debt securities in the amount of $100.0
million (the "Notes"). The Notes are unsecured, no sinking fund is provided and
the Notes are not redeemable prior to maturity. The Notes mature and are payable
on November 15, 2006. Interest on the Notes is 6.75% and is payable
semiannually. No interest payments were made during 1996.
LINES OF CREDIT
On February 1 and 13, 1996, the Company executed separate line of credit
agreements (the "Lines"), each in the amount of $25.0 million. The Lines have
final maturities of January 2001 and December 2000 and commitment fees of 8.0
and 6.5 basis points, respectively. Both Lines may be used for general corporate
purposes. There were no amounts outstanding on the Lines as of December 31,
1996. Interest paid on the Lines was $126,000 in the year ended December 31,
1996.
NOTE 10. COMMITMENTS AND CONTINGENT LIABILITIES
LEASES
The Company leases certain office facilities and equipment. Minimum rental
commitments under non-cancelable operating leases with a remaining term of more
than one year as of December 31, 1996, are as follows (in thousands):
Year ending December 31:
1997 $ 5,750
1998 4,708
1999 2,936
2000 465
2001 145
-------------
Total $ 14,004
=============
Total rent expense for all leases was $7.4 million, $6.2 million and $4.8
million in 1996, 1995 and 1994, respectively.
LEGAL PROCEEDINGS
Various 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 11. DIVIDENDS AND SHAREHOLDERS' EQUITY
DIVIDENDS
The ability of the Company to pay dividends is dependent on business conditions,
income, cash requirements of the Company, receipt of dividends from PMI and
other relevant factors. PMI's ability to pay dividends to TPG is limited under
Arizona law. The payment of dividends by PMI without the prior approval of the
Arizona state insurance department is limited to formula amounts based on net
income, net investment income, and capital and surplus, including unassigned
surplus, determined in accordance with statutory accounting practices, as well
as the timing and amount of dividends paid in the preceding twelve months.
Limitations on PMI's risk-to-capital ratio also effectively limit PMI's ability
to pay dividends because the payment of dividends reduces statutory capital.
Various state regulatory authorities impose a limitation that the
risk-to-capital ratio may not exceed 25 to 1. In addition, under a certain
support agreement with Allstate, PMI is prohibited
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
from paying any dividend that would cause its risk-to-capital ratio to equal or
exceed 23 to 1 (see Note 14). Under the most restrictive dividend limitations,
the maximum amount of dividends that PMI can distribute to TPG at December 31,
1996, without prior regulatory approval is $30.7 million. PMI's dividend
restrictions have not had, and are not expected to have, an impact on TPG's
ability to meet its cash obligations.
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 fix 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 which has voting,
dividend or liquidation rights superior to the common stock and which may
adversely affect the rights of holders of common stock.
Pursuant to the Runoff Support Agreement (see Note 14), 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.
EQUITY INCENTIVE PLAN AND DIRECTORS PLAN
During 1996, the Company amended and restated The PMI Group, Inc. Equity
Incentive Plan (the "Equity Incentive Plan") and The PMI Group, Inc. Stock Plan
for Non-Employee Directors (the "Directors Plan"). Pursuant to such plans, an
aggregate of 1,500,000 shares of common stock was reserved for issuance to
Directors, officers and, employees of TPG and its subsidiaries. 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 date of grant and have a three year vesting
period. The Directors Plan provides that each director who is not an employee of
the Company or any of its subsidiaries ("Non-Employee Director") will receive an
annual grant of up to 300 shares of common stock and will receive stock options
for 1,500 shares annually, after an initial option of up to 3,000 shares. The
shares will be 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 activity in the Equity Incentive Plan and the
Directors Plan during 1996 and 1995:
1996 1995
------------------------------------- ------------------------------------
SHARES WEIGHTED AVERAGE SHARES WEIGHTED AVERAGE
UNDER OPTION EXERCISE PRICE UNDER OPTION EXERCISE PRICE
------------- ----------------- -------------- -----------------
Options outstanding at the
beginning of year 487,181 $ 33.96 -- $ --
Options granted 105,100 45.73 520,617 33.96
Options exercised (33,526) 33.85 (5,494) 31.18
Options forfeited (20,151) 33.95 (27,942) 33.97
------- ----- ------- -----
Outstanding at end of year 538,604 $ 36.40 487,181 $ 33.96
======= ====== ======= =====
Weighted average remaining
contractual life (in years) 8.3 $32.14 - $56.37 9.4 $32.14 - $34.00
Exercisable at year end 147,031 33.55 21,859 32.12
Reserved for future grants 916,376 1,001,325
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
As discussed in Note 2, the Company accounts for stock-based compensation under
APB No. 25 and its related interpretations. Accordingly, no compensation cost
has been recognized for the Equity Incentive Plan and the Directors Plan.
Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for
Stock-Based Compensation, requires the disclosure of pro-forma net income and
earnings per share had the Company adopted the fair value method as of the
beginning of fiscal year 1995. Under SFAS No. 123, the fair value of stock based
awards to employees is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely tradable,
fully transferable options without vesting restrictions, which significantly
differ from the Company's stock option awards. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated values. The Company's
calculations were made using the Black-Scholes option pricing model with the
following weighted average assumptions: dividend yield range of .35% to .44% for
the 1996 options and .42% for the 1995 options; expected volatility range of
21.08% to 23.12% for the 1996 options and 24.38% for the 1995 options; risk free
interest rates of 5.40%, 5.83%, 6.51%, 6.53% and 6.54% for the 1996 options and
6.11% and 6.85% for the 1995 options; and an expected life of four years
following vesting. Forfeitures are recognized as they occur. If the computed
fair values of the 1996 and 1995 awards had been amortized to expense over the
vesting period of the awards, the Company's net income would have been reduced
to the pro forma amounts of $156.7 million and $134.3 million in 1996 and 1995,
respectively, resulting in pro forma earnings per share of $4.47 and $3.82,
respectively.
NOTE 12. STATUTORY ACCOUNTING
The following table reconciles consolidated shareholders' equity at December 31,
1996 and 1995, and net income for each of the three years in the period ended
December 31, 1996 as reported under GAAP to PMI statutory capital and
policyholders' surplus and net income, determined in accordance with statutory
accounting practices prescribed or permitted by insurance regulatory authorities
(in thousands):
PMI's statutory capital and policyholders' surplus: 1996 1995
---- ----
Consolidated shareholders' equity as reported under GAAP $ 986,862 $ 870,503
Less non-PMI shareholder's equity 50,529 32,457
---------- ---------
PMI shareholder's equity as reported under GAAP 936,333 838,046
Deferred policy acquisition costs (31,633) (22,986)
Deferred income taxes 37,643 32,052
Net unrealized gains on fixed-income securities, net of tax (30,149) (41,774)
Nonadmitted assets (6,153) (16,172)
Tax and loss bonds 90,976 40,540
Post-retirement benefits 4,552 3,193
Investment in subsidiaries (12,893) (8,703)
Other (201) (40)
--------- ---------
PMI statutory capital 988,475 824,156
Contingency reserve (674,841) (530,874)
--------- ---------
PMI statutory policyholders' surplus $ 313,634 $ 293,282
========= =========
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
PMI's statutory net income: 1996 1995 1994
---- ---- ----
Consolidated net income as reported under GAAP $157,918 $135,231 $106,132
Less non-PMI net income 7,557 2,195 1,597
-------- -------- --------
PMI net income as reported under GAAP 150,361 133,036 104,535
Deferred policy acquisition costs (8,647) 2,616 3,412
Deferred income taxes 52,845 34,298 29,963
Investment in subsidiaries 6,499 1,487 675
Other 1,526 1,033 471
-------- -------- --------
PMI statutory net income $202,584 $172,470 $139,056
======== ======== ========
Under statutory accounting practices, mortgage insurers are required to
establish each year a contingency reserve equal to 50% of premiums earned in
such year. Such amount must be maintained in the contingency reserve for 10
years after which time it is released to unassigned surplus. Prior to 10 years,
the contingency reserve may be reduced with regulatory approval to the extent
that losses in any calendar year exceed 35% of earned premiums for such year.
Under GAAP, the contingency reserve is not required.
Under statutory accounting practices, insurance policy acquisition costs are
charged against operations in the year incurred. Under GAAP, these costs are
deferred and amortized as the related premiums are earned.
Statutory financial statements only include a provision for current income taxes
due, and purchases of tax and loss bonds are accounted for as investments. GAAP
financial statements provide for deferred income taxes, and purchases of tax and
loss bonds are recorded as payments of current income taxes.
Under statutory accounting practices, certain assets, designated as nonadmitted
assets, are charged directly against statutory surplus. Such assets are
reflected on the GAAP financial statements.
Fixed-income investments classified as available for sale are carried at market
value under GAAP and are generally reported at amortized cost for statutory
purposes.
NOTE 13. BUSINESS SEGMENTS
The Company's two business segments are mortgage insurance ("MI"), including
ancillary services, and title insurance ("Title"). Following is segment
information as of and for the years ended December 31, 1996, 1995 and 1994 (in
thousands):
1996 1995 1994
---- ---- ----
MI Title Total MI Title Total MI Title Total
--------- ---------- ---------- --------- ---------- ---------- ---------- --------- ----------
Revenues $ 447,051 $54,373 $501,424 $363,718 $41,322 $405,040 $ 313,704 $46,281 $359,985
Income from operations
before taxes 217,511 4,595 222,106 177,641 2,900 180,541 134,993 3,558 138,551
Net income 154,914 3,004 157,918 133,196 2,035 135,231 103,819 2,313 106,132
Depreciation expense 4,467 801 5,268 5,151 875 6,026 4,784 694 5,478
Capital expenditures 9,710 503 10,213 5,833 535 6,368 7,683 1,040 8,723
Assets 1,476,511 33,408 1,509,919 1,274,386 30,054 1,304,440 1,070,072 27,349 1,097,421
NOTE 14. CAPITAL SUPPORT AGREEMENTS
PMI's claims-paying ratings from certain national rating agencies have, in the
past, been based in significant part on various capital support commitments from
Allstate and Sears ("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 were so paid or contributed (which possibility
management believes is remote), Allstate would receive subordinated debt or
preferred stock of PMI or TPG in return.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
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, (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.
On June 6, 1996, a CMG Capital Support Agreement was executed by PMI and CMIC
whereby both parties agreed to contribute funds, subject to certain limitations,
so as to maintain CMG's risk-to-capital ratio at or below 18.0 to 1. In
addition, the agreement specifies that under certain circumstances, PMI and CMIC
will contribute up to an additional $4.0 million and $4.8 million, respectively,
to CMG, over and above obligations, net of prior contributions, of $13.2 million
and $16.1 million, respectively, previously agreed to in a shareholder agreement
dated September 8, 1994. At December 31, 1996 CMG's risk-to-capital ratio was
13.9 to 1.
NOTE 15. QUARTERLY RESULTS (UNAUDITED)
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
1996 1995 1996 1995 1996 1995 1996 1995
---- ---- ---- ---- ---- ---- ---- ----
(In thousands, except per share data)
Revenues $115,906 $96,588 $119,056 $99,698 $127,450 $103,349 $139,012 $105,405
Net income 36,990 29,855 41,220 36,421 41,280 35,115 38,428 33,840
Earnings per Share 1.05 0.85 1.17 1.04 1.18 1.00 1.10 0.96
NOTE 16. SUBSEQUENT EVENT
On February 4, 1997, the Company, through a newly formed trust, privately issued
$100.0 million 8.309% capital securities, Series A. Such securities are
redeemable after February 1, 2007 at a premium and upon occurrence of certain
tax events, and mature on February 1, 2027. The net proceeds, totaling $99.0
million, will be used for general corporate purposes, including common stock
repurchases, acquisitions and additions to the investment portfolio. The capital
securities were issued by PMI Capital I (the "Issuer Trust"). TPG owns all of
the common securities of the Issuer Trust. The sole assets of the Issuer Trust
consist of approximately $103.1 million principle amount of junior subordinated
debentures (the "Debentures") issued by TPG to the Issuer Trust. The Debentures
bear interest at the rate of 8.309% per annum and mature on February 1, 2027.
Distributions on the capital securities occur on February 1 and August 1 of each
year, commencing August 1, 1997. The obligations of the Company under the
Debentures and a related guarantee and expense agreement constitute a full and
unconditional guarantee by the Company of the Issuer Trust's obligations under
the capital securities. The capital securities are subject to mandatory
redemption under certain circumstances. The capital securities will be presented
as a separate line item in the consolidated balance sheets of the Company,
entitled "Company Obligated Mandatorily Redeemable Capital Securities of
Subsidiary Trust Holding Solely Junior Subordinated Deferrable Interest
Debentures of the Company". The Company will record distributions payable on the
capital securities as interest expense in the consolidated statements of
operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 THROUGH 1996
R E P O R T O F
M A N A G E M E N T
To the Shareholders of The PMI Group, Inc.
The consolidated financial statements of The PMI Group, Inc. and subsidiaries
have been prepared by management and have been audited by the Company's
independent auditors, Deloitte & Touche LLP, whose report appears on this page.
Management is responsible for the consolidated financial statements, which have
been prepared in conformity with generally accepted accounting principles and
include amounts based on management's judgments.
Management is also responsible for maintaining internal control systems designed
to provide reasonable assurance, at appropriate cost, that assets are
safeguarded and that transactions are executed and recorded in accordance with
established policies and procedures. The Company's systems are under continuing
review and are supported by, among other things, business conduct and other
written guidelines, an internal audit function and the selection and training of
qualified personnel.
The Board of Directors, through its Audit Committee, oversees management's
financial reporting responsibilities. The Audit Committee meets regularly with
the independent auditors, representatives of management and the internal
auditors to discuss and make inquiries into their activities. Both the
independent auditors and the internal auditors have free access to the Audit
Committee, with and without management representatives in attendance.
/s/ W. Roger Haughton
W. Roger Haughton
President and Chief Executive Officer
January 22, 1997
/s/ John M. Lorenzen, Jr.
John M. Lorenzen, Jr.
Executive Vice President and Chief Financial Office
January 22, 1997
R E P O R T O F
I N D E P E N D E N T
A U D I T O R S
To the Board Of Directors and Shareholders of 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, 1996 and 1995, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1996. 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated 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 audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of The PMI Group, Inc. and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
- -------------------------------
San Francisco, California
January 22, 1997
(February 4, 1997 as to Note 16)
61