EXHIBIT 13.1
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
Certain written and oral statements made or incorporated by reference from time
to time by the Company or its representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, or are preceded by, followed by or
that include the words "believes," "expects," "anticipates," "estimates," or
similar expressions, and that relate to future plans, events or performance are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements include the
following: (i) during 1999, management expects the percentage of PMI's risk
related to risk-share programs and represented by pool risk to continue to
increase as a percentage of total risk. The Fannie Mae and Freddie Mac reduction
in mortgage insurance coverage requirements is expected to have a negative
impact on the growth rate of direct risk in force; (ii) management anticipates
ceded premiums will increase substantially in the future as a result of the
expected increase in risk-share programs; (iii) management anticipates the
percentage of insurance in force with higher coverage percentages will begin to
decrease in 1999 and such decreases should accelerate in the years following due
to a reduction in required mortgage insurance by Fannie Mae and Freddie Mac;
(iv) although management expects that California should continue to account for
a significant portion of total claims paid, management anticipates that with
continued improvement in the California economy, increased benefits of loss
mitigation efforts and improved default reinstatement rates, California claims
paid as a percentage of total claims paid should continue to decline; (v)
management believes that PMI's total default rate could increase in 1999 due to
the continued maturation of its 1994 and 1995 books of business; (vi) management
anticipates that contract underwriting will continue to generate a significant
percentage of PMI's new insurance written ("NIW"), (vii) The Company believes
Year 2000 modifications to its critical mortgage origination and processing
applications were implemented successfully and that these systems will be Year
2000 compatible; (viii) the Company has completed remediation and testing of its
telephone switches, and management believes that these switches and other
hardware and non-information technology systems will be Year 2000 compatible;
and (ix) the Company currently believes that the remaining modifications to
existing software and conversions to new software utilized by the Company will
be implemented successfully and that the Year 2000 issue will not have a
material adverse impact on internal systems or operations. When a forward-
looking statement includes a statement of the assumptions or bases underlying
the forward-looking statement, the Company cautions that, while it believes such
assumptions or bases to be reasonable and makes them in good faith, assumed
facts or bases almost always vary from actual results, and the difference
between assumed facts or bases and actual results can be material, depending on
the circumstances. Where, in any forward-looking statement, the Company or its
management expresses an expectation or belief as to future results, such
expectations or belief is expressed in good faith and believed to have a
reasonable basis, but there can be no assurance that the statement of
expectation or belief will result or be achieved or accomplished. 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 items
addressed in section Q. "Statements and Risk Factors Concerning the Company's
Operations and Future Results" (Risk
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Factors "RF# 1-14") set forth below and other risks detailed from time to time
in the Company's periodic filings with the Securities and Exchange Commission.
All forward-looking statements of the Company are qualified by and should be
read in conjunction with such risk disclosure. The Company undertakes no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
RESULTS OF CONSOLIDATED OPERATIONS:
1998 versus 1997
Consolidated net income was $190.4 million in 1998, an 8.6% increase over 1997.
The growth can be attributed to increases in premiums earned of 8.2% and other
income of 155.2% and to a decrease in losses and loss adjustment expenses of
10.9%, partially offset by an increase in other operating expenses, including
policy acquisition costs, of 30.8%. Including capital gains, diluted earnings
per share increased by 15.5% to $6.04 in 1998. Excluding capital gains, diluted
operating earnings per share increased by 14.0% to $5.53. Revenues in 1998
increased by 10.0% to $620.9 million.
Mortgage Insurance Operations
PMI's NIW increased by 81.7% primarily as a result of the growth in volume of
the private mortgage insurance industry as well as the increase in PMI's market
share and secondarily to a 2.6% increase in the average insured loan size to
$131,700.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America ("MICA"),
experienced an increase in total new insurance written of 55.0% to $187.4
billion, benefiting from the record year of total residential mortgage
originations, estimated at $1.5 trillion. (Source: Inside Mortgage Finance) The
increase was caused primarily by low interest rates, which produced record
levels of both refinance activity as well as new and existing home sales.
Refinancing as a percentage of PMI's NIW increased to 31.0% in 1998 from 13.8%
in 1997. In addition, the private mortgage insurance companies' market share
increased to 56.3% of the total low downpayment market (insurable loans) from
54.5% in 1997. (Source: Inside Mortgage Finance)
PMI's market share of NIW increased to 14.8% in 1998 from 12.7% in 1997. On a
combined basis with CMG Mortgage Insurance Company ("CMG"), market share
increased to 16.1% in 1998 compared with 13.8% in 1997. In the fourth quarter of
1998, combined market share increased to 16.4% compared with 13.7% in the fourth
quarter of 1997. The increases in market share were primarily due to contract
underwriting services, pool insurance products, and risk sharing programs
offered by PMI. Pool risk totaled $450.3 million for the year. There was no pool
risk written in 1997. Risk in force under risk-share programs with PMI's
customers, represented approximately two percent of the $19.3 billion total
primary risk in force at December 31, 1998. Risk in force under risk-share
programs with PMI's customers, excluding pool insurance, represented 10.2% of
total risk in force at December 31, 1998, compared with
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3.1% at December 31, 1997. During 1999, management expects the percentage of
PMI's risk related to risk-share programs and represented by pool risk to
continue to increase as a percent of total risk. The Fannie Mae and Freddie Mac
reduction in mortgage insurance coverage requirements is expected to have a
negative impact on the growth rate of direct risk in force. (See RF10)
PMI's cancellations of insurance in force increased by 68.2% to $24.9 billion in
1998 primarily due to mortgage prepayments as a result of low interest rates
which caused high levels of refinancing activity. As a result of the higher
cancellation activity, PMI's persistency rate decreased to 68.0% as of December
31, 1998, compared with 80.8% as of December 31, 1997.
Insurance in force increased by 3.7% in 1998. On a combined basis with CMG,
insurance in force grew by 5.9% to $84.9 billion at December 31, 1998. PMI's
market share of insurance in force grew by 0.5 percentage points to 15.3%. PMI's
risk in force increased by 6.8% and, when combined with CMG, grew by 8.9% to
$20.4 billion. The growth rate of risk in force is greater than insurance in
force due to terminating policies being replaced by new policies with higher
coverage percentages.
Mortgage insurance net premiums written grew by 10.1% to $409.8 million in 1998
primarily due to the growth of risk in force of both primary and pool insurance
and the continued shift to deeper coverage for primary insurance partially
offset by an increase in refunded premiums of 39.2% to $21.9 million as a result
of the increase in policy cancellations. Mortgage insurance premiums earned
increased 4.5% to $411.9 million in 1998 primarily due to the increase in
premiums written. Ceded premiums were $18.3 million in 1998, increasing 15.2%
from prior year. Management anticipates ceded premiums will increase
substantially in the future as a result of the expected increase in risk-share
programs. (See RF7)
PMI's monthly product represented 71.6% of risk in force at December 31, 1998,
compared with 58.2% at December 31, 1997. Mortgages with original loan-to-value
ratios greater than 90% and equal to or less than 95% ("95s") with 30% insurance
coverage increased to 34.4% of risk in force as of December 31, 1998, from 28.8%
as of December 31, 1997. Mortgages with original loan-to-value ratios greater
than 85% and equal to or less than 90% ("90s") with 25% insurance coverage
increased to 29.2% of risk in force as of December 31, 1998, compared with 23.6%
as of December 31, 1997. Management anticipates the percentage of insurance in
force with higher coverage percentages will begin to decrease in 1999 and such
decrease should accelerate in the years following due to a reduction in required
mortgage insurance by Fannie Mae and Freddie Mac. (See RF3)
Mortgage insurance losses and loss adjustment expenses decreased 10.2% to $135.1
million in 1998 primarily due to the continuing improvement of the nationwide
housing markets, particularly California, and the corresponding decrease in
claim payments. Loans in default decreased by less than one percent to 16,526 at
December 31, 1998. PMI's national default rate decreased by 0.07 percentage
points to 2.31% at December 31, 1998, primarily due to an increase in policies
in force.
Direct primary claims paid decreased by 19.5% to $118.4 million due to an 11.6%
decrease in the average claim size to approximately $23,300 and an 8.9% decline
in the number of claims paid to 5,077 in 1998. The reduction in claims paid is
the result of a smaller percentage of claims originating from the California
book of business and to increased loss mitigation efforts by PMI and lenders.
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Default rates on PMI's California policies decreased to 3.15% (representing
3,067 loans in default) at December 31, 1998, from 3.73% (representing 3,987
loans in default) at December 31, 1997. Policies written in California accounted
for approximately 48.2% and 64.5% of the total dollar amount of claims paid in
1998 and 1997, respectively. Although management expects that California will
continue to account for a significant portion of total claims paid, management
anticipates that with continued improvement in the California economy, increased
benefits of loss mitigation efforts and improved default reinstatement rates,
California claims paid as a percentage of total claims paid should continue to
decline. (See RF13) Management believes that PMI's total default rate could
increase in 1999 due to the continued maturation of its 1994 and 1995 books of
business. (See RF12)
Mortgage insurance policy acquisition costs incurred and deferred (including,
among other field expenses, contract underwriting expenses) increased by 69.3%
as a result of the 81.7% increase in NIW. Amortization of policy acquisition
costs increased 38.9%. (See Note 5 "Deferred Acquisition Costs" of Notes to
Consolidated Financial Statements) New policies processed by contract
underwriters represented 35.0% of PMI's NIW in 1998 compared with 21.6% in 1997.
Contract underwriting has become the preferred method among many mortgage
lenders for processing loan applications. Management anticipates that contract
underwriting will continue to generate a significant percentage of PMI's NIW.
(See RF7)
Other mortgage insurance operating expenses increased by 8.0% to $44.3 million
in 1998 from $41.0 million in 1997 resulting from Year 2000 remediation costs of
$3.9 million, compared with $0.3 million of such costs in 1997. The mortgage
insurance loss ratio declined by 5.4 percentage points to 32.8% in 1998 due to
the growth in premiums earned coupled with the decrease in losses and loss
adjustment expenses, as discussed above. The expense ratio increased by 2.8
percentage points to 25.5% primarily due to the increase in policy acquisition
costs resulting from the growth in NIW and secondarily to Year 2000 remediation
costs. Excluding Year 2000 remediation expenses, the expense ratio was 24.6% for
1998 compared to 22.6% for 1997. The combined ratio decreased by 2.6% to 58.3%
in 1998.
Title Insurance Operations
Title insurance premiums earned increased 32.3% to $79.3 million in 1998
primarily due to the record residential mortgage origination volumes, as
discussed above, and secondarily to American Pioneer Title Insurance Company's
("APTIC")'s expansion into new states. APTIC was licensed in 39 states at
December 31, 1998, a 14.7% increase from December 31, 1997. In 1998, 77.3% of
APTIC's premiums earned came from its Florida operations, compared with 81.6% in
1997. Underwriting and other expenses increased 30.1% to $69.1 million because
of an increase in agency fees and commissions related to the increase in
premiums earned. The title insurance combined ratio decreased by 3.9 percentage
points to 87.9%.
Other
In 1998, the Company's net investment income increased by $1.5 million to $84.7
million primarily due to a $1.8 million increase in equity earnings. Investments
in affiliates increased to $60.5 million at year-end 1998 from $17.0 million at
year-end 1997. The average book value of the investment portfolio increased 1.2%
and the yield decreased from 6.14% in 1997 to 6.06% in 1998.
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Other income, primarily contract underwriting revenues generated by PMI Mortgage
Services Co. ("MSC"), increased by 155.0% to $20.4 million in 1998 while other
expenses, primarily expenses incurred by MSC, increased by 27.6% to $142.6
million. These increases are the result of increased contract underwriting
services provided to the Company's mortgage insurance customers. (See RF7)
The Company's effective tax rate increased to 28.7% in 1998 from 27.8% in 1997
as a result of a decrease in the proportion of tax-exempt investment income
relative to total income.
1997 versus 1996
Consolidated net income in 1997 was $175.3 million, an 11.0% increase over 1996.
The increase was attributable primarily to increases in premiums earned of 10.0%
and secondarily to investment income of 23.3%. There was also an increase in
realized capital gains of 37.0%, partially offset primarily by an increase in
underwriting and other expenses of 23.1%, and secondarily to an increase of
$13.5 million in interest-related costs. Premiums earned increased from the
growth in mortgage insurance renewal premiums, partially offset by the effect of
the termination and commutation of a reinsurance treaty with Centre
Reinsurance Company of New York and Centre Reinsurance International Company
("Centre Re") recorded in the fourth quarter of 1996. The 1996 results of
operations, including premiums earned, losses and loss adjustment expenses and
underwriting expenses, were impacted by the Centre Re termination as discussed
below. Diluted earnings per share increased by 16.0% in 1997, which was
affected by the repurchase of 2.1 million shares of common stock in 1997.
Excluding capital gains, diluted earnings per share increased by 14.4% to
$4.85 in 1997. Revenues in 1997 increased by 12.6% to $564.6 million.
Mortgage Insurance Operations
PMI's NIW decreased by 14.5% to $15.3 billion in 1997 resulting from the number
of new mortgage insurance policies issued decreasing by 16.6% to 119,200
policies, partially offset by a 2.6% increase in the average loan size to
$128,400.
The primary factor contributing to the decrease in new policies issued was a
decline in market share. PMI's market share of NIW decreased to 12.7% in 1997
from 14.1% in 1996. On a combined basis with CMG, market share was 13.8% in 1997
compared with 14.7% in 1996. The decline in market share was primarily due to
the availability of a pool insurance product not offered by PMI for the majority
of 1997 and secondarily to increases in product and underwriting competition in
the California market. The secondary factor contributing to the decrease in new
policies issued was the decline in the total volume of insured loans in the
private mortgage insurance industry in 1997 compared with 1996. The private
mortgage insurance industry experienced a decline in total NIW of 4.8% to $120.9
billion in 1997 from $127.0 billion in 1996.
PMI's cancellations of insurance in force increased 23.3% to $14.8 billion in
1997 primarily due to an increase in refinancing activity throughout the
industry brought on by lower interest rates. In addition, management believes
that, in response to proposed mortgage insurance cancellation
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legislation, servicers were reviewing their loan portfolios and requesting
cancellations on loans with current loan-to-value ratios of 80% or less.
PMI's persistency rate decreased 2.5 percentage points to 80.8% as of December
31, 1997 due primarily to the cancellations discussed above. Insurance in force
grew at a rate of 0.6% and 8.3% during 1997 and 1996, respectively, to a total
of $77.8 billion at December 31, 1997. The year-over-year decline in the growth
rate of insurance in force was due primarily to lower NIW and higher policy
cancellations in 1997 compared with 1996. However, the growth rate of risk in
force was 4.4% in 1997 and was greater than the growth rate in insurance in
force because terminating policies were being replaced by new policies with
higher coverage percentages, and accordingly, higher premium rates.
Mortgage insurance net premiums written increased 6.4% to $372.1 million in 1997
primarily due to higher average premium rates and higher average loan sizes, and
also to the growth of risk in force from one year prior, offset primarily by the
effect of the Centre Re termination in 1996 and also to a decrease in new
premiums written. Excluding the impact of the additional profit commission
realized on the Centre Re termination, net premiums written increased by 15.6%.
New premiums written decreased by 38.9% to $13.2 million in 1997 while renewal
premiums increased by 9.6% to $378.4 million. The decrease in new premiums
written during 1997 resulted primarily from the decrease in NIW from the 1996
level. Renewal premiums increased primarily from a shift in the composition of
policies in force to loans with higher premium rates and secondarily to the
growth of risk in force. Mortgages defined as 95s with 30% insurance coverage
increased to 28.8% of risk in force as of December 31, 1997, from 21.9% as of
December 31, 1996. Similarly 90s with 25% insurance coverage increased to
23.6% of risk in force in 1997 compared with 19.6% in 1996.
Mortgage insurance premiums earned increased 9.6% to $394.0 million in 1997
primarily due to higher premium rates and higher average loan sizes and
secondarily to the growth in risk in force from one year prior, offset primarily
by the effect of the Centre Re termination in 1996 and also to the decrease in
NIW from the 1996 level. Excluding the impact of the Centre Re termination, net
premiums earned increased by 15.5%.
Mortgage insurance losses and loss adjustment expenses decreased slightly to
$150.4 million in 1997 from $150.6 million in 1996. This decrease was due
primarily to the effect of the Centre Re termination in 1996. Prior to the
impact of the Centre Re termination, mortgage insurance losses and loss
adjustment expenses would have increased by 10.6% due to an increase in the
number of loans in default caused by the growth and maturation of insurance in
force. Primary claims paid by PMI increased slightly, by 2.8%, to approximately
$147 million; however, the average claim size decreased by 4.3% to $26,400 due
primarily to a smaller percentage of claims originating from the California book
of business, and also to increased loss mitigation activity.
PMI's default rate increased to 2.38% at December 31, 1997, from 2.19% at
December 31, 1996. This increase was due primarily to the policy cancellations
discussed above, and secondarily to normal delinquency development in states
where PMI expanded its market presence, and also to the maturation of PMI's
1993 and 1994 books of business.
The default rates on PMI's California policies decreased to 3.73% (representing
3,987 loans in default) at December 31, 1997, from 3.81% (representing 4,261
loans in default) at December
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31, 1996. Policies written in California accounted for approximately 64% and 73%
of the total dollar amount of claims paid in 1997 and 1996, respectively.
Mortgage insurance underwriting and other expenses increased 31.1% to $84.4
million in 1997 primarily due to the effect of Centre Re Termination and ceding
commissions in 1996, and secondarily to an increase in contract underwriting
expenses. Excluding the impact of the 1996 Centre Re transactions, 1997 expenses
increased by 11.9% over 1996. Contract underwriting processed loans represented
21.6% of PMI's NIW in 1997 compared to 13.0% in 1996.
The mortgage insurance loss ratio decreased by 3.7 percentage points to 38.2% in
1997 primarily due to the growth in net premiums earned, and also to the
decrease in losses and loss adjustment expenses discussed above. The expense
ratio increased 4.3 percentage points to 22.7% primarily due to the Centre Re
transactions. The result was a 0.6 percentage point increase in the combined
ratio to 60.9%. Excluding the 1996 Centre Re transactions, the 1996 expense
ratio was 23.4% and the 1996 loss ratio was 39.9%, resulting in a combined ratio
of 63.3%.
Interest expense of $6.8 million was incurred in 1997 related to the long-term
debt issued by the Company in November 1996. The Company incurred an additional
$7.6 million of expenses related to distributions on the redeemable preferred
capital securities issued by the Company in February 1997.
Title Insurance Operations
Title insurance premiums earned increased 12.6% to $59.9 million in 1997 due to
increasing current markets combined with successful ongoing expansion efforts
into new states. Underwriting and other expenses increased 10.6% to $53.1
million directly because of the increase in fees and commissions payable to
third parties based on premiums earned. The title insurance combined ratio
decreased to 91.8% in 1997 from 93.5% in 1996.
Other
The Company's net investment income increased 23.3% in 1997 to $83.1 million
primarily the result of the growth in the average amount of invested assets.
This growth was due primarily to the $198.3 million of combined proceeds from
the November 1996 debt offering and the February 1997 redeemable preferred
capital securities offering, secondarily to positive cash flows generated by
operating activities, and also to the collection of $53.6 million in connection
with the Centre Re Termination, partially offset by the $120 million common
stock repurchases in 1997. The average investment yield (pretax) decreased to
6.14% in 1997 from 6.21% in 1996 due to declining interest rates in 1997.
Realized capital gains (net of losses) increased by 37.1% to $19.6 million due
primarily to the sale of approximately $50.0 million of equity securities in the
first quarter of 1997.
Other income, primarily revenues generated by MSC, increased by 15.9% to $8.0
million in 1997 while other expenses, primarily incurred by MSC, increased by
29.4% to $17.6 million primarily due to expanded ancillary services, primarily
contract underwriting.
The Company's effective tax rate decreased by 1.1 percentage points to 27.8% in
1997. The benefits of tax-preference investment income and other permanent
differences reduced the
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effective rates below the statutory rate of 35% during both periods. The
decrease in the effective tax rate was due to an increase in tax-exempt income
and to a decrease in the state income tax provision during 1997.
Liquidity, Capital Resources and Financial Condition
Liquidity and capital resource considerations are different for The PMI Group,
Inc. ("TPG") and PMI, its principal insurance operating subsidiary. TPG's
principal sources of funds are dividends from PMI and APTIC, investment income
and funds that may be raised from time to time in the capital markets.
PMI's ability to pay dividends to TPG is limited, among other restrictions,
under the insurance laws of Arizona. Such laws provide that: (i) PMI may pay
dividends out of available surplus and (ii) without prior approval of the
Arizona Insurance Director, such dividends during any 12-month period may not
exceed the lesser of 10% of policyholders' surplus as of the preceding year end,
or the last calendar year's investment income.
The laws of Florida limit the payment of dividends by APTIC to TPG in any one
year to 10% of available and accumulated surplus derived from realized net
operating profits and net realized capital gains.
In addition to the dividend restrictions described above, the Company's credit
agreements limit the payment of dividends by PMI, and various credit rating
agencies and insurance regulatory authorities have broad discretion to limit the
payment of dividends to TPG by PMI or APTIC. During 1998, APTIC declared and
paid a cash dividend of $3.2 million to TPG, substantially the full amount of a
dividend that can be paid by APTIC in 1998 without prior permission from the
Florida Department of Insurance. PMI declared and paid extraordinary dividends
of $100 million to TPG in 1998. TPG has two bank credit lines available totaling
$50.0 million. At December 31, 1998, there were no outstanding borrowings under
the credit lines.
TPG's principal uses of funds are common stock repurchases, the payment of
dividends to shareholders, funding of acquisitions, additions to its investment
portfolio, investments in subsidiaries, and the payment of interest. The $150
million stock buy-back program authorized by the TPG Board of Directors in
November 1997 was completed in the third quarter of 1998. In November 1998, the
Company announced a stock repurchase program in the amount of $100 million.
As of December 31, 1998, TPG had approximately $56.1 million of available funds.
This amount has decreased from the December 31, 1997 balance of $134.2 million
due to the investment in RAM Reinsurance Company Ltd. ("RAM Re") and the common
stock repurchases through 1998, offset by dividends received from PMI and APTIC.
The principal sources of funds for PMI are premiums received on new and renewal
business 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,
policy acquisition costs and other operating expenses, investment in
subsidiaries, and dividends to TPG. PMI generates positive cash flows from
operations as a result of premiums being received in advance of the payment of
claims. Cash flows generated from PMI's operating activities totaled $154.0
million and $180.1 million
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in 1998 and 1997, respectively. The 1997 amount includes the collection of $53.6
million as a result of a termination and commutation of a reinsurance treaty.
The Company's invested assets increased by $41.6 million at December 31, 1998
due to cash flows from consolidated operations of $178.1 million offset by stock
repurchases of $152.9 million and dividends paid of $6.2 million.
Consolidated reserves for losses and loss adjustment expenses increased by 6.4%
in 1998 primarily due to the 7.8% increase in PMI's primary reserve per default
to $12,500 at December 31, 1998 and to the buildup of pool loss reserves.
Consolidated shareholders' equity increased by $36.3 million in 1998, consisting
of increases of $190.4 million from net income, $2.6 million from stock option
activity, and $2.5 million from other comprehensive income net of unrealized
gains on investments, offset by common stock repurchases of $152.9 million,
and dividends declared of $6.2 million.
PMI's statutory risk-to-capital ratio at December 31, 1998 was 14.9:1, compared
with 14.6:1 at December 31, 1997. (See RF9)
Year 2000 Issues
Impact of the Year 2000 Issue. The Company's business processes are highly
automated and dependent upon the consistent and accurate functioning of its
computer systems and the computer systems of its customers. As a result, the
Company is directing significant resources toward mitigating its exposure to the
so-called "Year 2000 issue." The Year 2000 issue arises from the failure of
computer software and hardware to process dates into and through the year 2000:
the number "00," for example, would be read as "1900" rather than "2000." The
technical problem is multifaceted and is composed of several different potential
deficiencies including, among others: (1) the inability of hardware to
interpret years greater than 1999; (2) the failure of software to process date
data from, into, and between the twentieth and twenty-first centuries; (3) the
inability of the number "99" to register an actual date (i.e., 1999) rather than
indefinite or unknown information (i.e., an employee's date of retirement, if
unknown, would be characterized as "99-99-99"); (4) the inability of systems to
recognize that the year 2000 is a leap year; and (5) the failure of systems that
are otherwise Year 2000 compliant to transfer data between each other because
each system has used a different "fix," and the methods are incompatible with
each other. If any of these deficiencies occur, the system may produce
miscalculations and/or "crash" and be unable to transfer or process data,
causing disruption in one or more aspects of the Company's operations. The
problem also affects many of the microprocessors that control systems and
equipment.
For purposes of this discussion, "Year 2000 compatible" means that the computer
hardware, software or device in question will function in year 2000 without
modification or adjustment or will function in 2000 with a one-time manual
adjustment. However, there can be no assurance that any such year 2000
compatible hardware, software or device will function properly when interacting
with any year 2000 noncompatible hardware, software or device.
State of Readiness. The Company has in place a Year 2000 project plan to
address the Year 2000 issue. The plan consists of three phases. The first phase
involved collecting data with
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respect to date processing issues, determining the project scope, identification
of resources to implement remediation, budgeting and completion of the formal
project plan. This phase was completed in early 1998 and included a priority
ranking designed to direct resources to the most critical systems first. As a
result of its first phase assessment, the Company determined that it will be
required to modify or replace a significant portion of its software so that
software will be Year 2000 compatible. The Company also determined that
remediation of the critical mortgage insurance origination and processing
applications used by PMI and CMG needed to be substantially completed by the
first business day of 1999 in order to avoid possible date calculation errors in
1999 and to satisfy the requirements of the government sponsored enterprises
("GSEs") and the federal and state regulators of the Company's customers. The
Federal Financial Institutions Examination Council guidelines for banks and
thrifts set various interim milestones for third party service providers such as
the Company, with final testing and substantial implementation required by June
30, 1999. Remediation of the Company's less critical applications is expected to
be completed during 1999. To date, PMI and CMG have met all readiness deadlines
or targets established by the GSEs and other regulators.
The second phase, which involves project staff procurement, code remediation and
unit testing, test plan development, Year 2000 policies and procedures
development and vendor readiness assessment, is substantially complete. The
third phase, which involves string and system testing and system installation,
is substantially complete. The Company completed remediation and testing of the
critical mortgage origination and processing applications referred to above
prior to its deadline of the first business day of 1999 and has converted its
database to the remediated software. The Company believes Year 2000
modifications to its critical mortgage origination and processing applications
were implemented successfully and that these systems will be Year 2000
compatible. (See RF1) Additional testing, including industry-sponsored testing
and testing of customer interfaces, is expected to continue through 1999. The
Company has completed remediation and testing of its telephone switches, and
management believes that these switches and other hardware and non-information
technology systems will be Year 2000 compatible. (See RF1)
Risks of Year 2000 Noncompatibility and Infrastructure Risks. The Company
currently believes that the remaining modifications to existing software and
conversions to new software utilized by the Company will be implemented
successfully and that the Year 2000 issue will not have a material adverse
impact on internal systems or operations. (See RF1) If, however, the Company's
past or future remediation efforts prove to be either inadequate or ineffective,
significant disruptions to the Company's operations could ensue which could have
a material adverse effect on the Company's liquidity, financial condition and
results of operations. Furthermore, the Company relies on financial
institutions, government agencies, utility companies, telecommunications service
companies and other service providers outside of its control. There can be no
assurance that such third parties will not suffer a Year 2000 business
disruption and it is conceivable that such failures could, in turn, have a
material adverse effect on the Company's liquidity, financial condition and
results of operations.
Risk Related to Vendors and Customers. As part of its Year 2000 project plan,
the Company has initiated communications with all of its large customers and
significant vendors to determine the extent to which the Company is vulnerable
to those third parties' failure to remediate their own Year 2000 issues. The
Company's vulnerability would likely result from the inability of the Company's
or customers' systems to process data received from the other, which could
disrupt the Company's mortgage insurance origination and claims processing,
and/or a disruption in the
10
supply of goods and services procured from suppliers. Currently, a substantial
majority of the Company's mortgage insurance business is originated through non-
electronic channels, which serves to mitigate this type of customer risk,
although the Company anticipates that electronic originations will increase in
future periods. The Company has begun to receive responses from suppliers and
customers but has not independently confirmed the information received from
third parties with respect to their Year 2000 compliance status. The Company
plans to follow up with suppliers and customers that have not responded to its
initial inquiries. The Company's total Year 2000 project cost and estimates
include the estimated costs and time associated with assessing the impact of
third parties' Year 2000 issues, and are based in part upon such unconfirmed
information. Because of the large number of variables involved, the Company
cannot provide an estimate of the damage it might suffer if any of the Company's
significant customers or vendors failed to remediate their Year 2000 issues,
although management believes that the business disruption likely to result from
any prolonged Year 2000 non-compliance by customers or suppliers could have a
material adverse effect on the Company's liquidity, financial condition and
results of operations. (See RF1)
Costs to Address the Year 2000 Issue. The Company is utilizing both internal
and external personnel and resources to implement its Year 2000 project plan.
Currently, no planned material projects involving information or non-information
technology systems have been delayed or are anticipated to be delayed as a
result of the redirection of resources to the Year 2000 remediation effort. The
Company plans to complete its Year 2000 issue remediation project at a total
external cost of approximately $4.5 million, which will be funded from operating
cash flow and is being expensed as incurred. As of December 31, 1998, the
Company has incurred and expensed approximately $3.9 million in external costs
related to its Year 2000 project plan and remediation efforts. The estimated
costs do not include any potential costs related to customer or other claims, or
potential amounts related to executing contingency plans. The Company does not
separately track the internal costs incurred in connection with the Year 2000
project plan, which are principally payroll costs for employees working on the
project.
Contingency Plans. The Company is currently assessing possible contingency
plans designed to limit, to the extent possible, the business disruption and
financial effects of a failure by the Company to complete its Year 2000
remediation project in a timely manner. Although no formal contingency plan is
yet in place, the Company has considered its likely response in certain
circumstances. For example, if any of the Company's critical systems, such as
the mortgage insurance system's origination or billing applications, are
disrupted due to the Year 2000 issue, it is possible that the Company might need
to process data manually. The Company's intention in this event would be to
procure clerical personnel from temporary recruitment firms to process data.
Hiring such temporary personnel would materially increase the Company's
personnel expense and have a corresponding negative effect on operating income.
In the event of a major system disruption, the Company will have access to
duplicate records of critical data from the Company's systems which are
maintained and stored at an offsite location as a routine procedure related to
the Company's disaster recovery program. These duplicate records could be of
assistance in any Year 2000 recovery operation. The Company's contingency
assessment will continue through 1999 as the Company learns more about the
preparations and vulnerabilities of third parties regarding the Year 2000 issue
and a formal contingency plan is expected to be in place by June 30, 1999. (See
RF1)
The discussion above is designated as a Year 2000 Readiness Disclosure as
defined by the Year 2000 Information and Readiness Disclosure Act of 1998.
11
STATEMENTS AND RISK FACTORS CONCERNING THE COMPANY'S OPERATIONS AND FUTURE
RESULTS
General Conditions (RF1)
Several factors such as economic recessions, declining housing values, higher
unemployment rates, deteriorating borrower credit, rising interest rates,
increases in refinance activity caused by declining interest rates, changes in
legislation affecting the mortgage insurance industry, or combinations of such
factors might affect the mortgage insurance industry and demand for housing 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.
Other 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 product offerings and services, including mortgage
pool insurance and contract underwriting services; the ability to recruit and
maintain a sufficient number of qualified underwriters; the effect of risk-
sharing structured transactions; changes in the performance of the financial
markets; PMI's claims-paying ability rating; general economic conditions that
affect the demand for or acceptance of the Company's products; changes in
government housing policy; changes in government regulations or interpretations
regarding the Real Estate Settlement Procedures Act and customer consolidation.
PMI's financial condition and results of operations may materially and adversely
be impacted by changes in legislation which affects the ability of Fannie Mae or
Freddie Mac to offer a substitute for mortgage insurance, including self-
insurance and alternative forms of credit support, or for the FHA or the VA to
increase statutory lending limits or other expansion of eligibility for the FHA
and VA. (See RF2). PMI's financial condition and results of operations may
materially and adversely be impacted by changes in legislation, statutory
charters and regulations governing banks and savings institutions to form
reinsurance subsidiaries or permit the offering of other products which do not
require mortgage insurance. In addition, PMI's financial condition and results
of operations may materially and adversely be impacted by a reduction in the
amount of mortgage insurance coverage required by Fannie Mae and Freddie Mac.
(See RF3)
The costs of Year 2000 remediation, the dates on which the Company estimates
that it will complete such remediation and possible risks associated with the
Year 2000 issue are based upon the Company's current estimates and are subject
to various uncertainties that could cause the actual results to differ
materially from the Company's expectations. Such uncertainties include, among
others, the success of the Company in identifying systems that are not Year 2000
compliant, the nature and amount of programming required to remediate each
affected system, the nature and adequacy of testing performed by the Company,
the availability of qualified personnel, consultants and other resources, and
the success of the Year 2000 remediation efforts of others. If the Company's
recently completed remediation of its mission critical mortgage insurance
origination and application processing process is faulty or fails for any reason
to be Year 2000 compliant, this circumstance could adversely impact its business
operations and could
12
have a material adverse affect on the Company's financial condition, liquidity
and results of operations. See Management Discussion and Analysis - Year 2000
Issues.
Market Share and Competition (RF2)
The Company's financial condition and results of operations could be materially
and adversely affected by a decline in its market share, or a decline in market
share of the private mortgage insurance industry as a whole. 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 that choose to remain uninsured, self-insure through
affiliates, or offer residential mortgage products that do not require mortgage
insurance. The impact of competitive underwriting criteria and product
offerings, including mortgage pool insurance and contract underwriting, has a
direct impact on the Company's market share. Further, several of the Company's
competitors have greater direct or indirect capital reserves that provide them
with potentially greater flexibility than the Company in addressing competitive
issues.
PMI competes directly with federal and state governmental and quasi-governmental
agencies, principally the FHA and, to a lesser degree, the VA. The Office of
the Comptroller of the Currency has granted permission to certain national banks
to form a reinsurance company as a wholly-owned operating subsidiary for the
purpose of reinsuring mortgage insurance written on loans originated or
purchased by such bank. The Federal Reserve Board is in the process of
considering whether similar activities are permitted for bank holding companies.
The Office of Thrift Supervision has also recently granted permission for
subsidiaries of thrift institutions to reinsure private mortgage insurance
coverage on loans originated or purchased by affiliates of such thrift's parent
organization. The reinsurance subsidiaries of national banks, savings
institutions, or bank holding companies could become significant competitors of
the Company in the future. Mortgage lenders, other than banks, thrifts or their
affiliates, are forming reinsurance affiliates that are typically regulated
solely by the insurance authority of their state of domicile. Management
believes that such reinsurance affiliates will increase competition in the
mortgage insurance industry and may materially and adversely impact PMI's market
share.
PMI offers various risk-sharing structured transactions, including a captive
reinsurance program as part of its strategic relationships with its customers.
PMI's customers have indicated an increasing demand for such products. PMI's
captive reinsurance program allows a reinsurance company, generally an affiliate
of the lender, to assume mortgage insurance default losses either on a quota
share basis, or at a specified entry point up to a maximum aggregate exposure,
up to an agreed upon amount of total coverage. An increasing percentage of PMI's
NIW is being generated by customers which have captive reinsurance programs, and
it is expected that this will continue and increase. Based on the current
structure, such products have the potential of reducing the Company's business
revenue as more premiums are ceded to customer captives. There can be no
assurance that PMI's risk-sharing structured transactions will continue to be
accepted by its customers. The inability of the Company to provide acceptable
risk-sharing structured transactions to its customers would likely have an
adverse effect on the competitive position of PMI and consequently could
materially and adversely affect the Company's financial condition, liquidity and
results of operations.
Certain lenders originate a first mortgage lien with an 80% LTV ratio, a 10%
second mortgage lien, and 10% of the purchase price from borrower's funds
("80/10/10"). This 80/10/10 product
13
competes with mortgage insurance as an alternative for lenders selling loans in
the secondary mortgage market. The Federal Deposit Insurance Corporation and
other banking regulators recently approved rules to be effective April 1, 1999
that would require national banks to hold almost twice as much risk-based
capital to cover possible defaults on the 80/10/10 products when the lender
holds the first and second mortgage. State-chartered banks already are subject
to the higher capital requirement. If the 80/10/10 product becomes a widely
accepted alternative to mortgage insurance, it could have a material and adverse
impact on the Company's financial condition and results of operations.
Legislation and regulatory changes affecting the FHA have affected demand for
private mortgage insurance. Effective January 1, 1999, the Department of Housing
and Urban Development announced an increase in the maximum individual loan
amount that FHA can insure to $208,800 from $197,620. The maximum individual
loan amount that the VA can insure is $203,150. The Omnibus Spending Bill of
1999, signed into law on October 21, 1998, among other items, streamlined the
FHA downpayment formula by eliminating tiered minimum cash investment
requirements and establishing maximum loan-to-value ratios based on loan size
and closing costs, making FHA insurance more competitive with private mortgage
insurance in areas with higher home prices.
Although management believes that it is too early to ascertain the impact of the
increase in the maximum individual loan amount the FHA can insure, any increase
in the maximum loan amount would likely have an adverse effect on the
competitive position of PMI and, consequently, could materially and adversely
affect the Company's financial condition and results of operations.
Fannie Mae and Freddie Mac (RF3)
The GSEs are permitted by statute to purchase conventional high-LTV mortgages
from lenders who obtain mortgage insurance on those loans. Fannie Mae and
Freddie Mac have some discretion to increase or decrease the amount of private
mortgage insurance coverage they require on loans. Fannie Mae and Freddie Mac
both recently announced programs where reduced mortgage insurance coverage will
be made available for lenders that deliver loans approved by the GSEs' automated
underwriting services, Loan Prospector/(SM)/ and Desktop Underwriter/(TM)/,
respectively. Generally, Fannie Mae's and Freddie Mac's reduced mortgage
insurance coverage options provide for: (i) across-the-board reductions in
required MI coverage on 30-year fixed-rate loans recommended for approval by
GSE's automated underwriting services to the levels in effect in 1994; (ii)
reduction in required MI coverage, for loans with only a 5 percent down payment
(a 95 percent LTV), from 30 percent to 25 percent of the mortgage loan covered
by MI; (iii) reduction in required MI coverage, for loans with a 10 percent down
payment (a 90 percent LTV loan), from 25 percent to 17 percent of the mortgage
loan covered by MI.. In addition, the GSE's announced programs to further reduce
MI coverage upon the payment of an additional fee by the lender. Under this
option, a 95 percent LTV loan will require 18 percent of the mortgage loan have
mortgage insurance coverage. Similarly, a 90 percent LTV loan will require 12
percent of the mortgage loan have mortgage insurance. In order for the home
buyer to have MI at these levels, such loans would require a payment at closing
or a higher note rate.
14
Management believes it is too early to assess impact of the Fannie Mae and
Freddie Mac reduction of required levels of mortgage insurance on the Company's
financial condition and results of operation. If the reduction in required
levels of mortgage insurance were to become widely accepted by mortgage lenders
and their customers, however, such reduction could have a materially adverse
impact on the Company's financial condition and results of operation.
During October 1998, Freddie Mac sought to amend its charter to allow it to use
any method of default loss protection that is financially equal or superior, on
an individual or pooled basis, to the protection provided by private mortgage
insurance companies. The legislation containing the proposed charter amendment
was subsequently rescinded. Currently, Freddie Mac can purchase loans with
downpayments of less than 20%, only if the loans are insured or use other
limited methods to protect against default.
Subsequent to the withdrawal of the legislation, Freddie Mac announced that it
would pursue a permanent charter amendment that would allow Freddie Mac to
utilize alternative forms of default loss protection, such as spread accounts,
or otherwise forego the use of private mortgage insurance on higher loan-to-
value mortgages. In addition, Fannie Mae announced it is interested in pursuing
new risk management options and is working with mortgage insurers and lenders on
appropriate risk management and dispersion of risk, which may include a
reduction in the use of mortgage insurance.
Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of
mortgage insurance generally provide that a borrower's written request to cancel
mortgage insurance should be honored if: (a) the borrower has a satisfactory
payment record, no payment more than 30 days delinquent in the 12-month period
preceding the request for cancellation; and (b) the unpaid principal balance of
the mortgage is not greater than 80% of the original value of the property.
(See RF4 for a discussion of recent Federal legislation providing for guidelines
for automatic mortgage insurance cancellation)
The GSEs are the predominant purchasers and sellers of conventional mortgage
loans in the United States, providing a direct link between the primary
mortgage origination markets and the capital markets. Because loan originators
prefer to make loans that may be marketed in the secondary market to Fannie
Mae and/or Freddie Mac they are motivated to purchase mortgage insurance from
insurers deemed eligible by the GSEs. Although management believes that it is
too early to ascertain the impact of the increase in the maximum individual
loan amount the GSEs can insure, management believes any increase in the
maximum loan amount would likely increase the number of loans eligible for
mortgage insurance and may have the effect of increasing the size of the
mortgage insurance market, and have a positive effect on the competitive
position of PMI and consequently could materially affect the Company's
financial condition and results of operations.
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. Under Fannie
Mae and Freddie Mac regulations, PMI needs to maintain at least an "AA-" or
equivalent claims-paying ability rating in order to provide mortgage insurance
on loans purchased by the GSEs. Failure to maintain such a rating would
effectively cause PMI to be ineligible to provide mortgage insurance. A loss of
PMI's existing eligibility status, either due to a failure to maintain a minimum
claims-paying ability rating from the various rating agencies or non-compliance
with other eligibility requirements, would have a material, adverse effect on
the Company's financial condition and results of operations. (See RF2)
Insurance in Force (RF4)
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. PMI's policies for
insurance coverage typically have a policy duration of six to eight years.
Insurance coverage may be canceled by the policy owner or servicer of the loan
at any time. PMI has no control over the owner's or servicer's decision to
cancel insurance coverage and self-insure or place coverage with another
mortgage insurance company. There can be no assurance that policies for
insurance coverage originated in a particular year or for a particular customer
will not be canceled at a later time or that the
15
Company will be able to regain such insurance coverage at a later time. As a
result, the Company's financial condition and results of operation could be
materially and adversely affected by greater than anticipated policy
cancellations or lower than projected persistency resulting in declines in
insurance in force.
Upon request by an insured, PMI must cancel the mortgage insurance for a
mortgage loan. In addition, The Home Owners Protection Act of 1998 (the "Act"),
which is effective on July 29, 1999, provides for the automatic termination, or
cancellation upon a borrower's request, of private mortgage insurance upon
satisfaction of certain conditions. The Act applies to owner- occupied
residential mortgage loans regardless of lien priority, with borrower-paid
mortgage insurance, closed after the effective date of the Act. FHA loans are
not covered by the Act. Under the Act, automatic termination of mortgage
insurance would generally occur once the loan-to-value ratio ("LTV") reaches
78%. A borrower may generally request cancellation of mortgage insurance once
the LTV reaches 80% of the home's original value, or when actual payments reduce
the loan balance to 80% of the home's original value, whichever occurs earlier.
For borrower initiated cancellation of mortgage insurance, the borrower must
have a good payment history. Good payment history generally requires that there
have been no payments during the 12-month period preceding the loan's
cancellation date 30 days or more past due, or 60 days or more past due during
the 12-month period beginning 24 months before the loan's cancellation date.
Loans which are deemed "high risk" by the GSEs, require automatic termination of
mortgage insurance coverage once the LTV is first scheduled to reach 77% of the
original value of the property without regard to the actual outstanding balance.
The Act preempts all but more protective, preexisting state laws. Protected
state laws are preempted if inconsistent with the Act. Protected state laws are
consistent with the Act if they require: (i) termination of mortgage insurance
at an earlier date or higher mortgage principal balance than required by the
Act, or (ii) disclosure of more, earlier, or more frequent information. States
which enacted mortgage insurance cancellation laws on or before January 2, 1998,
have until July 29, 2000 to make their statutes consistent with the Act. States
that currently have mortgage insurance cancellation or notification laws
include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New
York, Texas and Washington. Management is uncertain about the impact of the Act
on PMI's insurance in force, but believes any reduction in premiums attributed
to the Act's required cancellation of mortgage insurance, will not have a
significant impact on the Company's financial condition and results of operation
for the foreseeable future. (See RF10)
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans. PMI and other mortgage insurance
companies generally experience an increase in the prepayment rate of insurance
in force, resulting from policy cancellations of older books of business with
higher rates of interest. Although PMI has a history of expanding business
during low interest rate environments, the resulting increase of NIW may
ultimately prove to be inadequate to compensate for the loss of insurance in
force arising from policy cancellations. A decrease in persistency, resulting
from policy cancellations of older books of business affected by refinancings
(which are affected, among other things, by decreases in interest rates) may
materially and adversely impact the level or rate of growth of insurance in
force or risk in force and consequently have similar impacts on the Company's
financial condition and results of operations.
Rating Agencies (RF5)
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard and
Poor's Rating Services, "Aa2" (Excellent) by Moody's Investors Service, Inc.,
"AA+" (Very Strong) by Fitch IBCA, and "AA+" (Very High) by Duff & Phelps Credit
Rating Co. 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, principally PMI's capital
resources as computed by the rating agencies, and are not applicable to the
Company's common stock or outstanding debt.
16
Rating agencies generally assess capital charges on pool insurance policies
based on price and structure. One published methodology for assessing the
capital requirement for pool insurance is based on the real estate depression
which occurred in oil producing states during the mid-1980's. Management
believes the current capital charge that could be levied on pool insurance risk
by one rating agency is approximately $1.00 of capital for each $1.40 of pool
insurance risk. In comparison, primary mortgage insurance regulators
specifically limit the amount of insurance risk that may be written by PMI
according to a number of financial tests, including limiting risk, to a multiple
of 25 times PMI's statutory capital (which includes the contingency reserve).
The rating agencies could change their view as to the capital charges that are
assessed on pool insurance products at any time. (See RF10)
Management believes that a significant reduction in PMI's claims-paying ratings
could have a material, adverse effect on the Company's financial condition and
results of operations. (See RF6)
Liquidity (RF6)
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 significantly influenced by
the level and severity of claims.
TPG's principal sources of funds are dividends from PMI and APTIC, investment
income and funds that may be raised from time to time in the capital markets.
Numerous factors bear on the Company's ability to maintain and meet its capital
and liquidity needs, including the performance of the financial markets,
standards and factors used by various credit rating agencies, financial
covenants in credit agreements, and standards imposed by state insurance
regulators relating to the payment of dividends by insurance companies. Any
significant change in the performance of the financial markets negatively
affecting the Company's ability to secure sources of capital, or changes in the
standards used by credit rating agencies which adversely impact PMI's claims-
paying ability rating, or changes in the insurance laws of Arizona, Florida or
Wisconsin that restrict the ability of PMI, APTIC or CMG to pay dividends at
currently permissible levels, could adversely affect the Company's ability to
maintain capital resources to meet its business needs, and thereby have a
material, adverse affect on the Company's financial condition, liquidity and
results of operations.
Contract Underwriting Services; New Products (RF7)
The Company provides contract underwriting services for a fee that enable
customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting. As a part of its
contract underwriting services, PMI provides remedies which may include the
assumption of some of the costs of repurchasing insured and uninsured loans from
the GSEs and other investors. Generally, the scope of these remedies are in
addition to those contained in PMI's master primary insurance policies. Due to
the increasing demand of contract underwriting services, the limited number of
underwriting personnel available, and heavy price competition among mortgage
insurance companies, PMI's inability to recruit and maintain a sufficient number
of qualified underwriters, or any significant increase in the cost PMI incurs to
17
satisfy remedy obligations for underwriting services, could materially and
adversely affect its market share and materially and adversely affect the
Company's financial condition and results of operations.
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 experiences delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products, including any
mortgage pool type products, or programs will be as profitable as the Company's
existing products and programs.
New York Department of Insurance (RF8)
In February 1999, the New York Department of Insurance stated in Circular Letter
No. 2, addressed to all private mortgage insurers licensed in New York that
certain pool risk-share and structured products and programs would be considered
to be illegal under New York law. PMI believes that it complies with the
requirements of Circular Letter No. 2 with respect to transactions that are
governed by it. In the event the New York Department of Insurance determined
PMI was not in compliance with Circular Letter No. 2, it could materially and
adversely affect the Company's financial condition and results of operations.
Risk-to-Capital Ratio (RF9)
The State of Arizona, and other regulators specifically limit the amount of
insurance risk that may be written by PMI, by a variety of financial factors.
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 with Allstate, 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 which generally require that the rating
agencies' risk-to-capital ratio not exceed 20 to 1.
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 and
adversely affect the Company's financial condition and results of operations.
Changes in Composition of Insurance Risk Written; Pool Insurance (RF10)
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, 1998, 46.3% 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"). At
December 31, 1998, 3.3% of PMI's risk in force consisted of 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. Since the
fourth quarter of 1997, PMI has offered a new pool insurance product. Pool
18
insurance is generally used as an additional credit enhancement for certain
secondary market mortgage transactions and generally covers the loss on a
defaulted mortgage loan that exceeds the claim payment under the primary
coverage, if primary insurance is required on that mortgage loan. Pool insurance
also generally covers the total loss on a defaulted mortgage loan which did not
require primary insurance, in each case up to a stated aggregate loss limit. New
pool risk written was $450 million for the year ended December 31, 1998.
Management is uncertain about the amount of new pool risk which will be written
in 1999, but believes total new 1999 pool risk will be less than in 1998.
Although PMI charges higher premium rates for loans that have higher risk
characteristics, including ARMs, 95s, 97s and pool insurance products, 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. Such losses could materially and adversely affect the Company's
financial condition and results of operations. (See RF5)
Potential Increase in Claims (RF11)
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured until required to be canceled under
applicable Federal or state laws 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. (See
RF5)
Loss Reserves (RF12)
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amounts, 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.
Regional Concentration (RF13)
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, Florida, and Texas, where PMI
has 17.6%, 7.3% and 7.2% of its risk in force concentrated and where the default
rate on all PMI policies in force is 3.15%, 3.08% and 2.18% compared with 2.31%
nationwide as of December 31, 1998.
Continuing Relationships with Allstate and Affiliate (RF14)
In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage
Insurance Company ("Forestview") whereby Forestview agreed to reinsure all
liabilities (net of amounts collected from third party reinsurers and
indemnitors) in connection with PMI's mortgage pool insurance business in
exchange for premiums received. In 1994, Forestview also agreed that as soon as
practicable after November 1, 1994, Forestview and PMI would seek regulatory
approval
19
for the Reinsurance Treaty to be deemed to be an assumption agreement
and that, upon receipt of the requisite approvals, Forestview would assume such
liabilities. Forestview's claims-paying ability is currently rated "AA" by
Fitch IBCA. Forestview's previous claims-paying ability rating of "AA"
(Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P") in
1997. These ratings are subject to revisions or withdrawal at any time by the
assigning rating organization. Management is uncertain at this time what impact
the withdrawal of the claims-paying ability rating will have on the parties'
ability to timely consummate the assumption transaction. Pursuant to this
agreement, PMI ceded $9.0 million of pool premiums to Forestview and Forestview
reimbursed PMI for pool claims on the covered policies in the amount of $26.8
million in 1998. The failure of Forestview to meet its contractual commitments
would materially and adversely affect the Company's financial condition and
results of operations.
On October 28, 1994, TPG entered into a Runoff Support Agreement (the "Runoff
Support Agreement") with Allstate Insurance Company ("Allstate") to replace
various capital support commitments that Allstate had previously provided to
PMI. Allstate agreed to pay claims on certain insurance policies issued by PMI
prior to October 28, 1994, if PMI's financial condition deteriorates below
specified levels, or if a third party brings a claim thereunder. Alternatively,
Allstate may make contributions directly to PMI or TPG. In the event that
Allstate makes payments or contributions under the Runoff Support Agreement
(which possibility management believes is remote), Allstate would receive
subordinated debt or preferred stock of PMI or TPG in return. No payment
obligation arose under the Runoff Support Agreement.
20
Consolidated Statements of
O p e r a t i o n s
Year Ended December 31,
(In thousands, except per share amounts) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
Revenues Premiums earned $ 491,226 $ 453,948 $ 412,738
Investment income, less investment expense 84,681 83,136 67,442
Realized capital gains 24,636 19,584 14,296
Other income 20,366 7,979 6,948
-----------------------------------------------
Total revenues 620,909 564,647 501,424
-----------------------------------------------
Losses and Losses and loss adjustment expenses 135,716 152,257 152,409
Expenses Policy acquisition costs 60,280 43,395 46,192
Underwriting and other operating expenses 142,625 111,745 79,810
Interest expense 7,029 6,766 907
Distributions on preferred capital securities 8,311 7,617 -
-----------------------------------------------
Total losses and expenses 353,961 321,780 279,318
-----------------------------------------------
Income before income taxes 266,948 242,867 222,106
Income tax expense 76,588 67,558 64,188
-----------------------------------------------
Net income $ 190,360 $ 175,309 $ 157,918
===============================================
Per Share Basic net income per common share $ 6.06 $ 5.25 $ 4.52
===============================================
Diluted net income per common share $ 6.04 $ 5.23 $ 4.51
===============================================
See notes to consolidated financial statements.
21
Consolidated
B a l a n c e S h e e t s
As of December 31,
(Dollars in thousands) 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
Assets Investments:
Available for sale, at market:
Fixed income securities (amortized
cost $1,268,625 and $1,234,178) $ 1,356,869 $ 1,308,768
Equity securities:
Common (cost $34,129 and $38,221) 58,785 73,596
Preferred (cost $17,240 and $12,049) 17,706 12,360
Common stock of affiliates, at underlying book value 60,450 16,987
Short-term investments 38,414 78,890
---------------------------------
Total investments 1,532,224 1,490,601
Cash 9,757 11,101
Accrued investment income 20,150 20,794
Reinsurance recoverable and prepaid premiums 42,102 31,676
Premiums receivable 24,367 19,756
Receivable from affiliate 2,229 451
Receivable from Allstate 23,657 16,822
Deferred policy acquisition costs 61,605 37,864
Property and equipment, net 37,630 31,393
Other assets 24,149 26,145
---------------------------------
Total assets $ 1,777,870 $ 1,686,603
=================================
Liabilities Reserve for losses and loss adjustment expenses $ 215,259 $ 202,387
Unearned premiums 94,886 94,150
Long-term debt 99,476 99,409
Reinsurance balances payable 14,764 11,828
Deferred income taxes 96,730 76,395
Other liabilities and accrued expenses 60,200 42,248
---------------------------------
Total liabilities 581,315 526,417
---------------------------------
Commitments and contingent liabilities (Note 11) - -
Company-obligated mandatorily redeemable preferred
capital securities of subsidiary trust holding
solely junior subordinated deferrable interest
debenture of
the Company 99,040 99,006
Shareholders' Preferred stock - $.01 par value; 5,000,000 shares authorized - -
Equity Common stock - $.01 par value; 125,000,000 shares
authorized, 35,196,002 and 35,145,247 issued 352 351
Additional paid-in capital 265,040 262,448
Accumulated other comprehensive income 74,462 71,936
Retained earnings 1,060,724 876,588
---------------------------------
1,400,578 1,211,323
Less treasury stock (4,917,401 and 2,684,000 shares at cost) 303,063 150,143
---------------------------------
Total shareholders' equity 1,097,515 1,061,180
---------------------------------
Total liabilities and shareholders' equity $ 1,777,870 $ 1,686,603
=================================
See notes to consolidated financial statements.
22
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,
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
Common Balance, beginning of year $ 351 $ 350 $ 350
Stock Stock grants and exercise of stock options 1 1 -
-----------------------------------------------
Balance, end of year 352 351 350
-----------------------------------------------
Additional Balance, beginning of year 262,448 258,059 256,507
Paid-in Stock grants and exercise of stock options 2,592 4,389 1,552
-----------------------------------------------
Capital Balance, end of year 265,040 262,448 258,059
-----------------------------------------------
Accumulated Balance, beginning of year 71,936 50,709 56,761
-----------------------------------------------
Other Unrealized gains on investments:
Comprehensive Unrealized holding gains arising during period
Income (net of tax of $9,982, $18,285, and $1,745) 18,539 33,957 3,240
Less: reclassification adjustment for gains
included in net income
(net of tax of $8,623, $6,854, and $5,004) (16,013) (12,730) (9,292)
-----------------------------------------------
Other comprehensive income (loss), net of tax 2,526 21,227 (6,052)
-----------------------------------------------
Balance, end of year 74,462 71,936 50,709
-----------------------------------------------
Retained Balance, beginning of year 876,588 707,885 556,969
Earnings Net income 190,360 175,309 157,918
Dividends declared (6,224) (6,606) (7,002)
-----------------------------------------------
Balance, end of year 1,060,724 876,588 707,885
-----------------------------------------------
Treasury Balance, beginning of year (150,143) (30,141) (84)
Stock Purchases of The PMI Group, Inc. common stock (152,920) (120,002) (30,057)
-----------------------------------------------
Balance, end of year (303,063) (150,143) (30,141)
-----------------------------------------------
Total shareholders' equity $ 1,097,515 $ 1,061,180 $ 986,862
===============================================
Comprehensive Net income $ 190,360 $ 175,309 $ 157,918
Income Other comprehensive income (loss), net of tax 2,526 21,227 (6,052)
-----------------------------------------------
Comprehensive income $ 192,886 $ 196,536 $ 151,866
===============================================
See notes to consolidated financial statements.
23
Consolidated Statements of
C a s h F l o w s
Year Ended December 31,
(In thousands) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
Cash Net income $ 190,360 $ 175,309 $ 157,918
Flows Reconciliation of net income to net cash provided by
from operating activities:
Operating Realized capital gains, net (24,636) (19,584) (14,296)
Activities Equity in earnings of affiliates (3,225) (1,455) (192)
Depreciation and amortization 6,282 4,679 3,283
Changes in:
Reserve for losses and loss adjustment expenses 12,872 2,613 7,687
Unearned premiums 736 (22,801) (23,371)
Deferred policy acquisition costs (23,741) (6,231) (8,647)
Accrued investment income 644 (1,355) (1,072)
Reinsurance balances payable 2,936 (1,467) (5,446)
Reinsurance recoverable and prepaid premiums (10,426) 51,703 (5,372)
Premiums receivable (4,611) (5,109) (14,647)
Income taxes 19,444 14,179 1,915
Receivable from affiliate (1,778) 127 (454)
Receivable from Allstate (6,835) - (2,089)
Other 20,079 (4,070) 6,589
--------------------------------------------
Net cash provided by operating activities 178,101 186,538 101,806
--------------------------------------------
Cash Proceeds from sales of equity securities 75,181 82,008 97,104
Flows Investment collections of fixed income securities 54,374 13,590 32,595
from Proceeds from sales of fixed income securities 120,404 367,865 211,945
Investing Purchases of fixed income securities (207,686) (573,627) (415,162)
Activities Purchases of equity securities (53,092) (33,010) (77,634)
Net decrease in short-term investments 40,476 2,986 434
Investment in affiliates (40,024) (3,600) (1,350)
Purchases of property and equipment (12,417) (13,687) (10,213)
--------------------------------------------
Net cash used in investing activities (22,784) (157,475) (162,281)
--------------------------------------------
Cash Issuance of redeemable preferred capital securities - 99,000 -
Flows Issuance of long-term debt - - 99,337
from Proceeds from exercise of stock options 2,592 3,181 1,135
Financing Dividends paid to shareholders (6,333) (6,733) (7,002)
Activities Purchases of The PMI Group, Inc. common stock (152,920) (120,002) (30,057)
--------------------------------------------
Net cash provided by (used in) financing
activities (156,661) (24,554) 63,413
--------------------------------------------
Net increase (decrease) in cash (1,344) 4,509 2,938
Cash at beginning of year 11,101 6,592 3,654
--------------------------------------------
Cash at end of year $ 9,757 $ 11,101 $ 6,592
============================================
See notes to consolidated financial statements.
24
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
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"), American Pioneer Title Insurance Company ("APTIC"), PMI Mortgage
Guaranty Co. ("PMG"), and PMI Capital I ("PCI"), PMI's wholly owned subsidiaries
PMI Mortgage Services Co. ("MSC") and PMI Securities Co. ("SEC"), 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 April 1998. On April
15, 1998, Allstate Corp. exchanged 8,602,650 shares of TPG common stock to
redeem the 6.76% exchangeable notes due April 15, 1998. After the exchange,
Allstate held approximately 1,897,350 shares of TPG common stock, which has
subsequently been sold by Allstate.
NOTE 2. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business -The Company, through PMI, primarily writes residential mortgage
guaranty insurance ("primary insurance"). During 1997, PMI also began offering a
mortgage pool insurance product, which differs in a number of respects from the
pool insurance products offered through 1993 ("Old Pool" See Note 6). In
addition, the Company writes title insurance through APTIC. Primary mortgage
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. Pool insurance is generally used as an additional credit enhancement for
certain secondary market mortgage transactions. 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 14). 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 component of accumulated other comprehensive income.
In September 1994, PMI acquired 45% of the common stock of CMG Mortgage
Insurance Company ("CMG") from CUNA Mutual Investment Corp. ("CMIC"). On October
1, 1998, PMI increased its equity investment in CMG to 50% by obtaining
additional shares of common stock at a total cost of $4.8 million. CMIC
continues to own the remaining 50% of the common stock of CMG. In addition, TPG
owns 22.3% of RAM Holdings Ltd. and RAM Holdings II Ltd. (collectively referred
to as "RAM Re"). Such affiliated investments are 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.
Property and Equipment - Property and equipment (including software) is carried
at cost less accumulated depreciation. The Company provides for depreciation
using the straight-line method over the estimated useful lives of the assets,
generally 3 to
25
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
10 years for equipment and 40 years for real property. Accumulated depreciation
on property and equipment was $38.9 million and $33.1 million at December 31,
1998 and 1997, respectively.
Insurance Accounting - Primary mortgage insurance policies are contracts that
are non-cancelable by the insurer, are renewable at a fixed price at the
insured's option, and provide for the payment of premiums on either a monthly,
annual or single 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, and any unreceived portion is
recorded in premiums receivable. 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 mortgage insurance business, including compensation,
premium taxes and other underwriting expenses, are deferred, to the extent
recoverable, and amortized over 24 months (see Note 5, "Deferred Acquisition
Costs").
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, 1998 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 per Common Share - Basic earnings per share (EPS) excludes dilution and
is computed by dividing net income available to common shareholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
The weighted average common shares outstanding for computing basic EPS were
31,393,782 for 1998, 33,385,828 for 1997 and 34,951,764 for 1996. The weighted
average common shares outstanding for computing diluted EPS includes only stock
options issued by the Company which have a dilutive impact and are outstanding
for the period, and had the potential effect of increasing common shares to
31,532,710 for 1998, 33,510,261 for 1997 and 35,039,976 for 1996. Net income
available to common shareholders does not change for computing diluted EPS.
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 7.
Concentration of Risk - A substantial portion of PMI's business is generated
within the State of California. For the year ended December 31, 1998, 14.9% of
new insurance written was in California. In addition, California's book of
business represented 17.6% of total risk in force at December 31, 1998.
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 13).
New Accounting Pronouncements - In 1998, PMI adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, SFAS No.
131, Disclosures about Segments of an Enterprise and Related Information, and
SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement
Benefits. SFAS No. 130 requires that an enterprise report, by major component
and as a single total, the change in its net assets during the period from
non-owner
26
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
sources. SFAS No. 131 establishes annual and interim reporting standards for an
enterprise's operating segments and related disclosures about its products,
services, geographic areas and major customers. SFAS No. 132 revises the
disclosure information and format for presentation of pension and other
postretirement benefits. Adoption of these statements did not impact the
Company's financial position, results of operations or cash flows for the
periods presented.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, which
establishes accounting and reporting standards for derivative instruments. The
statement is not expected to have a significant effect on PMI's financial
position or results of operations based on current operating activities.
Reclassification - Certain prior year amounts have been reclassified to conform
to current year presentation.
NOTE 3. INVESTMENTS
Market Values - The amortized cost and estimated market values for fixed income
securities are shown below:
Amortized Gross Unrealized Market
----------------
(In thousands) Cost Gains (Losses) Value
- -------------------------------------------------------------------------------------------------------------------------
At December 31, 1998
U. S. government and agencies $ 53,918 $ 2,060 $ - $ 55,978
Municipals 1,110,665 83,363 (290) 1,193,738
Corporate bonds 104,042 3,451 (340) 107,153
----------------------------------------------------------------------------------
Total $ 1,268,625 $ 88,874 $ (630) $ 1,356,869
==================================================================================
At December 31, 1997
U. S. government and agencies $ 42,017 $ 1,233 $ - $ 43,250
Municipals 1,044,964 71,369 (17) 1,116,316
Corporate bonds 147,197 2,269 (264) 149,202
----------------------------------------------------------------------------------
Total $ 1,234,178 $ 74,871 $ (281) $ 1,308,768
==================================================================================
Scheduled Maturities - The scheduled maturities for fixed income securities are
as follows at December 31, 1998:
Amortized Market
(In thousands) Cost Value
- -------------------------------------------------------------------------------
Due in one year or less $ 6,826 $ 6,878
Due after one year through five years 62,650 64,945
Due after five years through ten years 148,382 157,887
Due after ten years 993,592 1,069,145
Other 57,175 58,014
--------------------------------------
Total $ 1,268,625 $ 1,356,869
======================================
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, 1998 and 1997, 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.
27
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1998 1997
- ---------------------------------------------------------
Illinois 13.2% 13.4%
Washington 12.0 13.3
Texas 12.0 13.0
New York 8.6 7.7
Massachusetts 7.3 6.0
California 6.5 6.9
Indiana 6.1 5.4
Pennsylvania 5.5 5.3
At December 31, 1998, fixed income securities with a market value of $10.2
million were on deposit with regulatory authorities as required by law.
Unrealized Net Gains on Investments - Unrealized net gains on investments
included in accumulated other comprehensive income at December 31, 1998, are as
follows:
Net
Market Gross Unrealized Unrealized
(In thousands) Cost Value Gains (Losses) Gains
- --------------------------------------------------------------------------------------------------------------------------
Fixed income securities $ 1,268,625 $ 1,356,869 $ 88,874 $ (630) $ 88,244
Common stocks 34,129 58,785 25,220 (564) 24,656
Preferred stocks 17,240 17,706 697 (231) 466
Investment in affiliates 59,723 60,450 727 - 727
----------------------------------------------------------------------------------------
Total $ 1,379,717 $ 1,493,810 $ 115,518 $ (1,425) 114,093
=========================================================================
Less deferred income taxes 39,631
---------------
Total $ 74,462
===============
The difference between cost and market value of the investment in affiliates
reflects net unrealized gains on the affiliates' investment portfolio. The
stated market value does not necessarily represent the fair value of the
affiliates' common stock held by the Company.
The change in net unrealized gains, net of deferred income taxes, included in
other comprehensive income for fixed income securities and equity securities are
as follows:
(In thousands) 1998 1997 1996
- -------------------------------------------------------------------------------
Fixed income securities $ 8,874 $ 20,572 $ (11,777)
Equity securities (6,565) 517 5,895
Investment in affiliates 217 138 (170)
----------------------------------------------------
Total $ 2,526 $ 21,227 $ (6,052)
====================================================
28
Draft
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Investment Income - Investment income by investment type is as follows:
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Fixed income securities $ 76,427 $ 74,641 $ 63,715
Equity securities 2,466 1,476 2,136
Common stock of affiliates 3,225 1,455 192
Short-term 3,442 6,332 2,119
----------------------------------------------------
Investment income, before expenses 85,560 83,904 68,162
Less investment expense 879 768 720
----------------------------------------------------
Investment income, less investment expense $ 84,681 $ 83,136 $ 67,442
====================================================
Realized Capital Gains and Losses.
Net realized capital gains (losses) are as follows:
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
Fixed income securities $ 1,481 $ (777) $ 2,072
Equity securities 23,155 20,188 12,024
Short-term - 173 200
-------------------------------------------------------------
Realized capital gains -- net, before taxes 24,636 19,584 14,296
Less income taxes 8,623 6,854 5,004
-------------------------------------------------------------
Realized capital gains, net of taxes $ 16,013 $ 12,730 $ 9,292
=============================================================
Gross realized capital gains and losses on investments are as follows:
(In thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------
Gross realized capital gains $ 27,810 $ 26,167 $ 19,842
Gross realized capital losses (3,174) (6,583) (5,546)
----------------------------------------------------
Net realized capital gains $ 24,636 $ 19,584 $ 14,296
====================================================
29
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
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) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
Balance, January 1 $ 202,387 $ 199,774 $ 192,087
Less reinsurance recoverable 6,067 5,287 17,899
------------------------------------------------------------
Net balance, January 1 196,320 194,487 174,188
------------------------------------------------------------
Losses and loss adjustment expenses (principally in respect of
defaulting occurring in)
Current year 146,884 158,147 161,740
Prior years (11,168) (5,890) (9,331)
------------------------------------------------------------
Total losses and loss adjustment expenses 135,716 152,257 152,409
------------------------------------------------------------
Losses and loss adjustment expense payments (principally in
respect of defaulting occurring in)
Current year 12,503 27,700 23,353
Prior years 111,056 122,724 108,757
------------------------------------------------------------
Total payments 123,559 150,424 132,110
------------------------------------------------------------
Net balance, December 31 208,477 196,320 194,487
Plus reinsurance recoverable 6,782 6,067 5,287
------------------------------------------------------------
Balance, December 31 $ 215,259 $ 202,387 $ 199,774
============================================================
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 $11.2 million, $5.9 million and
$9.3 million in 1998, 1997 and 1996, respectively, due primarily to lower than
expected 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. DEFERRED ACQUISITION COSTS ("DAC")
PMI defers certain costs related to the acquisition of primary mortgage
insurance and amortizes these costs against related premium revenue in order to
match costs and revenues in accordance with GAAP. These acquisition costs vary
with, and are primarily related to, the acquisition of new business. Specific
costs PMI defers include field underwriting, field sales, and national accounts.
To the extent PMI or any of its subsidiaries are compensated by customers for
contract underwriting, those underwriting costs are not deferred.
DAC is amortized on an accelerated basis over 24 months rather than the 5-7 year
average policy life. Management believes this amortization method is
appropriately conservative, and is used so that deferred costs will have been
fully amortized prior to the peak claims paying period.
The DAC asset is affected by: (a) acquisition costs deferred in a period, and
(b) amortization of previously deferred costs in such period. In periods where
there is growth in new business (and therefore acquisition costs), the DAC asset
will increase because the amount of acquisition costs being deferred exceeds the
amount being amortized to expense. The following table reconciles beginning and
ending DAC for the years ended December 31, 1998, 1997 and 1996:
30
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------
Beginning DAC balance $ 37,864 $ 31,633 $ 22,986
Acquisition costs incurred and deferred 84,021 49,626 54,839
Amortization of deferred costs (60,280) (43,395) (46,192)
------------ ------------ ------------
Ending DAC balance $ 61,605 $ 37,864 $ 31,633
============ ============ ============
NOTE 6. 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.
The reinsurance agreement with Capital Mortgage Reinsurance Company of New York
was terminated effective December 31, 1997 and is in run-off through December
31, 2006 on policies existing prior to January 1, 1998. As a result of this
reinsurance treaty termination, the Company is no longer ceding primary
reinsurance to third party reinsurers (except under captive reinsurance
arrangements) on policies written after December 31, 1997.
In December 1993, the Company decided to cease writing Old Pool business (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 Old Pool net premiums and net losses from PMI to
Forestview. As a result of this ceding agreement, the Old Pool business had no
significant impact on the Company's results of operations for the years ended
December 31, 1998, 1997 and 1996. 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, Old 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 $2.7 million and $4.1 million included in other assets at December
31, 1998 and 1997, respectively. Gross Old Pool reinsurance recoverables and
receivables from Forestview and other reinsurers are as follows at December 31:
(in thousands) 1998 1997
- --------------------------------------------------------------------
Forestview $ 45,918 $ 89,580
Other reinsurers 19,308 23,565
-------------------------------
Total $ 65,226 $ 113,145
===============================
Reinsurance recoverable on paid primary losses from reinsurers was $6.8 million
and $6.1 million at December 31, 1998 and 1997, respectively. Prepaid primary
reinsurance premiums from non-affiliated reinsurers were $2.1 million and $3.0
million at December 31, 1998 and 1997, 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
ended December 31 are as follows:
31
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
(In thousands) 1998 1997 1996
- ------------------------------------------------------------------------------------
Premiums written
Direct $ 498,828 $ 435,971 $ 404,528
Assumed 7,141 1,383 (901)
Ceded (16,869) (5,302) (607)
------------------------------------
Premiums written, net of reinsurance $ 489,100 $ 432,052 $ 403,020
====================================
Premiums earned
Direct $ 506,096 $ 458,972 $ 425,831
Assumed 3,101 1,182 634
Ceded (17,971) (6,206) (13,727)
------------------------------------
Premiums earned, net of reinsurance $ 491,226 $ 453,948 $ 412,738
====================================
Losses and loss adjustment expenses
Direct $ 140,705 $ 157,012 $ 157,203
Assumed 176 219 (267)
Ceded (5,165) (4,974) (4,527)
------------------------------------
Losses and loss adjustment expenses,
net of reinsurance $ 135,716 $ 152,257 $ 152,409
====================================
Reinsurance ceding arrangements do not discharge the Company from its
obligations as the primary insurer.
NOTE 7. INCOME TAXES
The components of income tax expense are as follows:
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------------
Current $ 7,302 $ 3,859 $ 9,056
Deferred 69,286 63,699 55,132
-------------------------------------------------
Total income tax expense $ 76,588 $ 67,558 $ 64,188
=================================================
A reconciliation of the statutory federal income tax rate to the effective tax
rate reported on income from operations before taxes is as follows:
1998 1997 1996
- --------------------------------------------------------------------------------------
Statutory federal income tax rate 35.0% 35.0% 35.0%
Tax-exempt income (7.2) (7.5) (7.1)
State income tax (net) 0.4 0.2 0.9
Other 0.5 0.1 0.1
-------------------------------------------------
Effective income tax rate 28.7% 27.8% 28.9%
=================================================
On April 18, 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, 1998 the Company had income
taxes receivable of $16.8 million ($23.6 million including interest) 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 14). 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
32
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
reserves. The Company purchased tax and loss bonds of $47.4 million, $50.7
million and $50.4 million in 1998, 1997 and 1996, respectively.
The Company paid income taxes of $8.4 million, $8.4 million and $8.2 million in
1998, 1997 and 1996, respectively. Included in these amounts are federal income
tax payments to Allstate under the tax sharing agreement of $0.7 million in
1996.
The components of the deferred income tax assets and liabilities at December 31
are as follows:
(In thousands) 1998 1997
- --------------------------------------------------------------------------------
Deferred tax assets:
Discount on loss reserves $ 4,422 $ 3,743
Unearned premium reserves 4,181 6,591
Alternative minimum tax credit carryforward 31,870 23,687
Pension costs 3,131 3,037
Other assets 4,355 2,197
----------------------------
Total deferred tax assets 47,959 39,255
============================
Deferred tax liabilities:
Statutory contingency reserves 72,817 56,730
Policy acquisition costs 21,562 13,253
Unrealized net gains on investments 39,631 38,738
Software development costs 7,423 5,550
Other liabilities 3,256 1,379
----------------------------
Total deferred tax liabilities 144,689 115,650
----------------------------
Net deferred tax liability $ 96,730 $ 76,395
============================
NOTE 8. FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets and incurs various financial liabilities. The estimated fair value
amounts of certain liabilities indicated below have been determined by using
available market information and appropriate valuation methodologies. However,
considerable judgment is required in interpreting market data to develop the
estimates of fair value and, accordingly, the estimates presented herein are not
necessarily indicative of the amounts that could be realized in a current market
exchange.
1998 1997
- -------------------------------------------------------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
(In thousands) Value Fair Value Value Fair Value
- ---------------------------------------------------------------------------- -------------------------------------
6.75% Long-term debt $ 99,476 $ 103,997 $ 99,409 $ 100,983
8.309% Redeemable preferred
capital securities $ 99,040 $ 107,075 $ 99,006 $ 107,875
A number of the Company's significant assets and liabilities, including deferred
policy acquisition costs, property and equipment, loss reserves, unearned
premiums and deferred income taxes are not considered financial instruments.
33
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
NOTE 9. BENEFIT 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 ("Plan"), a
noncontributory defined benefit plan. The Plan has been funded by the Company to
the fullest extent permitted by federal income tax rules and regulations. Also,
employees earning in excess of $150,000 per year participate in The PMI Group,
Inc. Supplemental Employee Retirement Plan, a noncontributory defined benefit
plan. Benefits under both plans are based upon the employee's length of service,
average annual compensation and estimated social security retirement benefits.
The Company provides certain health care and life insurance benefits for retired
employees ("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 has the right to modify or
terminate these plans.
The following table presents certain information regarding the Plan and the OPEB
Plan as of December 31:
34
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Pension Benefits Other Benefits
---------------- --------------
(In thousands, except percentages) 1998 1997 1996 1998 1997 1996
------- ------- ------- ------- ------- -------
Change in benefit obligation
Benefit obligation at January 1, $ 11,381 $ 6,659 N/A $ 3,112 $ 2,782 N/A
Service cost 3,796 3,424 N/A 434 387 N/A
Interest cost 1,074 759 N/A 255 217 N/A
Actuarial loss (gain) 2,861 875 N/A 435 (269) N/A
Benefits paid (736) (336) N/A (17) (5) N/A
------------------------ ------------------------
Benefit obligation at December 31, 18,376 11,381 4,219 3,112
------------------------ ------------------------
Change in plan assets
Fair value of plan assets at January 1, 5,204 2,896 N/A - - N/A
Actual return on plan assets 366 180 N/A - - N/A
Company contribution 4,043 2,464 N/A 17 5 N/A
Benefits paid (736) (336) N/A (17) (5) N/A
------------------------ ------------------------
Fair value of plan assets at December 31, 8,877 5,204 - -
------------------------ ------------------------
Funded status
Funded status of plan at December 31, (9,499) (6,177) N/A (4,219) (3,112) N/A
Unrecognized actuarial loss (gain) 3,583 505 N/A (320) (781) N/A
Unrecognized prior service cost - - N/A 265 284 N/A
------------------------ ------------------------
Accrued and recognized benefit cost $ (5,916) $ (5,672) $ (4,274) $ (3,609)
======================== ========================
Components of net periodic benefit cost
Service cost $ 3,796 $ 3,424 $ 3,282 $ 434 $ 387 $ 438
Interest cost 1,074 759 484 255 217 215
Expected return on assets (515) (295) (147) - - -
Prior service cost amortization - - - 20 20 20
Actuarial loss (gain) recognized (68) (95) 6 (26) (28) -
------------------------------------------------------------------------
Net periodic benefit cost $ 4,287 $ 3,793 $ 3,625 $ 683 $ 596 $ 673
========================================================================
Weighted-average assumptions
Discount rate 6.75% 7.25% 7.50% 6.75% 7.25% 7.50%
Expected return on plan assets 8.50% 8.50% 8.50% N/A N/A N/A
Rate of compensation increase 5.50% 5.50% 5.50% N/A N/A N/A
Health care cost trend on covered charges N/A N/A N/A 6.00% 6.00% 6.00%
35
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Sensitivity of retiree welfare results. Assumed health care cost trend rates
have a significant effect on the amounts reported for the health care plans. A
one-percentage-point change in assumed health care cost trend rates would have
the following effects:
1-Percentage- 1-Percentage
(In thousands) Point Increase Point Decrease
- ---------------------------------------------------------------------------------------------------------------
Effect on total of service and interest cost components $ 184 $ 145
Effect on accumulated postretirement benefit obligation 863 577
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 ("401K Plan") covering both salaried and hourly employees. Eligible
employees who participate in the 401K Plan receive, within certain limits,
matching Company contributions. Costs relating to the 401K Plan amounted to $2.1
million, $1.2 million and $1.1 million for 1998, 1997 and 1996, respectively.
NOTE 10. DEBT AND CREDIT FACILITIES
Long-term Debt - On November 15, 1996, the Company issued unsecured debt
securities in the face amount of $100.0 million ("Notes"). The Notes mature and
are payable on November 15, 2006 and are not redeemable prior to maturity. No
sinking fund is required or provided for prior to maturity. Interest on the
Notes is 6.75% and is payable semiannually. Interest payments of $6.8 million
were made during both 1998 and 1997.
Lines of Credit - The Company has two lines of credit agreements ("Lines"), each
in the amount of $25.0 million. The Lines have final maturities of February 2001
and December 2001 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 at December 31, 1998 or 1997.
NOTE 11. 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, 1998 are as follows:
(In thousands) Amount
- ---------------------------------------------
Year ending December 31:
1999 $ 6,807
2000 7,604
2001 6,311
2002 5,366
2003 4,777
Thereafter 4,309
--------------
Total $ 35,174
==============
The Company intends to renew its corporate headquarters lease in 1999. Such
minimum expected rentals are included in the above amounts.
Total rent expense for all leases was $9.0 million, $7.6 million and $7.4
million in 1998, 1997 and 1996, respectively.
Legal Proceedings - Various legal actions and regulatory reviews are currently
pending that involve the Company. 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.
36
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
NOTE 12. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL SECURITIES
OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST
DEBENTURE OF THE COMPANY
On February 4, 1997, TPG, through a wholly-owned trust, privately issued $100.0
million of 8.309% preferred capital securities, Series A ("Capital Securities").
The Capital Securities are redeemable after February 1, 2007, at a premium or
upon occurrence of certain tax events, and mature on February 1, 2027. The net
proceeds, totaling $99.0 million, were used for general corporate purposes,
including common stock repurchases and additions to the investment portfolio.
The Capital Securities were issued by PMI Capital I ("Issuer Trust"). The sole
asset of the Issuer Trust consists of $103.1 million principal amount of a
junior subordinated debenture ("Debenture") issued by TPG to the Issuer Trust.
The Debenture bears interest at the rate of 8.309% per annum and matures on
February 1, 2027. The amounts due to the Issuer Trust under the Debenture and
the related income statement amounts have been eliminated in the Company's
consolidated financial statements. Distributions on the Capital Securities occur
on February 1 and August 1 of each year. The obligations of TPG under the
Debenture and a related guarantee and expense agreement constitute a full and
unconditional guarantee by TPG of the Issuer Trust's obligations under the
Capital Securities. The Capital Securities are subject to mandatory redemption
under certain circumstances. Distribution payments of $8.3 million and $4.2
million were made in 1998 and 1997, respectively.
NOTE 13. DIVIDENDS AND SHAREHOLDERS' EQUITY
Shareholder Rights Plan - On January 13, 1998, the Company adopted a Shareholder
Rights Plan ("Rights Plan"). In general, rights issued under the plan will be
exercisable only if a person or group acquires 10% or more of the Company's
common stock or announces a tender offer for 10% or more of the common stock.
The Rights Plan contains an exception that would allow passive institution
investors to acquire up to a 15% ownership interest before the rights would
become exercisable.
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, restrictions contained in the Company's credit agreements 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 support agreement with Allstate,
PMI is prohibited from paying any dividend that would cause its risk-to-capital
ratio to equal or exceed 23 to 1 (see Note 16). Management believes that PMI's
dividend restrictions have not had, and are not expected to have, a significant
impact on TPG's ability to meet its cash obligations. Under the most restrictive
dividend limitations, the maximum amount of dividends that PMI can distribute to
TPG at December 31, 1998, without prior regulatory approval is $16.5 million.
PMI paid ordinary and, after obtaining regulatory approval, extraordinary
dividends to TPG totaling $100.0 million and $76.4 million in the years ended
December 31, 1998 and 1997, respectively. APTIC paid ordinary dividends to TPG
totaling $3.2 million and $2.5 million in the years ended December 31, 1998 and
1997, respectively.
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 16), 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.
37
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Equity Incentive Plan and Directors Plan - During 1998, the Company amended and
restated The PMI Group, Inc. Equity Incentive Plan ("Equity Incentive Plan") and
The PMI Group, Inc. Stock Plan for Non-Employee Directors ("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 its subsidiaries 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 1998 and 1997:
1998 1997
- -----------------------------------------------------------------------------------------------------------
Weighted Weighted
Shares Average Shares Average
Under Option Exercise Price Under Option Exercise Price
------------------ --------------- --------------- ---------------
Options outstanding at
beginning of year 616,388 $ 42.30 538,604 $ 36.40
Options granted 366,650 71.04 206,310 54.61
Options exercised (51,928) 35.67 (92,653) 34.33
Options forfeited (21,356) 64.21 (35,873) 43.19
---------------------------------------------------------------------------
Outstanding at end of year 909,754 $ 53.75 616,388 $ 42.30
===========================================================================
Exercisable at year end 402,978 $ 39.07 230,331 $ 35.28
Reserved for future grants 398,145 - 743,439 -
- -----------------------------------------------------------------------------------------------------------
Note: The weighted average remaining contractual life of shares under option was
8.0 years (for an exercise price between $32.14 and $76.25) in 1998 and 8.0
years ($32.14 and $67.97) in 1997.
================================================================================
In addition, in February 1999, the Equity Incentive Plan was amended and
restated, subject to shareholder approval, to reserve an additional 1,500,000
shares for issuance.
As discussed in Note 2, the Company accounts for stock-based compensation under
APB No. 25 and its related interpretations. 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. 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 differ significantly 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 of 0.26% and 0.28% for the 1998 options, 0.29% to
0.37% for the 1997 options, and 0.35% to 0.44% for the 1996 options; expected
volatility range of 21.92% and 23.15% for the 1998 options, 20.61% to 21.90% for
the 1997 options and 21.08% to 23.12% for the 1996 options; risk-free interest
rates of 5.45% and 5.58% for the 1998 options, 6.06%, 6.43%, 6.36%, 6.18% and
5.86% for the 1997 options and 5.40%, 5.83%, 6.51%, 6.53% and 6.54% for the 1996
options; and an expected life of four years following the vesting. Forfeitures
are recognized as they occur.
38
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
If the computed fair values of the 1998, 1997 and 1996 awards had been amortized
to expense over the vesting period of the awards, the Company's net income,
basic net income per share and diluted net income per share would have been
reduced to the pro forma amounts indicated below:
(In thousands, except per share amounts) 1998 1997 1996
- ----------------------------------------------- ----------------- ---------------- -------------
Net income: As reported $ 190,360 $ 175,309 $ 157,918
Pro-forma 187,776 174,487 157,663
Basic earnings per share: As reported $ 6.06 $ 5.25 $ 4.52
Pro-forma 5.98 5.23 4.51
Diluted earnings per share: As reported $ 6.04 $ 5.23 $ 4.51
Pro-forma 5.95 5.21 4.50
NOTE 14. STATUTORY ACCOUNTING
The Company's insurance subsidiaries prepare statutory financial statements in
accordance with the accounting practices prescribed or permitted by their
respective state's Department of Insurance, which is a comprehensive basis of
accounting other than GAAP. The principles used in determining statutory
financial amounts differ from GAAP primarily for the following reasons:
Under statutory accounting practices, mortgage guaranty insurance
companies 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 permitted.
Under statutory accounting practices, insurance policy acquisition
costs are charged against operations in the year incurred. Under GAAP,
these costs are deferred and amortized over 24 months. (See Note 5,
"Deferred Acquisition Costs.")
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 including the purchase of tax and loss bonds, which are recorded
as a deferral of the income tax provision.
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.
Under statutory accounting practices, fixed maturity investments in
good standing are valued at amortized cost. Under GAAP, those
investments which the Company does not have the ability or intent to
hold to maturity are considered to be available for sale and are
recorded at market, with the unrealized gain or loss recognized, net of
tax, as an increase or decrease to accumulated other comprehensive
income.
The statutory net income, statutory surplus and contingency reserve liability of
PMI as of and for the years ended December 31 are as follows:
(In thousands) 1998 1997 1996
- ----------------------------------------------------------------------------
Statutory net income $ 214,040 $ 227,148 $ 202,584
---------------------------------------
Statutory surplus $ 165,459 $ 274,864 $ 313,635
---------------------------------------
Contingency reserve liability $ 1,028,440 $ 839,478 $ 674,841
---------------------------------------
39
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
The differences between the statutory net income and equity presented above for
PMI and the consolidated net income and equity presented on a GAAP basis
primarily represent the differences between GAAP and statutory accounting
practices as well as the results of operations and equity of other Company
subsidiaries.
NOTE 15. BUSINESS SEGMENTS
The Company's reportable operating segments include Mortgage Guaranty Insurance
and Title Insurance. The Mortgage Guaranty Insurance segment includes PMI, PMG,
RGC and Residential Insurance Co. The Title Insurance segment consists of the
results for APTIC. The Other segment includes TPG, MSC, PCI, and SEC. Key
products for each of the reportable segments are disclosed in Note 2, "Business
and Summary of Significant Accounting Policies." The Other segment includes the
income and expenses of the holding company, the results from the business of
contract underwriting and software licensing, and the activity of an inactive
broker-dealer.
The accounting policies of the segments are the same as disclosed in Note 2,
"Business and Summary of Significant Accounting Policies." Intersegment
transactions are not significant. The Company evaluates performance primarily
based on segment net income.
The following tables present information about reported segment income (loss)
and segment assets for the periods indicated.
Mortgage
1998 Guaranty Title Intersegment Consolidated
(in thousands) Insurance Insurance Other Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------------
Premiums earned $ 411,922 $ 79,304 $ - $ - $ 491,226
=========== =========== =========== =========== ===========
Net underwriting income (expenses)
before tax-external customers $ 172,414 $ 9,606 $ (9,049) $ - $ 172,971
Investment and other income 97,989 1,427 6,676 - 106,092
Equity in earnings of affiliates - - 392 2,833 3,225
Interest expense (3) - (7,026) - (7,029)
Distributions on preferred capital securities - - (8,311) - (8,311)
----------- ----------- ----------- ----------- -----------
Income (loss) before income tax expense 270,400 11,033 (17,318) 2,833 266,948
Income tax expense (benefit) 78,732 4,182 (6,326) - 76,588
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 191,668 $ 6,851 $ (10,992) $ 2,833 $ 190,360
=========== =========== =========== =========== ===========
Total assets $1,643,482 $ 42,165 $ 92,223 $ - $1,777,870
=========== =========== =========== =========== ===========
- ----------------------------------------------------------------------------------------------------------------------------------
40
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Mortgage
1997 Guaranty Title Intersegment Consolidated
(in thousands) Insurance Insurance Other Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------------
Premiums earned $ 394,010 $ 59,938 $ - $ - $ 453,948
=========== =========== =========== =========== ===========
Net underwriting income (expenses)
before tax-external customers $ 159,360 $ 4,992 $ (9,906) $ - $ 154,446
Investment and other income 93,625 1,257 6,467 - 101,349
Equity in earnings of affiliates - - - 1,455 1,455
Interest expense - - (6,766) - (6,766)
Distributions on preferred capital securities - - (7,617) - (7,617)
----------- ----------- ----------- ----------- -----------
Income (loss) before income tax expense 252,985 6,249 (17,822) 1,455 242,867
Income tax expense (benefit) 72,099 2,218 (6,759) - 67,558
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 180,886 $ 4,031 $ (11,063) $ 1,455 $ 175,309
=========== =========== =========== =========== ===========
Total assets $1,503,596 $ 37,050 $ 145,957 $ - $1,686,603
=========== =========== =========== =========== ===========
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgage
1996 Guaranty Title Intersegment Consolidated
(in thousands) Insurance Insurance Other Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------------
Premiums earned $ 359,527 $ 53,211 $ - $ - $ 412,738
=========== =========== =========== =========== ===========
Net underwriting income (expenses)
before tax-external customers $ 144,189 $ 3,433 $ (7,035) $ - $ 140,587
Investment and other income 78,365 1,162 2,707 - 82,234
Equity in earnings of affiliates - - - 192 192
Interest expense - - (907) - (907)
----------- ----------- ----------- ----------- -----------
Income (loss) before income tax expense 222,554 4,595 (5,235) 192 222,106
Income tax expense (benefit) 63,113 1,591 (516) - 64,188
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 159,441 $ 3,004 $ (4,719) $ 192 $ 157,918
=========== =========== =========== =========== ===========
Total assets $1,369,166 $ 33,408 $ 107,345 $ - $1,509,919
=========== =========== =========== =========== ===========
- ----------------------------------------------------------------------------------------------------------------------------------
The Company did not have any major customers that accounted for more than 10% of
its consolidated revenues for any of the years presented.
The Company does not have any material revenues and assets attributed to or
located outside the United States.
NOTE 16. 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
41
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
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.
The Runoff Support Agreement contains certain covenants, including covenants
that (i) PMI will write no new business after its risk-to-capital ratio equals
or exceeds 23 to 1; (ii) PMI will pay no dividends if, after the payment of any
such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; and
(iii) on the date that any of the following events occur: (A) PMI's
risk-to-capital ratio exceeds 24.5 to 1, (B) Allstate shall have paid any claims
relating to PMI policies directly to a policyholder or by paying an amount equal
to such claims to PMI (or to TPG for contribution to PMI) pursuant to the Runoff
Support Agreement, or (C) any regulatory order is issued restricting or
prohibiting PMI from making full or timely payments under policies, PMI will
transfer substantially all of its assets in excess of $50.0 million to a trust
account established for the payment of claims.
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 each contribute up to an additional $4.4 million to CMG, over and above
obligations, net of prior contributions, of $0.9 million each, agreed to in a
shareholder agreement dated September 30, 1998. At December 31, 1998 CMG's
risk-to-capital ratio was 15.8 to 1.
NOTE 17. QUARTERLY RESULTS (UNAUDITED)
First Quarter Second Quarter Third Quarter Fourth Quarter
---------------- --------------- --------------- ---------------
1998 1997 1998 1997 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
Revenues $ 150,634 $ 147,546 $ 147,469 $ 132,909 $ 167,409 $ 141,204 $ 155,397 $ 142,988
===============================================================================================
Net income $ 45,768 $ 49,172 $ 46,787 $ 42,279 $ 53,728 $ 41,913 $ 44,077 $ 41,945
===============================================================================================
Basic EPS $ 1.41 $ 1.44 $ 1.47 $ 1.26 $ 1.74 $ 1.26 $ 1.45 $ 1.29
===============================================================================================
Diluted EPS $ 1.40 $ 1.43 $ 1.46 $ 1.25 $ 1.73 $ 1.26 $ 1.45 $ 1.28
===============================================================================================
Diluted operating EPS * $ 1.24 $ 1.09 $ 1.41 $ 1.24 $ 1.43 $ 1.25 $ 1.45 $ 1.27
===============================================================================================
* Diluted operating earnings per share represents diluted earnings per share
excluding realized capital gains and their related income tax effect.
Earnings per share is computed independently for the quarters presented.
Therefore, the sum of the quarterly earnings per share amounts may not equal the
total computed for the year.
42
R e p o r t o f R e p o r t o f
M a n a g e m e n t 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
To the Shareholders of The PMI Group, Inc. of The PMI Group, Inc.
The consolidated financial statements of We have audited the accompanying
The PMI Group, Inc. and subsidiaries have consolidated balance sheets of The PMI
been prepared by management and have been Group, Inc. and subsidiaries ("Company")
audited by the Company's independent as of December 31, 1998 and 1997, and the
auditors, Deloitte & Touche LLP, whose related consolidated statements of
report appears on this page. Management operations, shareholders' equity and cash
is responsible for the consolidated flows for each of the three years in the
financial statements, which have been period ended December 31, 1998. These
prepared in conformity with generally consolidated financial statements are the
accepted accounting principles and include responsibility of the Company's
amounts based on management's judgments. management. Our responsibility is to
express an opinion on these consolidated
Management is also responsible for financial statements based on our audits.
maintaining internal control systems
designed to provide reasonable assurance, We conducted our audits in accordance with
at appropriate cost, that assets are generally accepted auditing standards.
safeguarded and that transactions are Those standards require that we plan and
executed and recorded in accordance with perform the audit to obtain reasonable
established policies and procedures. The assurance about whether the consolidated
Company's systems are under continuing financial statements are free of material
review and are supported by, among other misstatement. An audit includes
things, business conduct and other written examining, on a test basis, evidence
guidelines, an internal audit function and supporting the amounts and disclosures in
the selection and training of qualified the consolidated financial statements. An
personnel. audit also includes assessing the
accounting principles used and significant
The Board of Directors, through its Audit estimates made by management, as well as
Committee, oversees management's financial evaluating the overall financial statement
reporting responsibilities. The Audit presentation. We believe that our audits
Committee meets regularly with the provide a reasonable basis for our opinion.
independent auditors, representatives of
management and the internal auditors to In our opinion, such consolidated
discuss and make inquiries into their financial statements present fairly, in
activities. Both the independent auditors all material respects, the financial
and the internal auditors have free access position of The PMI Group, Inc. and
to the Audit Committee, with and without subsidiaries as of December 31, 1998 and
management representatives in attendance. 1997, and the results of their operations
and their cash flows for each of the three
years in the period ended December 31,
1998, in conformity with generally
W. Roger Haughton accepted accounting principles.
Chairman and Chief Executive Officer
John M. Lorenzen, Jr. Deloitte & Touche LLP
Executive Vice President and Chief San Francisco, California
Financial Officer January 20, 1999
January 20, 1999
43
Ten Year Summary of Financial and Operating Data (Dollars in thousands, except
per share data or otherwise noted)
1998 1997 1996 1995 1994
------------- ------------- ------------ ------------ ------------
Summary of Consolidated Operations:
Net premiums written $ 489,100 $ 432,052 $ 403,020 $ 314,021 $ 277,747
============= ============= ============ ============ ============
Premiums earned $ 491,226 $ 453,948 $ 412,738 $ 328,756 $ 296,345
Investment income, less investment expense 84,681 83,136 67,442 62,041 56,774
Realized capital gains, net 24,636 19,584 14,296 11,934 3,064
Other income 20,366 7,979 6,948 2,309 3,802
------------- ------------- ------------ ------------ ------------
Total revenues 620,909 564,647 501,424 405,040 359,985
Total losses and expenses(1) 353,961 321,780 279,318 224,499 221,434
------------- ------------- ------------ ------------ ------------
Income from continuing operations before taxes 266,948 242,867 222,106 180,541 138,551
Income (loss) from discontinued operations - - - - -
Income tax expense (benefit)(2) 76,588 67,558 64,188 45,310 32,419
------------- ------------- ------------ ------------ ------------
Net income $ 190,360 $ 175,309 $ 157,918 $ 135,231 $ 106,132
============= ============= ============ ============ ============
Mortgage Insurance Operating Ratios:
Loss ratio 32.8% 38.2% 41.9% 38.5% 40.5%
Expense ratio 25.5% 22.7% 18.4% 24.9% 30.1%
------------- ------------- ------------ ------------ ------------
Combined ratio 58.3% 60.9% 60.3% 63.4% 70.6%
============= ============= ============ ============ ============
Consolidated Balance Sheet Data:
Total assets $ 1,777,870 $ 1,686,603 $ 1,509,919 $ 1,304,440 $ 1,097,421
Reserve for losses and loss adjustment expenses $ 215,259 $ 202,387 $ 199,774 $ 192,087 $ 173,885
Long-term debt $ 99,476 $ 99,409 $ 99,342 $ - $ -
Preferred capital securities of subsidiary trust $ 99,040 $ 99,006 $ - $ - $ -
Shareholders' equity $ 1,097,515 $ 1,061,180 $ 986,862 $ 870,503 $ 687,178
Per Share Data:
Net income
Basic $ 6.06 $ 5.25 $ 4.52 $ 3.86 $ 3.03
Diluted(3) $ 6.04 $ 5.23 $ 4.51 $ 3.85 $ 3.03
Shareholders' equity $ 36.25 $ 32.69 $ 28.60 $ 24.87 $ 19.63
Cash dividends declared $ 0.20 $ 0.20 $ 0.20 $ 0.15 $ -
PMI Operating and Statutory Data:
Number of policies in force 714,210 698,831 700,084 657,800 612,806
Default rate 2.31% 2.38% 2.19% 1.98% 1.88%
Persistency 68.0% 80.8% 83.3% 86.4% 83.6%
Direct primary insurance in force (in millions) $ 80,682 $ 77,787 $ 77,312 $ 71,430 $ 65,982
Direct primary risk in force (in millions) $ 19,324 $ 18,092 $ 17,336 $ 15,130 $ 13,243
Statutory capital $ 1,193,699 $ 1,114,342 $ 988,475 $ 824,156 $ 659,402
Risk-to-capital ratio 14.9:1 14.6:1 15.9:1 15.8:1 17.7:1
New insurance written (NIW) $ 27,820,065 $ 15,307,147 $17,882,702 $14,459,260 $18,441,612
Policies issued 211,161 119,190 142,900 119,631 156,055
NIW market share 14.8% 12.7% 14.1% 13.2% 14.0%
Ten Year Summary of Financial and Operating Data (Continued)
(Dollars in thousands, except per share data or otherwise noted)
1993 1992 1991 1990 1989
------------- ------------- ------------ ------------ ------------
Summary of Consolidated Operations:
Net premiums written $ 291,089 $ 208,602 $ 143,305 $ 120,532 $ 102,940
============= ============= ============ ============ ============
Premiums earned $ 268,554 $ 173,039 $ 120,195 $ 101,913 $ 91,447
Investment income, less investment expense 45,733 40,847 40,402 38,261 35,943
Realized capital gains, net 1,229 686 1,335 (524) (437)
Other income - - - - -
------------- ------------- ------------ ------------ ------------
Total revenues 315,516 214,572 161,932 139,650 126,953
Total losses and expenses(1) 202,543 119,912 39,879 78,979 86,572
------------- ------------- ------------ ------------ ------------
Income from continuing operations before taxes 112,973 94,660 122,053 60,671 40,381
Income (loss) from discontinued operations (28,863) 6,726 3,709 1,562 974
Income tax expense (benefit)(2) 24,305 (10,911) 69,661 9,649 2,535
------------- ------------- ------------ ------------ ------------
Net income $ 59,805 $ 112,297 $ 56,101 $ 52,584 $ 38,820
============= ============= ============ ============ ============
Mortgage Insurance Operating Ratios:
Loss ratio 41.4% 33.2% 3.1% 47.4% 61.8%
Expense ratio 28.2% 27.0% 25.3% 25.5% 29.2%
------------- ------------- ------------ ------------ ------------
Combined ratio 69.6% 60.2% 28.4% 72.9% 91.0%
============= ============= ============ ============ ============
Consolidated Balance Sheet Data:
Total assets $ 985,129 $ 815,136 $ 663,215 $ 569,550 $ 493,853
Reserve for losses and loss adjustment expenses $ 135,471 $ 94,002 $ 78,045 $ 115,805 $ 125,210
Long-term debt $ - $ - $ - $ - $ -
Preferred capital securities of subsidiary trust $ - $ - $ - $ - $ -
Shareholders' equity $ 575,300 $ 513,583 $ 399,489 $ 338,632 $ 286,591
Per Share Data:
Net income
Basic $ 1.71 $ 3.21 $ 1.60 $ 1.50 $ 1.11
Diluted(3) $ 1.71 $ 3.21 $ 1.60 $ 1.50 $ 1.11
Shareholders' equity $ 16.44 $ 14.67 $ 11.41 $ 9.68 $ 8.19
Cash dividends declared $ - $ - $ - $ - $ -
PMI Operating and Statutory Data:
Number of policies in force 543,924 428,745 347,232 313,035 300,429
Default rate 1.81% 2.03% 2.38% 2.38% 2.46%
Persistency 70.0% 74.6% 85.2% 86.5% 85.9%
Direct primary insurance in force (in millions) $ 56,991 $ 43,698 $ 31,982 $ 26,938 $ 24,448
Direct primary risk in force (in millions) $ 11,267 $ 8,676 $ 6,481 $ 5,554 $ 5,152
Statutory capital $ 494,621 $ 456,931 $ 372,568 $ 314,037 $ 272,687
Risk-to-capital ratio 20.8:1 19.0:1 18.8:1 18.6:1 19.5:1
New insurance written (NIW) $25,469,907 $19,463,000 $ 8,663,000 $ 5,795,000 $ 5,117,000
Policies issued 207,356 161,893 75,095 49,943 45,134
NIW market share 18.6% 19.4% 15.9% 14.9% 13.7%
(1) In 1991, the Company significantly revised its estimate for losses and loss
adjustment expense, reducing total losses by $42.1 million and the loss
ratio by 35 percentage points, and increasing income from continuing
operations by $27.8 million.
(2) During 1991, the Company increased its tax liabilities and income tax
expense by $40.9 million in light of an unfavorable judgment by the U.S.
Tax Court. In 1992, the 1991 judgment was overturned, and the Company re-
evaluated its tax balances and reduced its tax liabilities and income tax
expense by $30.9 million.
(3) Diluted earnings per share per Statement of Financial Accounting Standards
No. 128, "Earnings per Share."