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<SEC-DOCUMENT>0000898430-02-001218.txt : 20020415
<SEC-HEADER>0000898430-02-001218.hdr.sgml : 20020415
ACCESSION NUMBER: 0000898430-02-001218
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 7
CONFORMED PERIOD OF REPORT: 20011231
FILED AS OF DATE: 20020401
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: PMI GROUP INC
CENTRAL INDEX KEY: 0000935724
STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351]
IRS NUMBER: 943199675
STATE OF INCORPORATION: DE
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-13664
FILM NUMBER: 02596819
BUSINESS ADDRESS:
STREET 1: 601 MONTGOMERY ST
CITY: SAN FRANCISCO
STATE: CA
ZIP: 94111
BUSINESS PHONE: 4157887878
MAIL ADDRESS:
STREET 1: 601 MONTGOMERY ST
CITY: SAN FRANCISCO
STATE: CA
ZIP: 94111
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>d10k.txt
<DESCRIPTION>PERIOD ENDING DECEMBER 31, 2001
<TEXT>
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-13664
THE PMI GROUP, INC.
(Exact name of registrant as specified in its charter)
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<S> <C> <C>
Delaware 601 Montgomery Street 94-3199675
(State of Incorporation) San Francisco, California 94111 (I.R.S. Employer
(Address of principal executive offices) Identification No.)
</TABLE>
(415) 788-7878
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
---------------------------- -----------------------------------------
Common Stock, $.01 par value New York Stock Exchange
Pacific Exchange
Preferred Stock Purchase Rights New York Stock Exchange
Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
--
The market value of the voting stock (common stock) held by non-affiliates of
the registrant as of the close of business on February 28, 2002 was
$3,170,313,685 based on the closing sale price of the common stock on the New
York Stock Exchange consolidated tape on that date.
Number of shares outstanding of the Registrant's common stock, as of the close
of business on February 28, 2002: 44,746,841.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the fiscal year ended December
31, 2001 are incorporated by reference into Items 6 through 8 of Part II.
Portions of the Proxy Statement for registrant's 2002 Annual Meeting of
Stockholders to be held on May 16, 2002 are incorporated by reference into Items
10 through 13 of Part III. The Exhibit Index is located on page 59.
<PAGE>
TABLE OF CONTENTS
Cautionary Statement
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<S> <C> <C> <C>
PART I
Item 1. Business ........................................................................ 4
A. Overview of Operations............................................................ 4
B. U.S. Mortgage Insurance Operations................................................ 5
1. Products................................................................ 5
2. Competition............................................................. 11
3. Customers............................................................... 14
4. Business Composition.................................................... 15
5. Sales; Mortgage Insurance Acquisition Channels.......................... 17
6. Underwriting Practices.................................................. 18
7. Affordable Housing...................................................... 21
8. Defaults and Claims..................................................... 22
9. Reinsurance............................................................. 29
10. Regulation.............................................................. 30
11. Financial Strength; Ratings............................................. 34
C. International Operations and Other Residential Lender Services.................... 35
1. International Mortgage Insurance........................................ 35
Australia and New Zealand
Europe
Hong Kong
2. Title Insurance......................................................... 39
3. Financial Guaranty Reinsurance.......................................... 40
4. Mortgage Loan Servicing................................................. 40
D. Investment Portfolio.............................................................. 40
E. Employees......................................................................... 41
Item 2. Properties............................................................................ 41
Item 3. Legal Proceedings..................................................................... 41
Item 4. Submission of Matters to a Vote of Security Holders................................... 42
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............. 44
Item 6. Selected Financial Data............................................................... 46
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................. 46
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................ 46
Item 8. Financial Statements and Supplementary Data........................................... 46
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................................ 46
</TABLE>
2
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<TABLE>
<S> <C>
PART III
Item 10. Directors and Executive Officers of the Registrant.................................... 46
Item 11. Executive Compensation................................................................ 46
Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 47
Item 13. Certain Relationships and Related Transactions........................................ 47
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 48
INDEX TO EXHIBITS....................................................................................... 59
</TABLE>
3
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Cautionary Statement Regarding Forward-Looking Statements
Certain written and oral statements we make 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
include the words "believes," "expects," "anticipates," "estimates" or similar
expressions, or that relate to future plans, events or performance are
forward-looking statements within the meaning of the federal securities laws.
When a forward-looking statement includes an underlying assumption, we caution
that, while we believe the assumption to be reasonable and make it in good
faith, assumed facts almost always vary from actual results, and the difference
between assumed facts and actual results can be material. Where, in any
forward-looking statement, we express an expectation or belief as to future
results, there can be no assurance that the expectation or belief will result.
Our actual results may differ materially from those expressed in our
forward-looking statements. Forward-looking statements involve a number of risks
or uncertainties including, but not limited to, the Investment Considerations
addressed in the "Management's Discussion and Analysis" section of the
Company's 2001 Annual Report to Stockholders (Exhibit 13.1), which is
incorporated by reference in Item 7. Other risks are referred to from time to
time in our periodic filings with the Securities and Exchange Commission. All of
our forward-looking statements are qualified by and should be read in
conjunction with such risk disclosures. Except as may be required by applicable
law, we undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
PART I
Item 1. Business
A. Overview of Operations - The PMI Group
The PMI Group, Inc. is an international provider of credit enhancement products
and lender services that promote home ownership and facilitate mortgage
transactions in the capital markets. Through our wholly and partially owned
subsidiaries, we offer residential mortgage insurance and credit enhancement
products domestically and internationally, title insurance, financial guaranty
reinsurance, mortgage servicing and other residential lender services.
Our primary operating subsidiary, PMI Mortgage Insurance Co., or PMI, is a
leading U.S. residential mortgage insurer, licensed in all 50 states and the
District of Columbia. Residential mortgage insurance protects lenders and
investors against potential losses in the event of borrower default.
. PMI generated 67% of our consolidated revenues in 2001.
. PMI's claims-paying ability is currently rated "AA+" (excellent) by
Standard & Poor's, "Aa2" (excellent) by Moody's and "AA+" (very
strong) by Fitch.
PMI's 50% owned subsidiary, CMG Mortgage Insurance Company, offers mortgage
insurance for loans originated by credit unions.
We also offer title insurance through our wholly owned subsidiary, American
Pioneer Title Insurance Company, and mortgage loan servicing to lenders through
our partially owned subsidiary, Fairbanks Capital Holding Corporation.
We have a number of international operations that offer mortgage insurance and
other credit enhancement products.
4
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. Our Australian subsidiaries, PMI Mortgage Insurance Ltd and PMI
Indemnity Limited, are leading providers of mortgage insurance in
Australia and New Zealand.
. Our Irish subsidiary, PMI Mortgage Insurance Company Limited,
headquartered in Dublin, Ireland, offers mortgage insurance and
mortgage credit enhancement products in the European Union.
. PMI reinsures residential mortgage insurance in Hong Kong.
. We own 50% interest in RAM Holdings Ltd. and RAM Holdings II
Ltd., financial guaranty reinsurance companies based in Bermuda.
Our consolidated net income was $307.2 million including extraordinary losses
for the year ended December 31, 2001, and $260.2 million for the year ended
December 31, 2000. As of December 31, 2001, our total assets were $3.0 billion,
including our investment portfolio which had a market value of $2.6 billion as
of that date. Our shareholders' equity was $1.8 billion as of December 31, 2001.
Our principal executive offices are located at 601 Montgomery Street, San
Francisco, California 94111. Our telephone number is (415) 788-7878. We are
scheduled to move our principal executive offices in 2002 to 3003 Oak Road,
Walnut Creek, California 94596.
B. U.S. Mortgage Insurance Operations
PMI provides private mortgage insurance in the United States to residential
mortgage lenders and investors. PMI is incorporated in Arizona and currently
headquartered in San Francisco, California.
Private mortgage insurance insures lenders and investors against potential
losses in the event of borrower default. Specifically, PMI covers default risk
on first mortgage loans on one to four unit residential properties. Mortgage
insurance facilitates the sale of low down payment mortgages in the secondary
mortgage market and expands home ownership opportunities by enabling people to
buy a home with a down payment of less than 20%. Mortgage insurance is also
purchased by investors and lenders desiring additional protection against
mortgage default or capital relief.
1. Products
Primary Mortgage Insurance
Primary mortgage insurance provides mortgage default protection to lenders or
investors on individual loans at specified coverage percentages. PMI's
obligation to an insured with respect to a claim is generally determined by
multiplying the specified "coverage percentage" by the "claim amount," which
includes any unpaid loan balance, delinquent interest and certain expenses
associated with the loan's default and foreclosure. In lieu of paying the
coverage percentage of the claim amount on a defaulted loan, PMI may pay the
claim amount, as defined in PMI's Master Policy, and take title to the mortgaged
property. PMI generally offers coverage percentages on primary insurance ranging
from approximately 6% to 42% of the claim amount. The insured selects the
coverage percentage, often to comply with investor requirements to reduce the
loss exposure on loans purchased by the investor.
PMI's primary new insurance written, or NIW, for the year ended December 31,
2001 was $48.1 billion. NIW does not include primary mortgage insurance placed
upon loans more than 12 months after their
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origination or loans where the insurance coverage exceeds 50%. PMI's primary
insurance in force and primary risk in force at December 31, 2001 were $109.2
billion and $25.8 billion, respectively. Primary insurance in force refers to
the current principal balance of all mortgage loans with primary insurance as of
a given date. Primary risk in force is the dollar amount equal to the product of
each individual insured mortgage loan's current principal balance multiplied by
the loan's specified primary coverage percentage.
Primary mortgage insurance premiums are usually charged to the borrower by the
mortgage lender or loan servicer, who in turn remits the premiums to PMI. In
certain instances, the lender pays the premiums to PMI without directly charging
the borrower. In those cases, the lender may adjust the interest rate on the
loan to reflect, in part, the mortgage insurance premium. Premium payments may
be paid to PMI on a monthly, annual or single premium basis.
Under PMI's monthly premium plans, premiums are paid at the mortgage loan
closing and monthly thereafter. PMI also offers a monthly plan under which the
first monthly premium is payable at the time the first monthly mortgage payment
is due. Monthly plans represented 97% of NIW in 2001 and 92% of NIW in 2000. As
of December 31, 2001, monthly plans represented 90% of PMI's primary risk in
force.
Annual premium plans require payment of the first-year premium at the time of
loan closing and annual renewal premium payments in advance each year
thereafter. Single premium plans require lump-sum premium payments at loan
closing or financed into the loan amount, which may be refundable if coverage is
canceled by the insured, which generally occurs when the loan is repaid or the
value of the property has increased significantly. Single premium and annual
premium plans represented 3% and 8% of NIW in 2001 and 2000, respectively.
Single and annual premium plans combined represented 10% of PMI's primary risk
in force as of December 31, 2001.
Generally, mortgage insurance is renewable at the option of the insured at the
premium rate fixed when the insurance on the loan was initially issued. As a
result, the impact of increased claims and incurred losses from policies
originated in a particular year cannot be offset by renewal premium increases on
policies in force or mitigated by PMI's nonrenewal of insurance coverage.
PMI may not cancel mortgage insurance, except for nonpayment of premiums or
certain material violations of PMI's Master Policy. The insured, the holder of
the loan or the loan's mortgage servicer may cancel mortgage insurance coverage
at any time. Fannie Mae 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 the borrower has a
satisfactory payment record and the principal balance is not greater than 80% of
the original value of the property or, in some instances, the current value of
the property. The Homeowners Protection Act of 1998 also provides for the
automatic termination, or cancellation upon a borrower's request, of private
mortgage insurance upon satisfaction of certain conditions.
A significant percentage of PMI's premiums earned is generated from existing
primary insurance in force and not from new insurance written. Accordingly, a
decline in insurance in force as a result of policy cancellations of older books
of business could harm our financial condition. During a period of falling
interest rates, an increasing number of borrowers refinance their mortgage loans
and PMI generally experiences a decrease in existing insurance in force,
resulting from policy cancellations of older books of business with higher rates
of interest. New insurance written during periods of low interest rates may
ultimately prove to be inadequate to offset the loss of insurance in force
arising from policy cancellations.
Fannie Mae and Freddie Mac, or the GSEs, are the predominant purchasers of
conventional mortgage loans in the United States. In order to sell low down
payment loans to the GSEs, lenders must comply with the GSEs' requirements by
purchasing private mortgage insurance, or maintaining lender recourse or lender
6
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participation. Lenders that purchase private mortgage insurance in connection
with the sale of loans to the GSEs must comply with the GSEs' coverage
percentage requirements. The GSEs have some discretion to increase or decrease
the amount of mortgage insurance coverage they require on loans provided minimum
requirements are met. For example, in 1995, the GSEs increased their coverage
requirements from 25% to 30% on mortgages with loan-to-value ratios, or LTV, of
90.01% to 95%, or 95s, and increased their coverage requirements from 17% to 25%
for mortgages with LTV's of 85.01% to 90%, or 90s. PMI's percentage of risk in
force with the "deeper" coverage requirements increased as a result of the
changed coverage requirements. As PMI charges higher premium rates for higher
coverage, the deeper coverage requirements imposed by the GSEs in 1995 resulted
in higher earned premiums for loans of similar type.
During 1999, the GSEs offered reduced coverage requirements for certain loans
approved for purchase by their automated loan underwriting systems. Coverage
requirements on these "approved" loans are similar to those required by the GSEs
prior to 1995. PMI has seen some movement by lenders toward these "reduced
coverage" programs. The GSEs will further reduce the coverage requirements for
loans approved for purchase by their automated underwriting systems if the
lender pays an up-front delivery fee. PMI believes that lenders generally have
declined to pay the delivery fee required to obtain this further reduction in
coverage. The GSEs also offer several high LTV programs that require coverage
similar to those levels established in 1995.
In cooperation with participating lenders, PMI has entered into agreements with
the GSEs to restructure primary mortgage insurance coverage on high LTV loans
sold to the GSEs over a specified period of time. The coverage restructuring
involves reduced amounts of primary coverage and a second layer of coverage,
usually in the form of pool insurance (see Pool Mortgage Insurance, below).
These restructuring transactions may provide for the provision of services by
the GSEs to the mortgage insurer and payment of fees by the mortgage insurer to
the GSEs for the reduced coverage and/or the services provided. This
restructured coverage represented a greater percentage of PMI's NIW and total
pool risk written in 2001 than in 2000. Should it continue, this trend could
negatively impact net premiums written and our yield on net premiums earned.
Pool Mortgage Insurance
Traditional Pool Insurance. "Traditional" pool insurance covers the entire loss
on a defaulted mortgage loan that exceeds the claim payment under any primary
coverage, up to a stated aggregate loss limit, or stop loss, for all of the
loans in the pool. Because the insurance exposure is not limited to a set
coverage percentage on specific loans as with primary insurance, the rating
agency capital requirements for traditional pool insurance are greater than for
primary insurance.
In 1997, PMI began offering GSE Pool, a traditional pool insurance product for
mortgage loans sold by PMI's customers to the GSEs. New risk written for GSE
Pool was $19.5 million and $106.0 million for the years ended December 31, 2001
and 2000, respectively. The average stop loss limit for GSE Pool as of December
31, 2001 was 1.1%. GSE Pool risk in force at December 31, 2001 was $801.5
million.
In 1999, pursuant to a Recapture Agreement between PMI and Forestview Mortgage
Insurance Company, PMI assumed mortgage pool insurance loss reserves presently
estimated to be $6.3 million, net of expense allocations, previously insured by
Forestview. These "old pools" are traditional pool policies written prior to
1994 and are past their peak claim periods. Risk in force for the Forestview
recaptured Old Pool portfolio was $1.1 billion at December 31, 2001.
In addition to GSE Pool and Old Pool, PMI has offered traditional pool products
to certain state housing authorities and investors. Other traditional pool risk
in force as of December 31, 2001 was $6.2 million.
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PMI is not actively offering new traditional pool insurance to its customers.
Traditional pool insurance is not counted by the mortgage insurance industry
towards NIW, primary insurance in force or primary risk in force. Accordingly,
references to such figures in this document do not include traditional pool
insurance, unless otherwise indicated.
Modified Pool Insurance. PMI offers modified pool insurance products that, in
addition to having a stated aggregate loss limit, have exposure limits on each
individual loan in the pool. PMI issues modified pool insurance coverage in
negotiated transactions (see Negotiated Transactions, below) and to the GSEs in
connection with the restructuring of primary mortgage insurance. Modified pool
insurance may be attractive to lenders and investors seeking capital relief or
the reduction of default risk beyond the protection provided by existing primary
mortgage insurance. Modified pool insurance may be used as a substitute for
primary insurance, used to cover loans that do not require primary mortgage
insurance because they have LTVs of less than 80%, or used as an additional
credit enhancement for secondary market mortgage transactions.
Prior to July 2001, PMI generally did not include modified pool insurance
towards NIW, primary insurance in force or primary risk in force. Effective July
2001, PMI revised several categories of insurance. Under the revised categories,
PMI includes modified pool insurance towards NIW, primary insurance in force and
risk in force when:
. the modified pool insurance is placed on a loan that does not also
have primary mortgage insurance coverage, and
. the difference between the loan's LTV and the modified pool coverage
percentage is greater than 50%. The difference between the LTV and the
modified pool coverage percentage is sometimes referred to as the
"down-to" percentage.
We believe that this definitional change does not materially affect PMI's
previously reported NIW, primary insurance in force and risk in force results or
its current year-end results as compared to comparable periods in 2000.
Total modified pool risk written in 2001 (excluding modified pool that PMI
included in NIW) was $414.7 million. Total modified pool risk in force as of
December 31, 2001 and 2000 was $554.1 million and $163.5 million, respectively
(excluding modified pool that PMI included in primary risk in force).
Negotiated Transactions
PMI engages in negotiated, secondary market "bulk" transactions. While the terms
vary from deal to deal, negotiated transactions generally involve bidding upon
and, if successful, insuring a large group of loans or committing to insure new
loan originations on agreed terms. Insurance issued in negotiated transactions
may include primary or modified pool, or a combination thereof. Some negotiated
transactions contain a risk-sharing component under which the insured shares in
losses in some manner. Negotiated transactions may involve loans that are or
will be securitized and in these instances PMI may be asked to provide "down to"
insurance coverage sufficient to reduce the insured's exposure on each loan to a
percentage of the loan balance selected by the insured.
PMI issued approximately $9 billion of primary mortgage insurance through
negotiated transactions in 2001, which accounted for approximately 19% of PMI's
NIW for 2001. In 2000, approximately 21% of PMI's NIW was acquired through
negotiated transactions. Negotiated transactions have come primarily from
secondary mortgage market participants, including underwriters of
mortgage-backed securities and mortgage investors such as the
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GSEs. We believe that negotiated transactions will make up a material portion of
the mortgage insurance industry's and PMI's NIW and pool risk written in 2002.
Negotiated transactions have impacted us in a number of ways and we believe this
business will continue to impact us in the future. In 2000, PMI's sales force,
which traditionally focused on mortgage originators, was reorganized, in part,
to allocate additional resources to pursue negotiated transactions with
secondary mortgage market participants. PMI maintains a "negotiated
transactions" team dedicated to acquiring and executing secondary market
transactions.
To obtain this business, PMI competes with other mortgage insurers and other
providers of credit enhancement who may offer alternative forms of credit
enhancement. Accordingly, PMI's ability to quickly and efficiently analyze large
loan portfolios and develop and adequately price complex insurance products is
critical. Generally, PMI prices and bids upon a loan portfolio by aggregating
the price of mortgage insurance to be charged for each particular loan in the
portfolio. PMI prices loans in negotiated transactions based upon a number of
risk factors, including borrower and credit characteristics, loan and property
characteristics including LTV, the level of insurance coverage requested,
housing market considerations and persistency estimations.
Negotiated transactions often include "non-traditional" loans, including
Alternative A and Alternative A- loans and less than A quality mortgages.
Alternative A loans have approximately the same credit profile as traditional
loans insured by PMI but have been underwritten with reduced income, deposit
and/or employment documentation. Alternative A- loans have slightly weaker
credit profiles than traditional loans insured by PMI and have been underwritten
with reduced income, deposit and/or employment documentation. Loans of less than
A quality have been underwritten to non-traditional and generally lower credit
requirements than credit guidelines for traditional loans.
Captive Reinsurance
Certain mortgage insurers, including PMI, reinsure portions of their risk
written on loans originated by certain lenders with captive reinsurance
companies affiliated with such lenders. PMI's captive reinsurance programs allow
the lender-affiliated reinsurance company to assume a portion of the mortgage
insurance default risk in exchange for a portion of the insurance premiums for
loans originated by the lender and insured by PMI.
. In 2001, approximately 43% of PMI's NIW was subject to captive
reinsurance arrangements, compared to approximately 34% of PMI's NIW
in 2000.
. As of December 31, 2001, approximately 29% of PMI's primary insurance
in force was subject to captive reinsurance arrangements, compared to
approximately 23% of PMI's primary insurance in force as of December
31, 2000.
. As of December 31, 2001, approximately 31% of PMI's total risk in
force was subject to captive reinsurance arrangement, compared to
approximately 24% of PMI's total risk in force in 2000.
These increases in the percentages of primary insurance in force and NIW subject
to captive reinsurance arrangements were the result of the heavy volume of
refinance activity during 2001 as well as additional reinsurance agreements
entered into during 2000 and 2001. PMI expects these percentages to continue to
increase in 2002 as refinance activity continues and an increasing amount of NIW
is subject to reinsurance agreements. This trend could negatively impact net
premiums written and the yield we obtain on net premiums earned.
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. In 2001, PMI ceded approximately 29% of the total premiums subject to
captive reinsurance arrangements for a commensurate level of risk,
compared to approximately 25% in 2000. This increase was primarily the
result of additional captive reinsurance arrangements and the heavy
refinance activity experienced during 2001.
. As of December 31, 2001, PMI had ceded approximately $692.2 million of
risk in force to captive reinsurers, and such ceded risk was supported
by restricted trust account balances of approximately $122.9 million.
PMI's captive reinsurance agreements primarily consist of what are known in the
industry as excess-of-loss reinsurance. In excess-of-loss reinsurance, PMI
retains a first loss position on a defined set of mortgage insurance risk,
reinsures a second loss layer of this risk with a captive reinsurer and retains
the remaining risk above the second loss layer up to the maximum coverage level.
PMI also has entered into four quota-share captive reinsurance agreements under
which the captive reinsurer assumes a pro rata share of all (i.e., first dollar)
losses in return for a pro rata share of the premiums collected.
In 2000, Freddie Mac issued revised Eligibility Criteria for Private Mortgage
Insurers that established certain financial requirements for captive reinsurance
transactions. These revised requirements contained new, detailed requirements
with respect to captive reinsurance transactions. Among other things, the new
requirements: (i) mandate that captive reinsurance agreements include risk
transfer in accordance with Financial Accounting Standards Board ("FASB") No.
113, Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts; and (ii) impose capital or rating requirements on
captive reinsurers that reinsure more than 25% of the ceded risk or premium
under a quota-share or excess-of-loss agreement. Freddie Mac also has the
authority to waive these requirements on a case by case basis. In addition,
under the terms of the Baynham settlement (see Item 3. Legal Proceedings), PMI
must obtain a written opinion of an independent actuary that the net ceded
premiums under each captive agreement is "commensurate or reasonably related to
the risk transferred" and that there is a real transfer of risk.
To ensure the performance of its captive reinsurers, PMI requires each captive
reinsurer to establish a trust account with a National Association of Insurance
Commissioner's approved United States domiciled bank and to maintain funds
therein in an amount not less than the greater of (i) loss, unearned premium and
contingency reserves required to be held under Arizona law, or (ii) 10% of the
risk reinsured for excess of loss reinsurance or 5% of the risk reinsured for
quota share reinsurance. These estimated liabilities and risk-to-capital ratios
are recalculated by PMI on a quarterly basis. All reinsurance premiums payable
by PMI are deposited directly into the trust accounts and the captive reinsurers
are permitted to make withdrawals from the trust account only if, and to the
extent that, the trust balances exceed certain predetermined reserve and
risk-to-capital levels and PMI as the sole beneficiary of the trust has
expressed written consent for such withdrawal.
Other Risk-Sharing Products
In addition to captive reinsurance, PMI offers other risk-sharing products,
including:
. layered co-insurance, a primary mortgage insurance program under which
the insured retains liability for losses between certain levels of
aggregate losses; and
. various products designed for, and in cooperation with, the GSEs
and/or lenders that involve some aspect of risk-sharing. Some of these
products are executed through negotiated transactions.
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Joint Venture - CMG Mortgage Insurance Company
CMG offers mortgage insurance for loans originated by credit unions. CMG is a
joint venture, equally owned by PMI and CUNA Mutual Investment Corporation, or
CMIC. CMIC is part of the CUNA Mutual Group which provides insurance and
financial services to credit unions and their members in the United States and
other countries. PMI and CMIC both provide services to CMG. At December 31,
2001, CMG had $8.9 billion of primary insurance in force. CMG's financial
results are reported in PMI's financial statements under the equity method of
accounting. CMG's operating results are not included in PMI's results shown in
Part I of this Form 10-K, unless noted. PMI and CMIC also jointly own CMG
Mortgage Assurance Company, or CMGA, which offers mortgage insurance for credit
union loans secured by junior liens, and CMG Mortgage Reinsurance Company, which
provides reinsurance to CMG and CMGA.
Under the terms of the joint venture arrangement, at the end of fifteen years,
or earlier under certain limited conditions, CMIC has the right to require PMI
to sell, and PMI has the right to require CMIC to purchase, PMI's interest in
CMG for an amount equal to the then current fair market value. For this purpose,
fair market value will be determined by agreement between PMI and CMIC or,
failing such agreement, through appraisal by nationally recognized
investment-banking firms. PMI and CMIC have entered into a capital support
agreement for the benefit of CMG in order to maintain CMG's claims-paying
ability rating at AA- by Standard & Poor's and AA by Fitch.
CMG has one captive reinsurance agreement and may enter into additional
arrangements in the future.
2. Competition
U.S. Private Mortgage Insurance Industry
The U.S. private mortgage insurance industry (excluding CMG) consists of seven
active mortgage insurers: PMI; Mortgage Guaranty Insurance Corporation; GE
Capital Mortgage Insurance Corporation, an affiliate of GE Capital Corporation;
United Guaranty Residential Insurance Company, an affiliate of American
International Group, Inc; Radian Guaranty Inc; Republic Mortgage Insurance Co.,
an affiliate of Old Republic International; and Triad Guaranty Insurance Corp.
According to the Mortgage Bankers Association of America, for the year ended
December 31, 2001, total mortgage originations were $2.1 trillion compared to
$1.1 trillion for the year ended December 31, 2000.
U.S. and State Government Agencies
PMI and other private mortgage insurers compete with federal and state
government and quasi-governmental agencies that sponsor their own mortgage
insurance programs. The private mortgage insurers' principal government
competitor is the FHA and, to a lesser degree, the Veterans Administration, or
VA. The following table shows the relative mortgage insurance market share of
FHA/VA and private mortgage insurers over the past five years.
<TABLE>
<CAPTION>
Federal Government and Private Mortgage Insurance
Market Share (Based on NIW)
---------------------------
Year Ended December 31,
-----------------------
2001 2000 1999 1998 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
FHA/VA ....................... 37.3% 41.4% 47.6% 43.7% 45.6%
Private Mortgage Insurance ... 62.7 58.6 52.4 56.3 54.4
----- ----- ----- ----- -----
Total ................... 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
</TABLE>
- ----------
Source: Inside Mortgage Finance
11
<PAGE>
Effective January 1, 2002, the Department of Housing and Urban Development, or
HUD, in accordance with its index, increased the maximum single-family loan
amount that the FHA can insure from $239,250 to $261,609 in high-cost areas.
While there is no maximum VA loan amount, lenders will generally limit VA loans
to $240,000. Private mortgage insurers have no limit as to maximum individual
loan amounts that they can insure. In January 2001, the FHA reduced the up-front
mortgage insurance premiums it charges on loans from 2.25% to 1.5% of the
original loan amounts. The FHA also has streamlined its down-payment formula
making FHA insurance more competitive with private mortgage insurance in areas
with higher home prices. These and other legislative and regulatory changes
could cause future demand for private mortgage insurance to decrease.
Federal Home Loan Bank Mortgage Partnership Finance Program. In October 1999,
the Federal Housing Finance Board, or FHF Board, adopted resolutions which
authorize each Federal Home Loan Bank, or FHLB, to offer programs to purchase
single-family conforming mortgage loans originated by participating member
institutions under the single-family member mortgage assets program. In July
2000, the FHF Board gave permanent authority to each FHLB to purchase such loans
from member institutions without any volume cap. Under the FHF Board's rules,
member institutions are also authorized to provide credit enhancement for
eligible loans that is not limited to mortgage insurance. Any expansion of the
FHLBs' ability to use alternatives to mortgage insurance could reduce the demand
for private mortgage insurance and harm our financial condition and results of
operations.
PMI and other private mortgage insurers also face limited competition from
several state housing insurance funds which are either independent agencies or
affiliated with state housing agencies.
Fannie Mae and Freddie Mac - The GSEs
As the predominant purchasers of conventional mortgage loans in the United
States, the GSEs provide a direct link between the mortgage origination and
capital markets. The GSEs may purchase conventional high LTV mortgages only if
the lender (i) secures private mortgage insurance from an eligible insurer on
those loans; (ii) retains a participation of not less than 10% in the mortgage;
or (iii) agrees to repurchase or replace the mortgage in the event of a default
under specified conditions. However, if the lender retains a participation in
the mortgage or agrees to repurchase or replace the mortgage, applicable federal
bank and savings institution regulations may increase the level of capital
required to be held by the lender and the lender's cost of doing business may be
adversely affected. Consequently, lenders prefer to make loans that can be sold
in the secondary market utilizing mortgage insurance from insurers deemed
eligible by the GSEs. PMI is a GSE authorized mortgage insurer.
Private mortgage insurers must satisfy requirements set by the GSEs to be
eligible to insure loans sold to the GSEs. One of the GSEs requires mortgage
insurers to maintain at least two of the three ratings equal to or higher than
AA- by Fitch, AA- by S&P or Aa3 by Moody's. Any change in PMI's eligibility
status with either GSE could have a material, adverse effect on our financial
condition and results of operations.
The GSEs have the ability to implement new eligibility requirements for mortgage
insurers. They also have the authority to change the pricing arrangements for
purchasing retained participation mortgages as compared to insured mortgages,
increase or reduce required insurance coverage percentages, and alter or
liberalize underwriting standards on low down payment mortgages they purchase.
Private mortgage insurers, including PMI, are affected by such changes. One of
the GSEs has indicated that it is considering adopting and implementing new
approval requirements for mortgage insurers. The extent to which these new
requirements may alter the guidelines for PMI's business operations, capital
requirements and products is not currently known.
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<PAGE>
In 2001, the maximum single-family principal balance loan limit eligible for
purchase by the GSEs was increased in accordance with the applicable index to
$275,000 and in January 2002 that limit was raised to $300,700. PMI believes
that any increase in this loan limit may positively affect the number of loans
eligible for mortgage insurance, thereby increasing the size of the mortgage
insurance market.
The GSEs are subject to oversight by HUD. In October 2000, HUD announced new GSE
mortgage purchase requirements, known as affordable housing goals. Under these
goals that began in 2001, at least 50% of all loans purchased by the GSEs must
support low- and moderate-income homebuyers and 31% of such units must be in
under-served areas. PMI believes that the GSEs' goals to expand purchases of
affordable housing loans have increased the size of the mortgage insurance
market. The GSEs also have expanded programs to include commitments to purchase
certain volumes of loans with LTV's between 95% and 97%, or 97s, and between 97%
and 100%, or 100s.
The Office of Federal Housing Enterprise Oversight, or OFHEO, is required to
develop risk-based capital regulations for the GSEs and in July 2001 OFHEO
published a risk-based capital rule that specified a risk-based capital stress
test that, when applied to the GSEs, determines the amount of capital that a GSE
must hold to maintain positive capital throughout a 10-year period of severe
economic conditions. The published rule treated credit enhancements issued by
private mortgage insurance companies with claims-paying ability ratings of "AAA"
more favorably than those issued by mortgage insurance companies with "AA"
ratings, such as PMI. The rule also provided capital guidelines for the GSEs in
connection with their use of other types of credit protection counter parties in
addition to mortgage insurers. In December 2001, OFHEO proposed a revised rule
and OFHEO finalized the revised rule in February 2002. The finalized rule
reduced, but did not eliminate, the differential between the "AAA" and "AA"
rated mortgage insurance companies. It is not clear whether the finalized rule
will result in the GSEs increasing their use of either AAA-rated mortgage
insurers instead of AA-rated entities or credit counter parties other than
mortgage insurers due to the more favorable capital treatment afforded to such
entities. Changes in the preferences of the GSEs for private mortgage insurance
to other forms of credit enhancement, or a tiering of mortgage insurers based on
their credit rating, could harm our financial condition and results of
operations.
Mortgage insurers, including PMI, compete with the GSEs when the GSEs seek to
assume mortgage default risk that could be covered by mortgage insurance. As
discussed above, the GSEs have introduced programs that allow lenders to
purchase reduced mortgage insurance coverage or provide for the restructuring of
existing mortgage insurance with reduced amounts of primary coverage and the
addition of pool coverage. In the past, Freddie Mac stated that it would pursue
a permanent charter amendment allowing it to utilize alternative forms of
default risk protection or otherwise forego the use of private mortgage
insurance on higher loan-to-value mortgages. In October 2000, Fannie Mae
announced its intention during the next three years to increase its share of
revenue associated with the management of mortgage credit risk by retaining
mortgage risk previously borne by its "risk-sharing partners," including
mortgage insurers.
In 2000 and 2001, the GSEs purchased primary and modified pool insurance
coverage on GSE-held loans with down payments exceeding 20%. The GSEs often
acquired this mortgage insurance, some of which was written by PMI, through a
bidding process. The GSEs are not required by regulation or charter to purchase
this coverage and PMI believes that the GSEs purchased this coverage to assist
in their risk-to-capital management programs. If the GSEs continue to purchase
mortgage insurance on loans with down payments exceeding 20%, it would represent
an additional market for private mortgage insurance in the United States.
Freddie Mac's and Fannie Mae's automated underwriting systems, Loan
Prospector(SM) and Desktop Underwriter(TM), respectively, can be used by
mortgage originators to determine whether Freddie Mac or Fannie Mae will
purchase a loan prior to closing. Through these systems, lenders are able to
obtain
13
<PAGE>
approval for mortgage insurance with any participating mortgage insurer. PMI
works with both agencies in offering insurance services through their systems,
while utilizing its proprietary risk management systems to monitor the risk
quality of loans insured through such systems. These automated underwriting
systems are used by the GSEs in connection with, among other things, their
reduced coverage and high-LTV programs. Generally, PMI's underwriting guidelines
allow PMI to place mortgage insurance coverage on any mortgage loans accepted by
the GSEs' automated underwriting systems for purchase. A significant portion of
PMI's NIW in 2001 consisted of loans accepted by the GSEs' automated
underwriting systems.
Mortgage Lenders
PMI and other private mortgage insurers compete indirectly with mortgage lenders
that elect to retain the risk of loss from defaults on all or a portion of their
high LTV mortgage loans rather than obtain insurance for such risk. 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, or an
80/10/10. This 80/10/10 product and other similar products compete with mortgage
insurance as an alternative for lenders selling loans in the secondary mortgage
market.
In addition to captive reinsurance arrangements with affiliates of lenders,
mortgage insurers share a portion of their coverage with their customers through
risk retention arrangements. PMI also offers various premium rates based on the
risk characteristics, loss performance or class of business of the loans to be
insured or on the costs associated with doing such business. While many factors
are considered in determining rates, there can be no assurance that the premiums
charged will be adequate to compensate us for the risks associated with the
coverage provided to our customers.
Gramm-Leach-Bliley Act
Effective March 2000, the Gramm-Leach-Bliley Act allows, among other things,
bank holding companies to engage in a substantially broader range of activities,
including insurance underwriting. The Gramm-Leach-Bliley Act allows a bank
holding company to form an insurance subsidiary, licensed under state insurance
law, to issue insurance products, including mortgage insurance. Any such
mortgage insurance subsidiary would be subject to state insurance regulations
including capital, reserve and risk diversification requirements and
restrictions on the payments of dividends. Further, before any loans insured by
the subsidiary are eligible for purchase by the GSEs, the insurance subsidiary
must meet the GSEs' eligibility standards that currently require a claims-paying
ability rating of at least AA- and the establishment of comprehensive operating
policies and procedures. Because aspects of the Gramm-Leach-Bliley Act still
require clarification and promulgation and because few bank holding companies
have sought to utilize the Gramm-Leach-Bliley Act, we are unable to ascertain
the full impact of the Act on PMI.
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 adopted a final
rule, effective as of February 2, 2001, that permits similar activities for bank
holding companies. The Office of Thrift Supervision has 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
us in the future.
3. Customers
PMI insures mortgage loans funded by mortgage originators. Mortgage originators
include mortgage bankers, savings institutions, commercial banks and other
mortgage lenders. Traditionally, PMI's primary
14
<PAGE>
customers have been mortgage bankers with the balance of PMI's customers being
savings institutions, commercial banks and other mortgage lenders. As the
beneficiary under PMI's master policy is the owner of the insured loan, the
purchaser of that loan is entitled to the policy benefits. The GSEs, as the
predominant purchasers of conventional mortgage loans in the U.S., are the
beneficiaries of the majority of our mortgage insurance coverage.
In 2001, PMI's top ten customers generated approximately 38% of its NIW,
compared to approximately 40% in 2000.
In 2001, the mortgage lending industry continued its consolidation trend. A
greater percentage of that industry's business in 2001 was originated by large
lenders. At least several large lenders, however, rely in part upon mortgage
brokers and smaller loan originators, or correspondents, to source and originate
loans on their behalf. To date, large lenders generally have allowed their
correspondents to control decisions relating to the ordering of mortgage
insurance and the selection of particular mortgage insurance providers. PMI
anticipates that large lenders in 2002 generally will continue to allow their
correspondents to control these decisions. The centralization of these decisions
by large lenders, however, could magnify the impact that mortgage lending
consolidation has on mortgage insurers. Accordingly, the loss of a large lender
as PMI's customer, or a large lender's decision to significantly reduce its
business with PMI could, if permanent, have an adverse effect on PMI.
In 2000 and 2001, PMI offered a variety of mortgage insurance products to
secondary market participants such as underwriters of mortgage-backed securities
and the GSEs. These entities entered into negotiated transactions with PMI
pursuant to which PMI insured pools of loans or committed to insure new loan
originations on agreed terms. Insurance issued in negotiated transactions may
include primary or modified pool insurance or a combination thereof.
4. Business Composition
A significant percentage of PMI's premiums earned is generated from existing
insurance in force and not from NIW. For each of PMI's last four policy years,
more than half of the NIW for the year remains in force. The insured, the policy
owner or servicer of a loan may cancel insurance coverage at any time.
The composition of PMI's risk in force is summarized in the table below. The
table is based upon information available on the date of mortgage origination.
15
<PAGE>
<TABLE>
<CAPTION>
Risk in Force
As of December 31,
2001 2000 1999 1998 1997
-------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
Primary Risk in Force (in millions) $ 25,772 $ 23,559 $ 21,159 $19,324 $18,092
LTV:
97s and above ................... 6.3% 5.7% 4.9% 3.3% 1.8%
95s ............................. 43.3 45.7 46.7 46.3 46.2
90s and below ................... 50.4 48.6 48.4 50.4 52.0
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Loan Type:
Fixed ........................... 90.5% 90.5% 91.4% 89.7% 83.3%
ARM ............................. 9.4 9.4 7.9 9.2 15.2
ARM (scheduled/potential negative
Amortization) ................... 0.1 0.1 0.7 1.1 1.5
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Mortgage Term:
Over 15 years ................... 99.0% 98.8% 95.6% 94.7% 93.7%
15 years and under .............. 1.0 1.2 4.4 5.3 6.3
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Property Type:
Single-family detached .......... 87.5% 87.3% 87.5% 87.1% 86.3%
Condominium ..................... 5.4 6.0 6.1 6.4 6.8
Other ........................... 7.1 6.7 6.4 6.5 6.9
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Occupancy Status:
Primary residence ............... 96.2% 97.2% 98.0% 98.6% 99.0%
Second home ..................... 1.6 1.5 1.2 1.0 0.8
Non-owner occupied .............. 2.2 1.3 0.8 0.4 0.2
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Loan Amount:
$100,000 or less ................ 22.8% 23.2% 24.0% 26.4% 27.3%
Over $100,000 and up to $250,000 67.2 68.2 68.6 66.1 65.6
Over $250,000 ................... 10.0 8.6 7.4 7.5 7.1
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Traditional ........................ 84.5% 91.4% 93.2% N/A N/A
Non-traditional (Alt A/Less than A) 15.5 8.6 6.8 N/A N/A
-------- -------- --------
Total ......................... 100.0% 100.0% 100.0%
======== ======== ========
Pool Risk in Force (in millions):
GSE Pool ........................ $ 801.5 $ 785.6 $ 681.2 $ 450.3 N/A
Old Pool ........................ 1,114.1 1,391.5 1,407.8 N/A N/A
Modified Pool ................... 554.1 163.5 100.4 42.4 N/A
Other traditional pool .......... 6.2 5.9 3.9 N/A N/A
</TABLE>
16
<PAGE>
. Fixed v. Adjustable Rate Mortgages. Relatively low interest rates between 1996
and 2001 resulted in an increasing percentage of mortgages insured by PMI at
fixed rates of interest. Based on PMI's experience, fixed rate loans represent
less risk than adjustable rate mortgages, or ARMs, because claim frequency on
ARMs is generally higher than on fixed rate loans.
. High LTV Loans. The composition of PMI's NIW and risk in force includes 95s,
which in PMI's experience have claims frequency approximately one and a half
times that of 90s. PMI also offers coverage for mortgages with LTV's in excess
of 95% and PMI believes that these loans have higher risk characteristics than
95s.
. Non-Traditional Loans. PMI's NIW and risk in force also includes
non-traditional loans, chiefly Alternative A and Alternative A- loans and less
than A quality mortgages. Loan characteristics, credit quality, loss
development, pricing structures and persistency on non-traditional loans can be
significantly different and riskier than PMI's traditional prime business, and
non-traditional loans generally do not meet the standard underwriting guidelines
of the GSEs. Non-traditional loans represented approximately 19% of PMI's 2001
NIW and 20% of PMI's NIW in 2000.
Management expects higher default rates and claim payment rates for ARMs, high
LTV loans and non-traditional loans and incorporates these assumptions into its
pricing. However, there can be no assurance that the premiums earned on ARMs,
high LTV loans, non-traditional loans and the associated investment income will
prove adequate to compensate for future losses from these loans.
Changes in Coverage Percentages. The severity of a claim on an insured loan
depends in part upon the specified coverage percentage for that loan. Deeper
coverage on a loan increases the potential severity of a claim on that loan.
Accordingly, PMI generally charges higher premium rates for deeper coverage
(higher coverage percentages).
. PMI's average coverage percentage was 23% for NIW in 2001 and 24% for
NIW in 2000.
. PMI's percentage of NIW comprised of 95s with 30% coverage (deep
coverage) decreased from 25% for the year ended December 31, 2000 to
23% for the year ended December 31, 2001. This decrease was due in
part to PMI's execution in 2001 of certain negotiated transactions
that included mortgage loans with lower coverage percentages, and to
the large refinance mortgage market in 2001 that resulted in PMI
insuring a greater percentage of 90s than 95s.
. The percentage of NIW made up of 90s with 25% coverage (deep coverage)
was 32% at December 31, 2001 and 27% at December 31, 2000.
5. Sales; Mortgage Insurance Acquisition Channels
Sales. PMI employs a sales force located throughout the country to sell its
products and provide services to lenders located throughout the United States.
PMI's sales force receives compensation comprised of a base salary with
incentive compensation tied to performance objectives. PMI's Product Development
and Pricing Department has primary responsibility for advertising, sales
materials, pricing and the creation of new products and services.
In light of continuing mortgage lender consolidation and the increasing
dominance of the largest mortgage originators, PMI's sales force is organized
tactically, focusing on customer relationships with an emphasis on "national
accounts," PMI's large lender customers. As a result of PMI's increasing
negotiated
17
<PAGE>
transactions business, PMI has dedicated additional resources to focus on PMI's
negotiated transactions customers.
Mortgage Insurance Acquisition Channels. To obtain mortgage insurance on a
specific mortgage loan a customer typically submits to PMI an application and
supporting documentation. If the loan is approved for mortgage insurance, PMI
issues a certificate of insurance to the customer. Historically, the customer's
application and PMI's response have been paper transactions executed via mail,
courier or facsimile. During the last several years, however, advances in
technology have enabled PMI to offer its customers the option of electronic
submission of applications and receipt of insurance commitments and
certificates. In 2001, 52% of PMI's primary insurance commitments (excluding
negotiated transactions) were issued electronically, compared to 23% in 2000.
A growing number of PMI's customers require that PMI provide its products and
services electronically. Many of these customers also require that PMI customize
its electronic delivery methods to their particular technology platforms. An
increasing portion of PMI's NIW is delivered electronically. Management expects
these trends to continue and, accordingly, believes that it is essential for PMI
to continue to invest substantial resources to maintain electronic connectivity
with its customers. In some instances, connectivity has become a primary factor
used by mortgage originators to choose a mortgage insurer.
While development and customization costs are substantial, electronic
acquisition and delivery of mortgage insurance benefits PMI. E-commerce reduces
paperwork for both PMI and its customers, streamlines the mortgage insurance
application process, reduces errors associated with re-entering information and
increases the speed with which PMI is able to respond to applications, all of
which can enhance PMI's relationship with lenders while reducing acquisition
costs. PMI's electronic acquisition channels, once developed, require
significantly less per transaction human effort than PMI's traditional paper
acquisition channels. Examples of PMI's electronic acquisition channels include:
. e-PMI(R). PMI introduced its electronic delivery channel for mortgage
insurance, "e-PMI," in 1999. PMI's customers can order mortgage
insurance directly from the e-PMI web-site or, in the case of certain
lenders, by using an embedded link that "frames" e-PMI within the
customer's own site. e-PMI offers users real-time access to, among
other things, mortgage insurance origination services, mortgage
insurance rates, and premium payment and refund information.
. EDI. PMI accepts applications for insurance electronically through
electronic data interchange, or EDI, links with lenders. EDI links
typically run over value-added networks and use industry-standard data
sets to exchange information.
. Connectivity to Third Party Internet Sites. PMI also electronically
connects to its customers directly through lender-specific web-sites
and, indirectly, through lender-neutral web-sites or "portals" and
loan origination and servicing systems.
. Tape-to-Tape Negotiated Transactions. PMI's negotiated transactions,
which often involve large loan portfolios, are conducted largely
electronically. Prior to insuring these groups of loans, PMI receives
from the insured details of the loan portfolios in electronic "tape"
format.
6. Underwriting Practices
Risk Management Approach
PMI underwrites its primary business based upon the historical performance of
risk factors of individual loan profiles and utilizes an automated underwriting
system in the risk selection process to assist the underwriter with decision
making. PMI's underwriting process evaluates five categories of risk:
18
<PAGE>
. Borrower. An evaluation of the borrower's credit history is an
integral part of PMI's risk selection process. In addition to the
borrower's credit history, PMI analyzes several factors, including the
borrower's employment history, income, funds needed for closing and
the details of the home purchase.
. Loan Characteristics. PMI analyzes four general characteristics of the
loan product to quantify risk: (1) LTV; (2) type of loan instrument;
(3) type of property; and (4) purpose of the loan. Certain categories
of loans are generally not insured by PMI because such loans are
deemed to have an unacceptable level of risk, such as loans with
scheduled negative amortization.
. Property Profile. PMI reviews appraisals used to determine the
property value.
. Housing Market Profile. PMI places significant emphasis on the
condition of regional housing markets in determining its underwriting
guidelines. PMI analyzes the factors that impact housing values in
each of its major markets and closely monitors regional market
activity on a quarterly basis.
. Mortgage Lender. PMI tracks the historical risk performance of all
customers that hold a master policy. This information is factored into
the determination of the loan programs that PMI will approve for
various lenders.
PMI uses national and territorial underwriting guidelines to evaluate the
potential risk of default on mortgage loans submitted for insurance coverage.
PMI has developed and refined the national guidelines over time, taking into
account its loss experience and the underwriting guidelines of the GSEs. PMI's
underwriting guidelines generally allow PMI to place mortgage insurance coverage
on any mortgage loans accepted by the GSEs' automated underwriting systems for
purchase by the GSEs.
PMI expects its underwriters to utilize their knowledge of local markets, risk
management principles and business judgment in evaluating loans on their own
merits in conjunction with PMI's underwriting guidelines. Accordingly, PMI's
underwriting staff is trained to consider combined risk characteristics and
their impact in different real estate markets and have discretionary authority
to insure loans which are substantially in conformance with PMI's published
underwriting guidelines. Significant deviations from such guidelines require
higher level underwriting approval. PMI also offers pre-loan and post-loan
credit counseling to borrowers with high-LTV loans.
PMI's underwriting guidelines are based, in part, upon analysis performed by its
automated underwriting system, the pmiAURA(SM) System. The pmiAURA System
employs claim and risk statistical models to predict the relative likelihood of
default by a mortgage borrower and it assigns risk scores predicting the
likelihood of default. The pmiAURA System's database contains performance data
on more than 3.5 million loans, and includes economic and demographic
information to enhance its predictive power.
The pmiAURA System can generate several types of scores, including: a loan risk
score that assesses the risk solely due to the borrower and loan and property
characteristics that are independent of market risk; a market score which is a
measure of the default risk due solely to the economic conditions of a specific
metropolitan area and a total risk score that combines the information in the
loan risk and market scores. As an added benefit, pmiAURA's extensive database
provides detailed performance reports of underwriting quality trends by
geographic region, product type, customer characteristics and other key factors.
These reports allow PMI's underwriting management to monitor risk quality on a
daily basis and to formulate long-term responses to developing risk quality
trends. Ultimately, such responses can lead to regional variations from, or
permanent changes to, PMI's underwriting guidelines. pmiAURA is approved by the
Wall Street rating agencies as an effective tool for establishing levels of
credit support needed on securities backed by non-conforming, conventional
loans. Underwriting Process
19
<PAGE>
Underwriting Process
Delegated Underwriting. The majority of PMI's NIW is underwritten pursuant to
PMI's Partner Delivered Quality Program, or PDQ Program. The PDQ Program is a
delegated underwriting program that allows approved lenders to determine whether
loans meet program guidelines and requirements and are thus eligible for
mortgage insurance. At present, more than 1,260 lenders approve applications
under the PDQ Program. PMI's delegated business accounted for approximately 55%
and 50% of PMI's NIW in 2001 and 2000, respectively. Delegated underwriting
enables PMI to meet mortgage lenders' demands for immediate insurance coverage
of certain loans. Delegated underwriting has become standard industry practice.
Under the PDQ Program, customers use their own PMI-approved underwriting
guidelines and eligibility requirements in determining whether PMI is committed
to insuring a loan. Upon receipt of delegated loans, PMI uses pmiAURA to
evaluate their key loan risk characteristics and to monitor the quality of
delegated business on an ongoing basis. Additionally, PMI audits a
representative sample of loans insured by lenders participating in the PDQ
Program on a regular basis to determine compliance with program requirements. If
a lender participating in the program commits PMI to insure a loan which fails
to meet all of the applicable underwriting guidelines, PMI is obligated to
insure such a loan except under certain narrowly-drawn exceptions to coverage,
for example, maximum loan-to-value criteria. Loans that are not eligible for the
PDQ Program may be submitted to PMI for insurance coverage through the standard
application process.
PMI believes that the performance of its delegated insured loans will not vary
materially over the long-term from the performance of all other insured loans
because: (i) only qualified lenders who demonstrate average or above-average
underwriting proficiency are eligible for the program; (ii) only loans meeting
average or above average underwriting eligibility criteria are eligible for the
program; and (iii) PMI has the ability to monitor the quality of loans approved
for insurance under the PDQ Program with proprietary risk management tools and
an on-site audit of each PDQ lender.
Non-delegated Underwriting. Customers that are not approved to participate in
the PDQ Program generally must submit to PMI an application for each loan,
supported by various documents. Applications submitted to PMI by mortgage
lenders generally include a copy of the borrower's loan application, an
appraisal report or other statistical evaluation on the property by either the
lender's staff appraiser or an independent appraiser, and a written credit
report on the borrower. Verifications of the borrower's employment, income and
funds needed for the loan closing are also required, unless the loan is
submitted by a lender that has been approved to participate in PMI's Quick
Application Program. This program allows selected lenders to submit insurance
applications that do not include all standard documents. The lender is required
to maintain written verification of employment and source of funds needed for
closing and other supporting documentation in its origination file. PMI may
schedule on-site audits of lenders' files on loans submitted under this program.
Once the loan package is received by PMI's home or field underwriting offices,
key borrower, property and loan product information are extracted from the file
and analyzed by the underwriter and/or the pmiAURA System. PMI generally
responds within one business day after it receives an application and supporting
documentation. PMI shares its knowledge of risk management principles and real
estate economic conditions with customers to improve the quality of submitted
business and reduce the rejection rate.
Negotiated Transactions. Negotiated transactions frequently involve a customer's
delivery of a portfolio of loans to PMI. Negotiated transactions require both
loan-by-loan analysis and evaluation of the loan portfolio as a whole. While the
underwriting process for negotiated transactions varies, underwriting steps
generally include:
20
<PAGE>
. Obtaining complete data files from customer including all PMI required
elements;
. Preparation and review of stratification summaries of the loans by
various loan risk factors, such as borrower credit characteristics,
LTV, loan type and property type;
. Review of loan group by PMI's Credit Policy department including
identification and exclusion of uninsurable loans;
. Due diligence underwriting of sample loan files and review of loan
originator and loan servicer; and
. Analysis of loans by PMI's proprietary claims modeling system
specifically tailored to negotiated transactions.
Contract Underwriting
Contract underwriting services are provided by PMI's wholly owned subsidiary,
PMI Mortgage Services Co., or MSC. MSC enables customers to improve the
efficiency and quality of their operations by outsourcing all or part of their
mortgage loan underwriting. MSC provides contract underwriting services for
mortgage loans for which PMI provides mortgage insurance and for loans for which
PMI does not. MSC also performs the contract underwriting activities of CMG.
As a part of its contract underwriting services, MSC provides monetary and other
remedies to its customers in the event that MSC fails to properly underwrite a
mortgage loan. Such remedies may include: (1) the purchase of additional or
"deeper" mortgage insurance; (2) assumption of some or all of the costs of
repurchasing insured and uninsured loans from the GSEs and other investors; or
(3) issuance of indemnifications to customers in the event that the loans
default for varying reasons including, but not limited to, underwriting errors
by MSC. Generally, the scope of these remedies is in addition to those contained
in PMI's master primary insurance policies. Worsening economic conditions or
other factors that could lead to increases in PMI's default rate could also
cause the number and severity of the remedies that must be offered by MSC to
increase. Such an increase could have a material effect on our financial
condition.
Contract underwriting services are important to mortgage lenders as they
continue to seek to reduce costs. New policies processed by contract
underwriters represented 26% of PMI's NIW in 2001 compared with 23% in 2000. PMI
anticipates that loans underwritten by MSC will continue to make up a
significant percentage of PMI's NIW and that contract underwriting will remain
the preferred method among many mortgage lenders for processing loan
applications. The number of contract underwriters deployed by us is directly
related to the volume of mortgage originations and/or refinancing.
PMI, through its contract underwriting systems, provides its customers with
access to Freddie Mac's and Fannie Mae's automated underwriting services, Loan
ProspectorSM and Desktop UnderwriterSM, respectively, which are used as tools by
mortgage originators to determine whether Freddie Mac or Fannie Mae will
purchase a loan prior to closing.
7. Affordable Housing
In recent years, expanding home ownership opportunities for low and
moderate-income individuals and communities has been an increasing priority for
PMI, lenders and the GSEs. PMI's approach to affordable lending is to develop
products and services that assist responsible borrowers who may not qualify
using traditional underwriting practices. These underwriting standards do not
accommodate borrowers who have historically not managed their affairs in a
responsible manner; rather they seek to identify those home buyers who have met
or will meet their obligations in a timely and conscientious manner.
Additionally,
21
<PAGE>
affordable housing programs assist homebuyers who have demonstrated good credit
quality and who have the ability and the willingness to meet their mortgage
obligations but who may not have accumulated sufficient cash for a traditional
down payment. The beneficiaries of these programs have included recent
immigrants who have not established traditional credit histories, borrowers not
accustomed to using traditional savings institutions and home buyers who,
although consistently employed, lack the traditional stability with a single
employer due to the nature of their employment.
To further promote affordable housing, PMI has entered into risk-sharing
arrangements or "layered co-insurance" with certain institutional lenders,
Native American tribes and housing authorities. Layered co-insurance is utilized
primarily by financial institutions to meet Community Reinvestment Act ("CRA")
lending goals and by Native American tribes and housing authorities to provide
homeownership opportunities to traditionally under-served populations. Under
such arrangements, the mortgage insurance is structured so that financial
responsibility is shared between the lender or Native American tribe/housing
authority and PMI. Typically PMI is responsible for the first loss layer, as
well as a third catastrophic layer, with the lender or Native American
Tribe/Housing Authority retaining a predetermined second loss layer.
PMI has also established partnerships with numerous national organizations to
mitigate affordable housing risks and expand the understanding of
responsibilities of home ownership. These community partners include Consumer
Credit Counseling Services, Neighborhood Reinvestment Corp. and the affiliated
Neighborhood Housing Services of America, the National Black Caucus, Social
Compact, the National American Indian Housing Conference, the AFLCIO Housing
Advancement Trust and the American Homeownership and Counseling Institute. In
addition, PMI has developed partnerships with local organizations in an effort
to expand home ownership opportunities and promote community revitalization.
Included among these organizations are the Oakland, California based Unity
Council, the San Francisco Chinatown Community Development Corporation, the
Orange County Affordable Home Ownership Alliance, the East Los Angeles Community
Corporation and several Native American nations. Finally, PMI has partnered with
the Los Angeles chapter of Consumer Credit Counseling Services to sponsor and
present seminars which provide consumers with the tools they need to identify
and avoid being victimized by predatory lending practices.
Programs offered under PMI's affordable housing initiatives receive the same
credit and actuarial analysis as all other standard programs although some
programs utilize affordable underwriting guidelines established by lenders that
differ from PMI's criteria. PMI believes that some affordable housing loans may
have higher risks than its other insured business. As a result, PMI has
instituted various programs including pre- and post-purchase borrower counseling
and risk sharing approaches, seeking to mitigate the additional risks that may
be associated with some affordable housing loan programs.
8. Defaults and Claims
Defaults
PMI's claim process begins with notification of a default from the insured on an
insured loan. "Default" is defined in PMI's master policy as the borrower's
failure to pay when due an amount equal to the scheduled monthly mortgage
payment under the terms of the mortgage. Generally, the master policy requires
an insured to notify PMI of a default no later than the last business day of the
month following the month in which the borrower becomes three monthly payments
in default. In most cases, defaults are reported earlier. PMI's insureds
typically report defaults within approximately 60 days of the initial default.
Borrowers default for a variety of reasons, including the reduction of income,
unemployment, divorce, illness, the inability to manage credit, and the level of
interest rates. Borrowers may cure defaults by making all of the delinquent loan
payments or by selling the property in full satisfaction of all amounts due
under the mortgage. Defaults that are not cured result in most cases in a claim
to PMI.
22
<PAGE>
The following tables show the number of loans insured, the number of loans in
default and the default rate for PMI's primary insurance portfolio.
<TABLE>
<CAPTION>
At December 31,
---------------
2001 2000 1999 1998 1997
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Primary Insurance
Number of Insured Loans in Force ... 905,906 820,213 749,591 714,210 698,831
Number of Loans in Default ......... 25,907 18,093 15,893 16,528 16,638
Default Rate ....................... 2.86% 2.21% 2.12% 2.31% 2.38%
</TABLE>
At December 31, 2001, PMI's default rate for primary insurance acquired through
negotiated transactions was 5.5%. PMI's default rate for its pool insurance
portfolio excluding Old Pool at December 31, 2001 was approximately 1.3%
compared to approximately 0.7% at December 31, 2000.
We believe that the higher default rate for negotiated transactions than for
primary and pool insurance is due to the greater concentration of
non-traditional loans in negotiated transactions. We believe that loans in PMI's
developing non-traditional primary book (Alternative A or A- and less than A
quality loans) will have higher ultimate default and claim rates than loans in
PMI's traditional book. We expect the default rate on PMI's entire primary
insurance portfolio to increase in 2002 due to forecasted increases in
unemployment and the continuing maturation of the portfolio.
Primary default rates differ from region to region in the United States
depending upon economic conditions and cyclical growth patterns. The two tables
below set forth primary default rates by region for the various regions of the
United States and the ten largest states by PMI's risk in force as of.
<TABLE>
<CAPTION>
Primary Default Rates by Region(1)
----------------------------------
As of Period End,
-----------------
2001 2000 1999
---- ---- ----
Region Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
- ------ ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Pacific(2) ...................2.67 2.49 2.09 2.16% 2.13% 2.01% 2.03% 2.19% 2.31% 2.31% 2.28% 2.64%
New England(3)................1.50 1.81 1.45 1.66 1.69 1.52 1.44 1.61 1.88 1.51 1.55 1.69
Northeast(4)..................3.07 2.87 2.42 2.72 2.64 2.37 2.37 2.53 2.64 2.62 2.54 2.87
South Central(5)..............2.75 2.43 2.00 1.98 2.01 1.75 1.65 1.73 1.81 1.74 1.64 1.78
Mid-Atlantic(6)...............2.50 2.26 1.97 2.17 2.09 2.01 1.97 2.07 2.11 2.17 2.04 2.21
Great Lakes(7)................3.47 3.06 2.52 2.31 2.45 2.02 1.94 1.78 1.95 1.91 1.85 1.91
Southeast(8)..................3.09 2.75 2.25 2.47 2.47 2.21 2.13 2.21 2.31 2.18 2.02 2.25
North Central(9)..............2.76 2.42 1.94 2.05 1.97 1.79 1.71 1.69 1.67 1.70 1.67 1.88
Plains(10)....................2.67 2.46 2.00 1.89 1.80 1.73 1.68 1.67 1.65 1.78 1.59 1.76
Total Portfolio...........2.86 2.57 2.12 2.22 2.21 1.99 1.93 2.01 2.12 2.07 1.99 2.22
</TABLE>
- ----------
(1) Default rates are shown by region on location of the underlying property.
(2) Includes California, Hawaii, Nevada, Oregon and Washington.
(3) Includes Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island and
Vermont.
(4) Includes New Jersey, New York and Pennsylvania.
(5) Includes Alaska, Arizona, Colorado, Louisiana, New Mexico, Oklahoma, Texas
and Utah.
(6) Includes Delaware, Maryland, Virginia, Washington, D.C. and West Virginia.
(7) Includes Indiana, Kentucky, Michigan and Ohio.
(8) Includes Alabama, Arkansas, Florida, Georgia, Mississippi, North Carolina,
South Carolina and Tennessee.
(9) Includes Illinois, Minnesota, Missouri and Wisconsin.
(10) Includes Idaho, Iowa, Kansas, Montana, Nebraska, North Dakota, South Dakota
and Wyoming.
23
<PAGE>
<TABLE>
<CAPTION>
PMI's Default Rates for Top 10 States by
Primary Risk in Force(1)
------------------------
Percent
Of PMI's Default
Primary Risk in Rate
Force as of As of
December 31, December 31,
--------------- ------------
2001 2001 2000 1999 1998 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
California ............... 12.5% 2.56% 2.26% 2.59% 3.15% 3.73%
Florida .................. 8.5 3.03 2.91 3.00 3.08 2.93
Texas .................... 6.8 2.86 2.13 2.06 2.18 2.25
Illinois ................. 4.9 3.16 2.34 2.01 2.35 2.56
Washington ............... 4.4 2.72 1.75 1.62 1.58 1.66
New York ................. 4.7 3.22 2.94 2.85 2.98 2.94
Pennsylvania ............. 3.6 3.11 2.47 2.38 2.64 2.38
Georgia .................. 3.8 3.11 2.31 1.95 2.01 1.87
Virginia ................. 2.9 1.87 1.43 1.42 1.55 1.67
Massachusetts ............ 2.5 2.04 1.66 1.49 1.67 1.67
Total Portfolio .......... 2.86 2.21 2.12 2.31 2.38
</TABLE>
- --------------
(1) Top ten states as determined by primary risk in force as of December 31,
2001. Default rates are shown by states based on location of the underlying
property.
Claim activity is not spread evenly throughout the coverage period of a primary
book of business. Based on PMI's experience, the majority of claims on
traditional primary loans occur in the third through sixth years after loan
origination, and relatively few claims are paid during the first two years after
loan origination. Primary insurance written from the period of January 1, 1996
through December 31, 1999 represented 34% of PMI's primary insurance in force at
December 31, 2001. This portion of PMI's book of business is in its expected
peak claim period with respect to traditional primary loans. (We believe that
loans in PMI's non-traditional primary book will have earlier incidences of
default than loans in PMI's traditional book. Non-traditional loans represented
15% of PMI's primary insurance in force at December 31, 2001, and 9% and 7% at
December 31, 2000 and 1999, respectively.) The following table sets forth the
dispersion of PMI's primary insurance in force and risk in force as of December
31, 2001, by year of policy origination and average annual mortgage interest
rate since PMI began operations in 1972.
<TABLE>
<CAPTION>
Insurance and Risk in Force by Policy Year
and Average Coupon Rate
-----------------------
Average Primary Percent Primary Percent
Policy Year Rate(1) Insurance in Force of Total Risk in Force of Total
- ----------- ------- ------------------ --------- ------------- --------
(In thousands) (In thousands)
<S> <C> <C> <C> <C> <C>
1972-1992................. 9.3% $ 2,615,139 2.4% $ 531,165 2.1%
1993...................... 7.3 3,632,710 3.3 738,210 2.9
1994...................... 8.4 2,629,919 2.4 565,120 2.2
1995...................... 7.9 2,251,172 2.1 593,615 2.3
1996...................... 7.8 3,525,997 3.2 946,531 3.7
1997...................... 7.6 4,122,341 3.8 1,099,208 4.3
1998...................... 6.9 13,256,673 12.1 3,369,698 13.1
1999...................... 7.4 16,544,382 15.2 4,144,761 16.1
2000...................... 8.1 15,815,895 14.5 3,695,786 14.3
2001...................... 7.0 44,763,453 41.0 10,087,763 39.1
------------ ----- ----------- -----
Total Portfolio........... $109,157,681 100.0% $25,771,857 100.0%
============ ===== =========== =====
</TABLE>
(1) Average annual mortgage interest rate derived from Freddie Mac and Mortgage
Bankers Association data.
24
<PAGE>
Claims and Policy Servicing
Direct primary claims paid by PMI in 2001 increased to $76.9 million from $66.7
million in 2000. GSE Pool claims paid by PMI in 2001 increased to approximately
$5.4 million from approximately $1.5 million in 2000.
The frequency of defaults does not directly correlate to the number of claims
PMI receives. This is because the rate at which defaults cure is influenced by
borrowers' financial resources and circumstances and regional economic
differences. Whether an uncured default leads to a claim principally depends on
the borrower's equity at the time of default and the borrower's or the insured's
ability to sell the home for an amount sufficient to satisfy all amounts due
under the mortgage loan. When the chance of a defaulted loan reinstating is
minimal, PMI works with the servicer of the loan for possible loan workout or
early disposal of the underlying property. Property dispositions typically
result in savings to PMI over the percentage coverage amount payable under the
master policy.
Under the terms of PMI's primary master policy, the insured is required to file
a claim with PMI no later than 60 days after it has acquired title to the
underlying property, usually through foreclosure. An insurance "claim amount"
includes:
. the amount of unpaid principal due under the loan;
. the amount of accumulated delinquent interest due on the loan,
excluding late charges, to the lesser of the date of claim filing or
sixty days following the acquisition of title to the underlying
property;
. certain expenses advanced by the insured such as hazard insurance
premiums, property preservation expenses and property taxes to the
date of claim filing; and
. certain foreclosure costs, including attorneys' fees.
The claim amount is subject to review and possible adjustment by PMI. Depending
on the applicable state foreclosure law, an average of about 12 months elapses
from the date of default to filing of a claim on an uncured default. PMI's
master policy excludes coverage for physical damage whether caused by fire,
earthquake or other hazard where the borrower's default was caused by an
uninsured casualty.
PMI has the right to rescind coverage and not pay a claim if the insured, its
agents or the borrower misrepresent material information in the insurance
application. According to industry practice, a misrepresentation is generally
considered material if the insurer would not have agreed to insure the loan had
the true facts been known at the time of certificate issuance.
Within 60 days after a claim and supporting documentation have been filed, PMI
has the option of:
. paying the coverage percentage specified in the certificate of
insurance multiplied by the claim amount;
. in the event the property is sold pursuant to an arrangement made
prior to or during the 60-day period after the claim is filed, which
we refer to as a prearranged sale, paying the lesser of (1) 100% of
the claim amount less the proceeds of sale of the property or (2) the
coverage percentage multiplied by the claim amount; or
. paying 100% of the claim amount in exchange for the insured's
conveyance to PMI of good and marketable title to the property, with
PMI then selling the property for its own account. Properties acquired
under this option are included on PMI's balance sheet in other assets
as residential properties from claim settlements, also known as REO.
25
<PAGE>
PMI attempts to choose the claim settlement option which best mitigates the
amount of its claim payment. However, PMI generally settles by paying the
coverage percentage multiplied by the claim amount. In 2001 and 2000, PMI
settled 21% and 27%, respectively, of the primary claims processed for payment
on the basis of a prearranged sale. In both 2001 and 2000, PMI exercised the
option to acquire the property on approximately 12% of the primary claims
processed for payment. At December 31, 2001, PMI owned $31.1 million and at
December 31, 2000 PMI owned $26.8 million of REO valued at the lower of cost or
estimated realizable value. This increase resulted primarily from increases in
the number and value of REO.
The ratio of the claim paid to the original risk in force relating to such loan
is referred to as "claim severity" and is a factor that influences PMI's losses.
The main determinants of claim severity are the age of the mortgage loan, the
value of the underlying property, accrued interest on the loan, expenses
advanced by the insured and the foreclosure expenses. These amounts depend in
part on the time required to complete foreclosure, which varies depending on
state laws. Pre-foreclosure sales and other early workout efforts help to reduce
overall severity. The average primary claim severity level has decreased from
100% in 1994 to 76% in 2001. PMI's primary claim severity level in 2000 was 72%.
Technology for Claims and Policy Servicing
Technology is an integral part of the claims and policy servicing process and
PMI believes that technology will continue to take on a greater role in
increasing internal efficiencies, mitigating losses and improving customer
service. With increasing frequency, PMI's customers expect PMI to offer them
technological solutions with respect to claims submission, claim payment and
policy servicing.
Defaults and Claims. PMI, through its automatic default reporting process, or
ADR, allows paperless reporting of default information by the insured. PMI uses
an automated claim-for-loss worksheet program that compiles pertinent data while
automatically calculating the claim amount and predicting the best settlement
alternative. To enhance efficiencies and ease of use for its customers, PMI
developed Document Free ClaimEaseSM, which is designed to require only an
addendum to the uniform claim-for-loss worksheet, thereby reducing paperwork and
resulting in more rapid claims settlements. PMI offers customers the option of
receiving claim payments by direct deposit to their bank accounts rather than by
check. To contain costs and expand internal efficiencies, PMI uses optical
imaging in its claims functions allowing PMI to eliminate the transfer and
storage of documents relating to claims.
Policy Servicing. PMI has developed several technology tools with respect to
policy servicing and claims. Introduced in 2001, e-PMI ServicingSM provides
access to PMI's servicing database via the Internet, allowing customers and
servicers to initiate policy coverage and servicing transfers, notify PMI of
defaults, file primary insurance claims, and verify premium, payment and refund
information. In addition, PMI offers pmiPHONE-CONNECT, a voice response
application that enables the insured to access PMI's database via telephone to
initiate policy coverage, inquire on the status of coverage, and to obtain
information on billing, refunds and renewals. Similar inquiries and exchanges of
information between customers and PMI are available via EDI.
Loan Performance
The table below shows cumulative losses paid by PMI at the end of each
successive year after the year of original policy issuance ("policy year"),
expressed as a percentage of the cumulative premiums written on such policies.
26
<PAGE>
Years Percentage of Cumulative Losses Paid
Since To Cumulative Premiums Written
Policy
Issue Policy Issue Year (Loan Closing Year)
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 0.4 0.4 0.9 0.3 0.2 -- 0.1 0.0 -- -- --
2 11.8 23.3 38.1 14.8 9.8 4.5 1.5 0.4 0.1 0.3 0.7
3 39.2 90.4 112.1 47.3 44.0 18.7 5.2 2.0 2.0 3.6 7.1
4 74.2 139.3 166.3 83.0 83.1 35.2 8.7 5.1 6.1 10.8 17.8
5 95.5 168.3 180.9 129.3 114.3 47.4 12.2 9.7 11.6 21.9 31.7
6 100.8 168.0 229.6 165.9 127.1 56.4 15.6 13.1 18.5 32.4 41.8
7 90.8 184.8 251.0 177.5 135.9 60.7 18.5 17.5 23.1 40.3 50.5
8 98.5 197.3 265.4 184.6 139.3 63.0 21.3 20.7 26.2 45.7 56.2
9 107.8 203.6 265.7 187.7 141.9 65.0 24.1 23.0 29.1 49.6 59.2
10 111.4 205.6 264.4 189.8 142.6 65.3 25.8 25.1 31.5 51.7 60.9
11 113.0 207.1 263.8 191.0 142.9 65.9 27.4 26.5 33.6 52.8 61.4
12 114.1 208.8 264.4 191.3 142.6 65.8 28.4 27.8 34.6 53.1 61.4
13 114.6 208.9 263.3 191.1 142.1 65.8 28.8 28.4 35.0 53.3
14 115.0 209.8 262.2 190.6 141.7 65.9 29.0 28.6 35.2
15 115.1 209.5 261.5 190.1 141.5 66.0 29.1 28.5
16 115.3 209.2 260.8 189.8 141.3 66.0 29.1
17 115.5 208.9 260.4 189.5 141.0 66.0
18 115.5 208.5 259.8 189.5 140.9
19 115.5 208.1 259.6 189.5
20 115.4 208.1 259.6
21 115.4 208.0
22 115.3
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 -- -- -- -- 0.1 0.0 0.0 -- 0.1 1.2 1.1
2 0.8 1.1 1.0 1.0 2.8 2.9 2.3 1.2 2.7 10.2
3 6.6 6.9 5.5 6.5 10.4 8.3 5.8 3.8 5.9
4 16.9 16.3 13.4 13.7 15.4 11.9 8.7 5.7
5 28.9 28.3 18.7 18.0 18.2 14.2 10.4
6 39.8 36.1 21.1 20.1 19.2 15.3
7 47.4 40.3 21.9 20.9 20.1
8 51.3 41.5 22.0 21.3
9 52.7 41.3 21.8
10 52.6 41.1
11 52.7
</TABLE>
The above table shows that, measured by cumulative losses paid relative to
cumulative premiums written ("cumulative loss payment ratios"), the performance
of policies originally issued in the years 1980 through 1984 was adverse, with
cumulative loss payment ratios for those years ranging from 115.3% to 259.6% at
the end of 2001. Such adverse experience was significantly impacted by
deteriorating economic and real estate market conditions in the "Oil Patch"
states. In 1985, PMI adopted substantially more conservative underwriting
standards that, along with increased premium rates and generally improving
economic
27
<PAGE>
conditions, are believed by us to have contributed to the lower cumulative loss
payment ratios in subsequent years.
The table also shows the general improvement in PMI's cumulative loss payment
ratios since policy year 1982. This reflects both improved claims experience for
the more recent years and the higher premium rates charged by PMI beginning in
1985. Policy years 1986 through 1988 generally have had the best cumulative loss
payment ratios of any years since 1980. Policy years 1989 through 1992 displayed
somewhat higher loss payment ratios than 1986 through 1988 at the same age of
development. This was due primarily to the increased refinancings of mortgages
originating in policy years 1989 to 1992 which resulted in reduced aggregate
premiums and led to higher default rates on California loans. For policy years
1993 through 1999, cumulative losses have been developing at a favorable rate
for PMI due to improving economic conditions.
In 2000 and 2001, PMI expanded its product offerings to include insurance for
non-traditional loans. Non-traditional loans generally have shorter lives and
earlier incidences of default than traditional "A quality" loans. These earlier
incidences of default have resulted in a larger than normal number of claims
already paid in calendar years 2000 and 2001 on loans insured during those
years. Claim payments, when divided by the relatively small amount of written
premium on loans insured, have resulted in a cumulative claim payment ratio for
the 2000 policy year of 10.2% at December 31, 2001. This ratio represents 784
policies issued in 2000 upon which claims were paid in 2000 and 2001.
Loss Reserves
A significant period of time may elapse between the occurrence of the borrower's
default on mortgage payments (the event triggering a potential future claims
payment), the reporting of such default to PMI and the eventual payment of the
claim related to such uncured default. To recognize the liability for unpaid
losses related to the default inventory PMI, in accordance with industry
practice, establishes loss reserves in respect of defaults included in such
inventory, based upon the estimated claim rate and estimated average claim
amount. Included in loss reserves are loss adjustment expense ("LAE") reserves,
and incurred but not reported ("IBNR") reserves. These reserves are estimates
and there can be no assurance that PMI's reserves will prove to be adequate to
cover ultimate loss developments on reported defaults. Consistent with industry
accounting practices, PMI does not establish loss reserves in respect of
estimated potential defaults that may occur in the future.
PMI's reserving process for primary insurance is based on default notifications
received by PMI in a given year (the "report year method"). In the report year
method, ultimate claim rates and average claim amounts selected for each report
year are estimated based on past experience. Claim rates and amounts are also
estimated by region for the most recent report years to validate nationwide
report year estimates that are then used in the normal reserving methodology.
For each report year the claim rate, estimated average claim amount and the
number of reported defaults are multiplied together to determine the amount of
direct incurred losses for that report year. Losses paid to date for that report
year are subtracted from the estimated report year incurred losses to obtain the
loss reserve for that report year. The sum of the reserves for all report years
yields the total loss reserve on reported defaults.
Pool business loss reserving is subject to the same assumptions and economic
uncertainties as primary insurance and generally involves the following process.
PMI divides all currently pending pool insurance delinquencies into six
categories of delinquency, which connote progressively more serious stages of
default (e.g., delinquent less than four months, delinquent more than four
months, in foreclosure but no sale date set). A claim rate is selected for each
category based on past experience and management judgment. Expected claim sizes,
stated as a percentage of the outstanding loan balance on the delinquent loan,
are
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similarly selected. The loss reserve is then generally calculated as the sum
over all delinquent loans of the product of the outstanding loan balance, the
claim rate and the expected claim size percentage.
PMI reviews its claim rate and claim amount assumptions on at least a quarterly
basis and adjusts its loss reserves accordingly. The impact of inflation is not
explicitly isolated from other factors influencing the reserve estimates
although inflation is implicitly included in the estimates. PMI does not
discount its loss reserves for financial reporting purposes.
PMI's reserving process is based upon the assumption that past experience,
adjusted for the anticipated effect of current economic conditions and projected
future economic trends, provides a reasonable basis for estimating future
events. However, estimation of loss reserves is a highly subjective process
especially in light of changing economic conditions. In addition, economic
conditions that have affected the development of the loss reserves in the past
may not necessarily affect development patterns in the future.
PMI's Actuarial Services department performs the loss reserve analysis. On the
basis of such loss reserve analysis, we believe that the loss reserves are, in
the aggregate, computed in accordance with commonly accepted loss reserving
standards and principles and meet the requirements of the insurance laws and
regulations to which it is subject. We also believe that the loss reserves are a
reasonable provision for all unpaid loss and LAE obligations under the terms of
its policies and agreements.
Such reserves are necessarily based on estimates and the ultimate net cost may
vary from such estimates. These estimates of ultimate losses are 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. These estimates are regularly reviewed and updated using
the most current information available. Any resulting adjustments are reflected
in current financial statements. (For a reconciliation of the beginning and
ending reserve for losses and loss adjustment expenses, see Part II, Item 8.
Financial Statements Note 5 - Loss Reserves.)
9. Reinsurance
The use of reinsurance as a source of capital and as a risk management tool is
well established within the mortgage insurance industry. Reinsurance does not
discharge PMI, as the primary insurer, from liability to a policyholder. The
reinsurer simply agrees to indemnify PMI for the reinsurer's share of losses
incurred under a reinsurance agreement, unlike an assumption arrangement, where
the assuming reinsurer's liability to the policyholder is substituted for that
of PMI's.
Effective August 20, 1999, PMI entered into an excess-of-loss reinsurance treaty
relating to aggregate stop loss limit pool insurance contracts issued by PMI
during 1997 and 1998. The participating reinsurers have claims-paying ratings of
AA or AAA from Standard and Poor's. PMI also has a 5% quota share reinsurance
agreement in place with a participating reinsurer relating to primary business
written by PMI during 1993-1997. Under the terms of this arrangement, the
reinsurer indemnifies PMI for 5% of all losses paid under the reinsured primary
business to which it cedes 5% of the related premiums less a ceding commission.
Effective January 1, 2001, PMI commenced reinsuring its wholly owned Australia
subsidiary, PMI Mortgage Insurance Ltd, on an excess-of-loss basis. Under the
terms of the agreement, for each of the 2001-2005 calendar years, PMI is
obligated to indemnify PMI Mortgage Insurance Ltd for losses that exceed 130% of
PMI Mortgage Insurance Ltd's net earned premiums for each year, but not losses
that exceed 220% of such net earned premiums.
Certain states limit the amount of risk a mortgage insurer may retain to 25% of
the indebtedness to the insured and, as a result, the deep coverage portion of
such insurance over 25% must be reinsured. To
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minimize reliance on third party reinsurers and to permit PMI and CMG to retain
the premiums (and related risk) on deep coverage business, The PMI Group formed
several wholly owned subsidiaries including Residential Guaranty Co., or RGC,
Residential Insurance Co., or RIC, PMI Mortgage Guaranty Co., or PMG, and,
together with CMIC (CMG's co-owner), CMG Re to provide reinsurance of such deep
coverage to PMI and CMG. PMI and CMG use reinsurance provided by its reinsurance
subsidiaries solely for purposes of compliance with statutory coverage limits.
The PMI Group's reinsurance subsidiaries generally have the ability to write
direct mortgage insurance and to provide reinsurance to unaffiliated mortgage
insurers.
In 1997, PMI began offering GSE pool insurance to select lenders and
aggregators. In connection with the pool policies issued, PMI may only retain
25% of the risk covered by such policies. PMI reinsures the remaining risk
though RGC, PMG and RIC.
In addition, in 1999, PMI acquired Pinebrook Mortgage Insurance Company, or
Pinebrook, from Allstate Insurance Company. Pinebrook's sole business at the
present time is to provide excess-of-loss coverage to PMI on certain pool
insurance policies issued by PMI during the early 1990s.
As discussed in Section B.1, Products, above, PMI also reinsures portions of its
risk written on loans originated by certain lenders with captive reinsurance
companies affiliated with such lenders.
10. Regulation
State Regulation
General. Our insurance subsidiaries are subject to comprehensive, detailed
regulation intended for the protection of policyholders, rather than for the
benefit of investors, by the insurance departments of the various states in
which they are licensed to transact business. Although their scope varies, state
insurance laws generally grant broad powers to supervisory agencies or officials
to examine companies and to enforce rules or exercise discretion touching almost
every significant aspect of the insurance business. These include the licensing
of companies to transact business and varying degrees of scrutiny of and control
over claims handling practices, reinsurance arrangements, premium rates, the
forms and policies offered to customers, financial statements, periodic
financial reporting, permissible investments and adherence to financial
standards relating to statutory surplus, dividends and other criteria of
solvency intended to assure the performance of contractual obligations to
policyholders.
Mortgage insurers are generally restricted by state insurance laws and
regulations to writing mortgage insurance business only. This restriction
prohibits our mortgage insurance subsidiaries from directly writing other types
of insurance. The non-insurance subsidiaries of The PMI Group are not subject to
regulation under state insurance laws except with respect to transactions with
their insurance affiliates.
Insurance Holding Company Regulation. All states have enacted legislation that
requires each insurance company in a holding company system to register with the
insurance regulatory authority of its state of domicile and to furnish to such
regulatory authority financial and other information concerning the operations
of, and the interrelationships and transactions among, companies within the
holding company system that may materially affect the operations, management or
financial condition of the insurers within the system. The states also regulate
transactions between insurance companies and their parents and affiliates.
Generally, such regulations require that all transactions within a holding
company system between an insurer and its affiliates be fair and reasonable and
that the insurer's statutory policyholders' surplus following any transaction
with an affiliate be both reasonable in relation to its outstanding liabilities
and adequate to its needs.
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The PMI Group is treated as an insurance holding company under the laws of the
State of Arizona based on its ownership and affiliation with PMI, PMG, RGC and
RIC ("Arizona Insurers"). The Arizona insurance laws regulate, among other
things, certain transactions in our common stock and certain transactions
between The PMI Group and its Arizona Insurers, or any one of them with each
other or with any other affiliate. Specifically, no person may, directly or
indirectly, offer to acquire or acquire beneficial ownership of more than 10% of
the voting securities of The PMI Group or any one of the Arizona Insurers unless
such person files a statement and other documents with the Arizona Director of
Insurance and obtains the Director's prior approval after a public hearing is
held on the matter. In addition, material transactions between The PMI Group,
PMI, PMG, RGC and RIC and their affiliates are subject to certain conditions,
including that they be "fair and reasonable." These restrictions generally apply
to all persons controlling or under common control with PMI or PMG, RGC and RIC.
"Control" is presumed to exist if 10% or more of PMI's or PMG's, RGC's and RIC's
voting securities is owned or controlled, directly or indirectly, by a person,
although the Arizona Director of Insurance may find that "control" in fact does
or does not exist where a person owns or controls either a lesser or greater
amount of securities. In addition, Arizona law requires that the Arizona
Director of Insurance be given 30-day prior notice of most types of agreements
and transactions between an insurance company and any affiliate, including, but
not limited to, investments, loans, sales, purchases, exchanges, guarantees,
reinsurance agreements, and management/cost allocation/service agreements, and
the Director is authorized to deny any transactions that do not meet applicable
standards of fairness and soundness.
The Insurance Holding Company laws and regulations are substantially similar in
Florida (where APTIC is domiciled), Illinois (where Pinebrook is domiciled) and
Wisconsin (where CMG, CMG Re, CMGA, CLIC and WMAC Credit are domiciled), and
transactions among these subsidiaries, or any one of them and another affiliate
(including The PMI Group) are subject to regulatory review and approval in the
respective state of domicile. Under Florida law, however, regulatory approval
must be obtained prior to the acquisition, directly or indirectly, of 5% or more
of the voting securities of APTIC or The PMI Group (compared to 10% in Arizona).
The applicable requirements of Wisconsin law are similar to those of Arizona law
regulating insurance holding companies. Similarly, Pinebrook, an
Illinois-domiciled insurer is subject to that state's holding company laws,
which are substantially similar to Arizona's. For purposes of Arizona, Florida,
Illinois and Wisconsin law, "control" means the power to direct or cause the
direction of the management of an insurer, whether through the ownership of
voting securities, by contract or otherwise, subject to certain exceptions.
Reserves. PMI, RGC, PMG and RIC are required under the insurance laws of Arizona
and many other states, including New York and California, to establish a special
contingency reserve with annual additions of amounts equal to 50% of premiums
earned. Pinebrook is subject to the same requirement under Illinois law, as are
CMG, CMG Re, CMGA, CLIC and WMAC Credit under Wisconsin law. The insurance laws
of the various states, including Florida, impose additional reserve requirements
applicable to title insurers such as APTIC. For example, title insurers must
maintain, in addition to reserves for outstanding losses, an unearned premium
reserve computed according to statute, and are subject to limitations with
respect to the level of risk they can assume on any one contract. At December
31, 2001, PMI had statutory policyholders' surplus of $190.8 million and
statutory contingency reserve of $1.7 billion.
Dividends. PMI's ability to pay shareholder dividends is limited, among other
things, by the insurance laws of Arizona and other states. (Although none of the
other Arizona insurers have ever paid shareholder dividends, they are subject to
the same statutory limitations as PMI.) Under Arizona law, PMI may pay dividends
out of available surplus without prior approval of the Arizona Insurance
Director, as long as such dividends during any 12-month period do not exceed the
lesser of (i) 10% of policyholders' surplus as of the preceding calendar year
end, or (ii) the preceding calendar year's investment income. In accordance with
the foregoing, PMI is permitted to pay ordinary dividends (as such are termed
under the Arizona statute) to The PMI Group of $19.7 million in 2002 without
prior approval of the Arizona Director. Any
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dividend in excess of this amount (either alone or together with other
dividends/distributions made in the last 12 months) is an extraordinary dividend
and requires the prior approval of the Arizona Director. In 2001, PMI paid
shareholder dividends to The PMI Group of $50 million, which was paid in two $25
million installments in October and December. These amounts would be added to
any proposed dividends to be paid within the subsequent twelve months to
determine if such future dividends were "extraordinary" and, as such, would
require the Director's prior approval. The Director may approve of an
extraordinary dividend if he or she finds that, following the distribution, the
insurer's policyholders' surplus is reasonable in relation to its liabilities
and adequate to its financial needs. The Director is also required to approve a
return of capital from PMI's contributed capital.
In addition to Arizona, other states may limit or restrict PMI's ability to pay
shareholder dividends. For example, California, New York and Illinois prohibit
mortgage insurers from declaring dividends except from undivided profits
remaining on hand over and above the aggregate of their paid-in capital, paid-in
surplus and contingency reserves.
CMG faces shareholder dividends/distributions restrictions under Wisconsin laws
similar to those faced by PMI in Arizona. CMG, like PMI, is also subject to
other state laws restricting or limiting a mortgage insurer's ability to declare
or pay shareholder dividends, including California, Illinois and New York. CMG
Re and CMGA in Wisconsin and Pinebrook in Illinois are subject to substantially
similar requirements and limitations on shareholder dividends, but none of these
entities has paid a shareholder dividend or expects to do so in the near future.
PMI acquired CLIC and WMAC Credit in August of 2001 from WMAC Investment Corp.,
an affiliate of Leucadia National Corporation. Although these Wisconsin
domiciled insurers paid extraordinary dividends under their prior ownership, PMI
does not expect them to declare or pay shareholder dividends in the immediate
future. (Our title insurance company, American Pioneer Title Insurance Co., also
faces shareholder dividend/distributions restrictions. These and other
regulatory restrictions are discussed in Item 1.C.2, Title Insurance.)
In addition to the dividend restrictions described above, insurance regulatory
authorities have broad discretion to limit the payment of dividends by insurance
companies. For example, if insurance regulators determine that payment of a
dividend or any other payments to an affiliate (such as payments under a tax
sharing agreement, payments for employee or other services, or payments pursuant
to a surplus note) would, because of the financial condition of the paying
insurance company or otherwise, be hazardous to such insurance company's
policyholders or creditors, the regulators may block payments that would
otherwise be permitted without prior approval.
Premium Rates and Policy Forms. PMI and CMG's premium rates and policy forms are
subject to regulation in every state in which each is licensed to transact
business in order to protect policyholders both against the adverse effects of
excessive, inadequate or unfairly discriminatory rates and to encourage
competition in the insurance marketplace. In most states premium rates and
policy forms must be filed prior to their use. In some states, such rates and
forms must also be approved prior to use. Changes in premium rates are subject
to being justified, generally on the basis of the insurer's loss experience,
expenses and future trend analysis. The general default experience in the
mortgage insurance industry may also be considered.
Reinsurance. Regulation of reinsurance varies by state. Except for Arizona,
Illinois, Wisconsin, New York and California, most states have no special
restrictions on mortgage guaranty reinsurance other than standard reinsurance
requirements applicable to property and casualty insurance companies. Certain
restrictions apply under Arizona law to domestic companies and under the laws of
several other states to any licensed company ceding business to unlicensed or
unaccredited reinsurers. Under such laws, if a reinsurer is not admitted or
accredited in such states, the domestic company ceding business to the reinsurer
(e.g., PMI) cannot take credit in its statutory financial statements for the
risk ceded to such reinsurer absent
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compliance with certain reinsurance security requirements. Arizona prohibits
reinsurance unless the reinsurance arrangements meet certain requirements even
if no statutory financial statement credit is to be taken. In addition, Arizona
and several other states limit the amount of risk a mortgage insurer may retain
with respect to coverage of an insured loan to 25% of the entire indebtedness to
the insured. Coverage in excess of 25% must be reinsured.
Examination. PMI, PMG, RGC, RIC, APTIC, CMG, CMG Re, CMGA, CLIC, WMAC Credit and
Pinebrook are subject to examination of their affairs by the insurance
departments of each of the states in which they are licensed to transact
business. The Arizona Director of Insurance periodically conducts a financial
examination of insurance companies domiciled in Arizona. In lieu of examining a
foreign insurer, the Commissioner may accept an examination report by a state
that has been accredited by the National Association of Insurance Commissioners.
Likewise, the Insurance Departments of Florida, Illinois and Wisconsin perform
periodic financial and market conduct examinations of insurers domiciled in
their jurisdictions.
Federal Laws and Regulation
In addition to federal laws that directly affect mortgage insurers, private
mortgage insurers including PMI are impacted indirectly by federal legislation
and regulation affecting mortgage originators and lenders; by purchasers of
mortgage loans such as Freddie Mac and Fannie Mae; and by governmental insurers
such as the FHA and VA. For example, changes in federal housing legislation and
other laws and regulations that affect the demand for private mortgage insurance
may have a materially adverse effect on PMI. Legislation that increases the
number of persons eligible for FHA or VA mortgages could have a materially
adverse effect on our ability to compete with the FHA or VA.
The Homeowners Protection Act, effective 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 Homeowners
Protection Act applies to owner-occupied residential mortgage loans regardless
of lien priority and to borrower-paid mortgage insurance closed after the
effective date of the Act. FHA loans are not covered by the Homeowners
Protection Act. Under the Homeowners Protection Act, automatic termination of
mortgage insurance would generally occur once the loan-to-value ratio, or 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" as defined by the Act.
The Real Estate Settlement and Procedures Act of 1974, or RESPA, applies to most
residential mortgages insured by PMI and related regulations provide that
mortgage insurance is a "settlement service" for purposes of loans subject to
RESPA. Subject to limited exceptions, RESPA prohibits persons from accepting
anything of value for referring real estate settlement services to any provider
of such services. Although many states including Arizona prohibit mortgage
insurers from giving rebates, RESPA has been interpreted to cover many non-fee
services as well. The recently renewed interest of HUD in pursuing violations of
RESPA has increased awareness of both mortgage insurers and their customers of
the possible sanctions of this law.
Home Mortgage Disclosure Act. Most originators of mortgage loans are required to
collect and report data relating to a mortgage loan applicant's race,
nationality, gender, marital status and census tract to HUD or the Federal
Reserve under the Home Mortgage Disclosure Act of 1975, or HMDA. The purpose of
HMDA is to detect possible discrimination in home lending and, through
disclosure, to discourage such discrimination. Mortgage insurers are not
required pursuant to any law or regulation to report HMDA data although, under
the laws of several states, mortgage insurers are currently prohibited from
discriminating
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on the basis of certain classifications. Mortgage insurers have, through their
trade association Mortgage Insurance Companies of America, or MICA, entered
voluntarily into an agreement with the Federal Financial Institutions
Examinations Council, or MFIEC, to report the same data on loans submitted for
insurance as is required for most mortgage lenders under HMDA.
Mortgage lenders are subject to various laws, including HMDA, RESPA, the
Community Reinvestment Act, and the Fair Housing Act. Fannie Mae and Freddie Mac
are also subject to RESPA and various laws, including laws relating to
government sponsored enterprises, which may impose obligations or create
incentives for increased lending to low and moderate income persons or in
targeted areas.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act became effective on March 11,
2000 and allows, among other things, bank holding companies to engage in a
substantially broader range of activities, including insurance underwriting, and
allows insurers and other financial service companies to acquire banks. The
Gramm-Leach-Bliley Act also imposes new consumer information privacy
requirements on financial institutions, including obligations to protect and
safeguard consumers' nonpublic personal information and records, and limitations
on the re-use of such information.
National Association of Insurance Commissioners. The National Association of
Insurance Commissioners, or NAIC, has developed a rating system, the Insurance
Regulatory Information System, or IRIS, primarily intended to assist state
insurance departments in overseeing the statutory financial condition of all
insurance companies operating within their respective states. IRIS consists of
11 key financial ratios, which are intended to indicate unusual fluctuations in
an insurer's statutory financial position and/or operating results. The NAIC
applies its IRIS financial ratios to PMI on a continuing basis in order to
monitor PMI's financial condition.
11. Financial Strength; Ratings
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard &
Poor's, "Aa2" (Excellent) by Moody's and "AA+" (Very Strong) by Fitch. In March
2002, Standard and Poor's affirmed PMI's AA+ rating and stable ratings outlook.
In October 2000, Moody's announced that it changed PMI's and The PMI Group's
ratings outlook from negative to stable and also confirmed its Aa2 financial
strength rating of PMI. In April 2001, Fitch affirmed PMI's AA+ financial
strength rating. In February 2002, Standard & Poor's informed us that it had
completed a new U.S. mortgage insurance stress model as part of its mortgage
insurance rating methodology.
PMI's claims-paying ability ratings from certain national rating agencies have
been based in part on the third party reinsurance arrangements discussed above
and on various capital support commitments from Allstate Insurance Company.
Under the terms of a runoff support agreement with Allstate, in the event (i)
PMI's risk-to-capital ratio exceeds 23 to 1, (ii) PMI's statutory policyholder
surplus is less than $15.0 million, or (iii) a third party beneficiary brings a
claim under the runoff support agreement, then Allstate may, at its option, in
satisfaction of certain obligations it may have under such agreement (A) pay to
PMI (or to The PMI Group for contribution to PMI) an amount equal to claims
relating to policies written prior to termination of the Allstate support
arrangements which are not paid by PMI or (B) pay such claims directly to the
policyholder. In the event Allstate makes any payment contemplated by the runoff
support agreement (which possibility we believe is remote and, in the event
unexpected losses or unforeseen events cause the risk-to-capital ratio to
increase, there are several courses of action available to us to maintain PMI's
risk-to-capital ratio below 23 to 1), Allstate will be entitled to receive, at
its option, subordinated debt or preferred stock of PMI or The PMI Group, as
applicable, in return.
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Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. In order to
be Fannie Mae and Freddie Mac eligible, PMI must maintain an AA- rating with any
public national rating agency.
C. International Operations and Other Residential Lender Services
In keeping with our goal of being a global provider of credit enhancement
products and lender services while achieving profitable growth, our key
strategies include focusing on our core mortgage insurance business while
diversifying and expanding our lines of business and international operations.
Revenues for the year ended December 31, 2001 from our consolidated
subsidiaries, excluding PMI, were approximately 25% of our consolidated revenues
compared with approximately 19% in 2000. The growth in revenue attributed to
these subsidiaries was approximately 64% in 2001. These percentages exclude
revenue from RAM Holdings Ltd. and RAM Holdings II Ltd., or RAM Re, a financial
guaranty reinsurance company based in Bermuda in which The PMI Group owns 45%
interest, and Fairbanks Capital Holding Corporation, or Fairbanks, which offers
mortgage loan servicing to residential lenders. Ram Re and Fairbanks are
accounted for on the equity method in our consolidated financial statements.
They contributed approximately $10.2 million of investment and other income in
2001, compared to $3.5 million in 2000.
1. International Mortgage Insurance
Australia and New Zealand
We offer mortgage insurance in Australia and New Zealand through our indirect,
wholly owned subsidiaries, PMI Mortgage Insurance Ltd ("PMI Ltd") and PMI
Indemnity Limited. PMI Ltd was founded in 1965 and was acquired by PMI in August
1999. PMI Ltd is headquartered in Sydney, Australia, and has offices in
Melbourne, Brisbane, Adelaide, and Perth in Australia and in Auckland, New
Zealand. In September 2001, PMI acquired CGU LMI, now renamed PMI Indemnity
Limited. PMI Indemnity is the fourth largest mortgage insurer in Australia and
the largest in New Zealand. The integration of PMI Indemnity's operations into
PMI Ltd has commenced and this integration is expected to be completed in 2002.
The combined operations of PMI Ltd and PMI Indemnity are referred to as PMI
Australia.
At December 31, 2001, the total assets of PMI Australia were $337.5 million. The
PMI Group does not hedge the foreign exchange exposure in Australia dollars to
US dollars. The average exchange rate was 0.520 in 2001 compared to 0.585 in
2000.
Following PMI's acquisition of PMI Indemnity, the Australian and New Zealand
mortgage insurance markets are served by three mortgage insurance companies: PMI
Australia, Royal Sun Alliance and GE.
Single premiums and 100% coverage characterize Australian mortgage insurance,
known as "lenders mortgage insurance" or "LMI." As in the United States, lenders
usually collect the single premium from the prospective borrowers and remit the
amount to the mortgage insurer. The mortgage insurer in turn invests the
proceeds and reports the single premium in its financial statements over time
according to an actuarially determined multi-year schedule. The premium is
potentially partly refundable if the policy is cancelled within the first year
only.
LMI provides insurance coverage for the unpaid loan balance following the sale
of the security property up to a maximum of 100% of the loan amount.
Historically, losses normally range from 20% to 30% of the original loan amount
on defaulted loans. "Top cover" predominates in New Zealand where the total loss
(including expenses) is paid up to a prescribed percentage of the original loan
amount. Typical top cover in New Zealand is 20% to 30%.
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The majority of the loans insured by PMI Australia are ARM's with loan terms of
between twenty and thirty years. Changes in interest rates impact the frequency
of defaults and claims with respect to these loans. Because of the preponderance
of ARM loans that simultaneously adjust with prevailing market rates, borrowers
have little incentive to refinance their mortgages. Initial period, "teaser" or
"honeymoon" rates represent the only real inducement for borrowers to refinance
their existing mortgage loan with another mortgage lender. In fact, given that
mortgage interest is not tax deductible in Australia or New Zealand, borrowers
have a strong incentive to reduce their principal balance by amortizing or
prepaying their mortgages. These actions commensurately lower loss exposure.
In 2001, PMI Australia launched pmi97, a three percent down payment product, and
pmi100, a no down payment product, utilizing PMI's experience to determine risk
profiles and pricing levels. Also in 2001, the Australian Federal Government
announced an increase in the grant amounts available under the first home owners
grant scheme (FHOGS). This increase provided a significant stimulus to new
housing construction in 2001. In response to this development, PMI Australia
began offering pmiFHOGS, a product to support first-time home buyers who are
eligible for FHOGS grants. The FHOGS initiative and a significant decline in
mortgage interest rates during 2001 contributed to the growth in mortgage
lending and property price appreciation in the major real estate markets in
Australia in 2001.
PMI Australia's applicable regulator is the Australian Prudential Regulatory
Authority ("APRA"), which regulates all financial institutions in Australia
including mortgage insurers. APRA, among other things, sets statutory reserve
levels and regulates the payments of dividends. APRA also sets the capital
requirements for regulated institutions and provides for reduced capital
requirements for depository institutions that insure residential mortgages above
80% LTV with an "A" Standard & Poor's or equivalent rated mortgage insurance
company. In 2001, APRA announced that it will introduce new regulatory standards
for all insurers, effective July 1, 2002. We believe that the new standards will
continue to require that Australian mortgage insurers, including PMI Australia,
be monoline insurers.
The four major Australian banks, Westpac, Commonwealth, Australia New Zealand
Bank and National Australia Bank, collectively provide 60% or more of
Australia's residential housing finance. Other participants in Australian
mortgage lending include regional banks, building societies, credit unions, and
non-bank mortgage originators, called "mortgage managers." Mortgage managers
typically fund their lending activities via the domestic and global capital
markets and mortgage backed securitizations.
Securitization for seasoned mortgages is actively pursued by depository
institutions in Australia. Mortgage insurance is the most frequently used form
of credit enhancement for these bond issues and mortgage insurance is ultimately
placed on all loans (whether high or low LTV) destined for securitization.
Mortgage managers tend to place mortgage insurance on the lower LTV loans at
origination to be assured that each individual loan is an acceptable risk to the
mortgage insurer. Banks generally purchase mortgage insurance on lower LTV loans
immediately prior to securitization. In either case, the coverage follows the
standard 100% coverage, primary insurance. This segment of the residential MBS
market grew in 2001 and PMI Ltd provided credit enhancement with respect to a
number of large MBS transactions in 2001.
A significant portion of PMI Australia's business is acquired through captive
mortgage insurance and reinsurance arrangements with its lending customers.
These captive arrangements typically contain a contractual period under which
the lender commits to send PMI Australia a prescribed volume of business. PMI
Ltd wrote approximately 50% of its new business premium under these arrangements
in 2001.
Generally the captive or reinsurance arrangements operate in one of three ways.
In one arrangement, loans are 100% insured by PMI Australia and then a
proportion of each loan is reinsured on a quota share basis by the lender's
captive insurer. In exchange for this loss risk transfer PMI Australia pays a
negotiated
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premium to the captive. Under another arrangement, a lender's wholly owned
captive writes the insurance risk and cedes a large portion of the risk on a
quota share reinsurance basis to PMI Ltd. In this case, PMI Australia receives a
reinsurance premium from the captive for the risk it assumes. Alternatively,
under a joint venture captive arrangement with PMI Australia, PMI manages and
reinsures the risk of the joint venture captive. In the event that the lender or
PMI Australia wishes to terminate the captive arrangement, PMI Australia
generally has the first right to purchase the lender's equity interest in the
captive.
As of December 31, 2001, PMI Australia's insurance in force totaled
$43.3 billion compared to $20.1 billion at year end 2000. PMI Australia's net
premiums written was $55.9 million in 2001 and $36.8 million in 2000. Reserves
for losses for PMI Australia at December 31, 2001 was $14.4 million compared to
$5.4 million at year end 2000.
Undertakings provided by PMI in 2001 supported an upgrade in PMI Ltd's S&P
rating from AA- to AA, an upgrade by Moody's from an A1 rating to Aa3, and an
affirmation by Fitch of its AA rating. PMI Indemnity is rated AA- by S&P, Aa3 by
Moody's, and AA by Fitch.
Europe
In February 2001, PMI formed PMI Mortgage Insurance Company Limited ("PMI
Europe"), a mortgage insurance and credit enhancement company incorporated and
located in Dublin, Ireland, and an affiliated sales company incorporated in
England and located in London. In May 2001, PMI Europe was fully authorized to
provide credit, suretyship and miscellaneous financial loss insurance by the
Irish Minister for Enterprise Trade & Employment. PMI Europe's claims-paying
ability is rated AA by Standard & Poor's and Fitch and Aa3 by Moody's Investors
Service. These ratings are based upon PMI Europe's initial capitalization, its
management expertise, a capital support agreement provided by PMI, and a
guarantee by The PMI Group of PMI's obligations under the capital support
agreement.
PMI Europe's authorization enables it to offer its products in all of the
European Union member states. The applicable regulator of PMI Europe is the
Minister for Enterprise Trade & Employment. Ireland is a member of the European
Union and applies the harmonized system of regulation set out in the European
Union directives. This system requires all insurance companies to obtain
authorization before conducting business. The criteria for authorization are set
out in the directives. Insurers are only entitled to provide insurance in the
classes for which they have authorization. The regulatory regime requires PMI
Europe to maintain appropriate technical provisions against risks accepted and
an additional solvency margin of unencumbered assets. It must also maintain an
equalization reserve in respect of credit insurance risks. The regulator
requires actuarial certification of the technical provisions and imposes a
solvency margin in excess of the minimum set out in the European Union
Directives. The regulator has broad powers of intervention including the right
(i) to appoint inspectors to an insurer, (ii) to prohibit an insurer from taking
on new business or making investments, (iii) to require an insurer to limit its
premium income, to make a deposit, or to furnish information (iv) to require an
insurer to realize assets or to produce a business plan to put it on a sound
commercial footing and (v) to withdraw an authorization in appropriate
circumstances. Auditors of insurers are obliged to inform the regulator of
certain matters. Irish insurance companies are required to submit comprehensive
annual financial returns to the regulator. Changes in significant shareholdings
(direct or indirect) must be approved in advance.
PMI Europe expects to derive most of its opportunities from the larger, more
mature mortgage markets in Europe, including the United Kingdom, Germany, Spain,
France, Italy, the Netherlands, and Ireland.
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Additional opportunities may arise in the smaller or emerging European markets,
including Sweden, Poland and the Czech Republic.
PMI Europe currently offers capital markets products, stop loss insurance and
primary insurance. Capital markets products are designed to support secondary
market transactions, notably mortgage-backed securities transactions or
synthetic securities transactions (principally "credit default swaps").
Mortgage-backed securities are issued as a tool of capital management or
funding. Lenders typically engage in these transactions to reduce the capital
they must hold pursuant to local banking capital regulations.
In 2001, PMI Europe participated in two credit default swap transactions,
designed to allow the mortgage lenders involved to reduce their amounts of
regulatory capital. In each transaction, PMI Europe assumed a specific layer of
risk in a portfolio of prime-quality, residential mortgages. In the first
transaction, which closed in November 2001, PMI assumed $220 million of mortgage
default risk on $1.5 billion of mortgages on properties located in the
United Kingdom. The risk assumed by PMI Europe in this credit default swap
covers a spectrum rated BBB up to AAA by the three major ratings agencies, S&P,
Moody's and Fitch. In the second transaction, which closed in December 2001, PMI
Europe assumed $31.3 million of mortgage default risk on a $1.2 billion German
residential loan portfolio originated and serviced by one of Europe's largest
mortgage lenders. In the second transaction, PMI Europe guaranteed the AA
tranche of the credit default swap. In each transaction, PMI Europe established
a special purpose vehicle as the direct swap counterparty, with PMI Europe
guaranteeing the obligations of the special purpose vehicle. The special purpose
vehicles were used to meet regulatory requirements and their operations are
reflected in the financial statements of The PMI Group. Competitors in this
product line include U.S. mortgage insurance companies, financial guaranty
insurance companies, banks, and traditional bond investors. Many of these
competitors have significantly greater financial resources than PMI Europe.
PMI Europe also offers stop loss insurance coverage. These products are
typically provided to a lender's captive mortgage insurance company to reduce
that lender's "catastrophic" risk exposure. These transactions are believed to
be risk-remote in that the lender or its captive assumes a significant amount of
first loss risk. This insurance structure is used frequently in the United
Kingdom by its largest mortgage lenders. PMI Europe did not complete any stop
loss insurance/reinsurance transactions in 2001. Potential competitors with
respect to these products include mortgage insurance companies and multi-line
insurers.
PMI Europe's third product line, primary insurance, is similar to the products
offered in the US, Australia and New Zealand. Primary insurance is mortgage
insurance applied to, priced, and settled on each loan. (The coverage does not
typically vary or address any aspects of the total group of loans.) In Europe
today, this product is only purchased regularly in the United Kingdom and
Ireland. PMI Europe is attempting to develop greater interest and use of primary
insurance in other European countries. In 2001, PMI Europe did not write any
primary insurance. Competitors in this area are more limited than for the other
products discussed above. Potential competitors at the moment include mortgage
insurers and multi-line insurers.
Hong Kong
In 1999, PMI opened its Hong Kong branch and entered into a reinsurance
arrangement with the Hong Kong Mortgage Corporation, or HKMC, a public sector
entity created to add liquidity to the Hong Kong residential mortgage market.
The HKMC is a direct insurer of residential mortgages with LTVs of up to 90%.
PMI, among other insurers, provides reinsurance coverage on amounts over 70%
LTV. For the year ended December 31, 2001, PMI reinsured $395.2 million of
loans, as compared to $252.9 million in 2000. In 2001, Centre Solutions
announced an exclusive deal with Standard Chartered Bank, or SCB, to provide a
mortgage insurance product nearly identical to the HKMC's program. Prior to this
announcement, SCB had been the largest lender-participant in the HKMC program,
contributing approximately 25% of the overall business.
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2. Title Insurance
In 1992, we acquired American Pioneer Title Insurance Co. ("APTIC"), a
Florida-based title insurance company, as part of its strategy to provide
additional mortgage-related services to its customers. APTIC is licensed in 46
states and the District of Columbia. A title insurance policy protects the
insured party against losses resulting from title defects, liens and
encumbrances existing as of the effective date of the policy and not
specifically excepted from the policy's coverage.
Based on direct premiums written during 2000, APTIC is ranked 5 among the 27
active title insurers conducting business in the State of Florida. For the year
ended December 31, 2001, 51% of APTIC's premiums earned came from its Florida
operations.
APTIC generates title insurance business through both direct and indirect
marketing to realtors, attorneys and lenders. As a direct marketer, APTIC
operates under the name Chelsea Title Company, a branch network of title
production facilities and real estate closing offices. As an indirect marketer
APTIC recruits and works with corporate title agencies, attorney agencies and
approved attorneys. Its agency business accounted for 96% of APTIC's premiums
earned for the years ended December 31, 2001 and 2000.
While the industry trend in the residential market appears to be towards direct
operations consisting of underwriter owned or controlled entities, APTIC's
operational plan is geared towards developing and cultivating agency
relationships. APTIC has created a suite of computerized software designed to
assist its agents in the areas of real estate settlement, real property
examination and electronic commerce. These products, together with APTIC's
assistance to its policy issuing agents in the areas of underwriting, claims,
audit, and title agency management, create an atmosphere for the development and
continuous cultivation of long term contractual relationships. Title policy
issuing agency relationships are memorialized by written contracts and are
generally long-term in nature without the right of immediate unilateral
termination by either party.
As part of APTIC's risk management program, it has, since 1986, entered into
reinsurance treaties with other insurers covering policies issued. Currently,
APTIC has a reinsurance agreement with ACE Capital Title Reinsurance Company
("ACE") which, in general, provides for automatic reinsurance of title policies
in excess of $1.0 million but not greater than $26.0 million. Policies in excess
of $10.0 million require written consent of ACE. Policies in excess of $26.0
million are reinsured through the use of facultative agreements with ACE and/or
other reinsurers.
APTIC's claims-paying ability is currently rated AA (very high) by Fitch, A" by
Demotech, Inc. and A by LACE. APTIC's claims-paying rating by Fitch is based in
part on a capital support agreement provided by PMI and the reinsurance
agreement discussed in the preceding paragraph.
APTIC is subject to comprehensive regulation in the states in which it is
licensed to transact business. Among other things, such regulation requires
APTIC to adhere to certain financial standards relating to statutory reserves
and other criteria of solvency. Generally, title insurers are restricted to
writing only title insurance, and may not transact any other kind of insurance.
This restriction prohibits APTIC from using its capital and resources in support
of other types of insurance businesses. The insurance laws of the various
states, including Florida, impose reserve requirements on APTIC. For instance,
title insurers such as APTIC must maintain, in addition to reserves for
outstanding losses, an unearned premium reserve computed according to statute
and are subject to limitations with respect to the level of risk they can assume
on any one contract. The laws of Florida, in general, limit the payment of
dividends by APTIC to The PMI Group in any one year to the greater of either 10%
of APTIC's statutory surplus as to policyholders derived from realized net
operating profits on its business and realized net capital gains or
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APTIC's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year. As a result, APTIC may be
limited in its ability to pay dividends to The PMI Group. APTIC made a $2.5
million dividend to The PMI Group in 2001, which was paid in $1 million and $1.5
million installments in April and June. The dividend was not "extraordinary"
under Florida law and did not require the prior approval of the Florida
Insurance Commissioner, although APTIC was required to provide the Commissioner
with ten days advanced notice of each of the dividend installments.
3. Financial Guaranty Reinsurance
We own 24.9% of RAM Re, the first AAA rated financial guaranty reinsurance
company based in Bermuda. RAM Re commenced business in the first quarter of
1998. Three of our executives serve as directors of RAM Re. RAM Re's financial
results are reported in our financial statements under the equity method of
accounting.
4. Mortgage Loan Servicing
We acquired our initial interest in Fairbanks Capital Holdings Corp., or
Fairbanks, in March 2000. Fairbanks, through its wholly owned subsidiary,
acquires and services single-family residential mortgages and specializes in the
resolution of non-performing and under-performing mortgages. As of December 31,
2001, Fairbanks serviced approximately $36 billion in mortgages compared to
approximately $12 billion as of December 31, 2000. This increase primarily was
due to Fairbanks' acquisition of mortgage servicing rights from BA/EquiCredit in
December 2001. In December 2001, we made two additional investments in
Fairbanks, increasing our investment in Fairbanks to $55.8 million and our
ownership interest in Fairbanks to 45.7%. Fairbanks' financial results are
reported in our financial statements under the equity method of accounting.
D. Investment Portfolio
Excluding our investments in unconsolidated affiliates, approximately 88% of our
investment portfolio is managed under The PMI Group and Subsidiaries Investment
Policy Statement, and includes the investment portfolios of The PMI Group and
The PMI Group's subsidiaries. The remaining 22% of our investment portfolio is
managed by APTIC, PMI Australia and PMI Europe under separate investment
policies that are reviewed at least annually by PMI's Treasury personnel. Our
pre-tax income from our total investments (including equity earnings from our
unconsolidated affiliates) represented 16% of our 2001 and 2000 pre-tax
revenues.
The Policy's goal is to attain consistent after tax total returns. Emphasis is
placed on providing a predictable level of income and on the maintenance of
adequate levels of liquidity, safety and preservation of capital; growth is a
secondary consideration. In addition to satisfying state regulatory limits on
the amount that can be invested in any single investment category, e.g., no more
than 20% of assets may be invested in common stocks, a minimum average fixed
income credit quality of "A" rating must be maintained and no single credit risk
may exceed 5% of total investments. At December 31, 2001, based on market value,
approximately 92% of our fixed income investments under the Policy were invested
in securities rated "A" or better, with 59% rated "AAA" and 18% rated "AA," in
each case by at least one nationally recognized securities rating organization.
The balance of the portfolio under the Policy was invested in equity securities.
Under Arizona law, PMI may invest up to 10% of its assets in investments that
are not otherwise expressly authorized, including derivative instruments.
Additionally, PMI is subject to other state regulations regarding investment
activities with which PMI currently comply. Our policy is also to limit our
derivative transactions to currency and interest rate swaps necessary to
minimize revenue fluctuations related to our
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international operations. The Policy is subject to change depending upon state
regulatory, economic and market conditions and our existing or anticipated
financial condition and operating requirements, including our tax position. (PMI
Europe provides credit default protection to various European banks with respect
to residential mortgage loans. These transactions, which are structured as
guarantees of credit derivatives, do not represent, nor are they recorded as,
investment or hedging activities of PMI Europe. Rather, they are central to PMI
Europe's business of providing credit default protection to European mortgage
lenders.)
At December 31, 2001, the market value of our investment portfolio (excluding
investments in affiliates) was approximately $2.4 billion. At December 31, 2001
the amortized cost of our total investment portfolio (excluding investments in
affiliates) was approximately $2.3 billion. At that date, the market value of
the investments under the Policy was approximately $2.1 billion. At December 31,
2001, municipal securities represented 65% of the market value of the
investments under the Policy. Fixed income securities due in less than one year,
within one to five years, within five to ten years; after ten years, and other
represented 5.5%, 26.0%, 16.1%, 52.2% and 0.2%, respectively, of such total
market value.
As of December 31, 2001, APTIC's investment portfolio had a market value of
approximately $41.7 million. APTIC's investment portfolio is managed internally
in accordance with APTIC's investment policies. As of December 31, 2001,
approximately 93% of APTIC's portfolio consisted of bonds rated AA and higher.
PMI Australia's investment portfolio of approximately $288.6 million as of
December 31, 2001 is managed externally in accordance with PMI Australia's
investment policies. As of December 31, 2001 approximately 91% of PMI
Australia's portfolio consisted of bonds rated AA and higher. As of December 31,
2001, PMI Europe's investment portfolio had a market value of approximately
$77.9 million, of which $61.3 million was invested in high grade U.S. dollar
denominated money market funds with the remaining $16.6 million invested in FNMA
Mortgage-backed securities.
E. Employees
As of December 31, 2001, The PMI Group, its wholly-owned subsidiaries and CMG,
had 1,235 full-time and part-time employees, of which 749 persons performed
services primarily for PMI, 136 were employed by PMI Australia, 21 performed
services primarily for CMG, and an additional 329 persons were employed by
APTIC. Our employees are non-union and we consider our employee relations to be
good. In addition, MSC had 737 temporary workers and contract underwriters as of
December 31, 2001.
Item 2. Properties
PMI currently leases its home office in San Francisco, California, which
contains approximately 100,000 square feet of space. The lease expires in 2004.
In December 2000, PMI entered into a contract to purchase a seven-story office
building site in Walnut Creek to serve as its world headquarters. Construction
is underway on the office building and completion of the approximately 195,000
square foot building is scheduled to occur in 2002. PMI also leases space for
its 23 branch offices throughout the United States comprising
approximately 79,750 square feet with lease terms of no more than five years.
During 2000, PMI transferred its operation data center to Rancho Cordova,
California, which consists of approximately 15,000 square feet of office space.
PMI believes its existing properties are well utilized and are suitable and
adequate for its operations.
Item 3. Legal Proceedings
On December 17, 1999, G. Craig Baynham and Linnie Baynham, or Plaintiffs, filed
a putative RESPA class action lawsuit against PMI. This action was filed by
Plaintiffs in the U.S. District Court for the Southern District of Georgia,
Augusta Division, or Court.
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On December 15, 2000, we announced that PMI had entered into an agreement with
Plaintiffs to settle the action. PMI denied all facts and allegations in the
lawsuit that related to Section 8 of the RESPA and related state law claims. A
final order approving the settlement was entered on June 25, 2001. An appeal has
been filed to overturn the Court's decision to not allow certain individuals to
intervene in the case prior to the entry of the final order. If the appeal is
successful, such individuals could have standing to challenge the terms of the
settlement and final order. Our obligation to fund payment of claims and
expenses pursuant to the approved settlement is stayed during the pendency of
the appeal. We currently estimate that the gross amount of the settlement will
be approximately $20 million. To account for the settlement, PMI took an
after-tax charge against fourth quarter 2000 earnings of $3.7 million, and
subsequently, incurred an additional $1.0 million charge, net of tax, in the
third quarter of 2001. These charges, in aggregate, are the estimated cost of
settlement less anticipated insurance recoveries. The aggregate charge is based,
in part, upon an estimate of insurance payments we will receive from our
insurance carriers as reimbursement for certain costs and expenses incurred by,
and to be incurred by, us in connection with our defense and settlement of the
action. We participated without success in non-binding mediation with our
insurance carriers with respect to the amount of any such payments and now must
commence litigation to obtain reimbursement. There can be no assurance that our
estimate of the amount of insurance payments will be realized through
litigation. If we do not realize the estimated amount of insurance proceeds, we
will be required to take an additional charge against earnings and this could
harm our results of operations.
The settlement agreement contains a three year injunction, terminating on
December 31, 2003, which extends to all members, present and future, of the
putative class. The injunction provides that so long as certain products and
services challenged in the lawsuit, including agency pool insurance, contract
underwriting, reinsurance agreements with reinsurance affiliates of lenders and
mortgage insurance restructuring transactions with the GSEs, meet the minimum
requirements for risk transfer and cost recovery specified in the injunction
they will be deemed to be in compliance with RESPA and other applicable laws.
The injunction also prohibits lawsuits by class members for any mortgage
insurance related claims, including but not limited to such products and
services, for any loan transaction closed on or before December 31, 2003.
Under the terms of the agreement, all borrowers who have obtained, or will
obtain, a "federally-related" mortgage loan that is insured by a certificate of
primary mortgage insurance issued by PMI between December 18, 1996 and November
30, 2000 (with exceptions for borrowers whose loans were insured as
bulk/seasoned loans) are entitled to receive a payment. As part of the
settlement agreement, the class members will give a general release to us,
lenders and the GSEs for all claims including claims under RESPA and related
state law claims.
Various other legal actions and regulatory reviews are currently pending that
involve us and specific aspects of our conduct of business. In the opinion of
management, the ultimate liability or resolution in one or more of the foregoing
actions is not expected to have a material adverse effect on our financial
condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of 2001 to a vote of
stockholders through the solicitation of proxies or otherwise.
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EXECUTIVE OFFICERS OF REGISTRANT
Set forth below is certain information regarding The PMI Group's executive
officers as of December 31, 2001, including age as of March 31, 2002, and
business experience for at least the past five years.
W. ROGER HAUGHTON, 54, is Chairman of the Board and Chief Executive Officer of
The PMI Group and PMI. He brings more than 32 years of experience to his
position. Mr. Haughton came to PMI in 1985 from Allstate Insurance Company. He
was appointed President and Chief Executive Officer of PMI in January 1993. He
became President, Chief Executive Officer and a Director of The PMI Group when
the Company went public in April 1995, and was elected Chairman of the Board in
May 1998. A graduate of the University of California at Santa Barbara, Mr.
Haughton holds a B.A. in economics. He is a member of the Executive Committee
and past President of Mortgage Insurance Companies of America, the industry
trade association. Mr. Haughton has a long history of active volunteerism with
various affordable housing organizations, including Habitat for Humanity, and is
on the board and former Chairman of Social Compact, a Washington D.C.
organization dedicated to promoting revitalization of America's inner cities. He
is also on the board of San Francisco's Bay Area Council. Mr. Haughton is a
Trustee for the University of California at Santa Barbara, and he also serves on
the policy advisory boards for both the Fisher Center for Real Estate & Urban
Economics at UC Berkeley and the School of Real Estate at the University of San
Diego. He is an Ex Officio member of the Governance and Nominating Committee.
L. STEPHEN SMITH, 52, has been President and Chief Operating Officer of The PMI
Group and PMI since September 1998. Prior thereto he was Executive Vice
President of Marketing and Field Operations of PMI since May 1994 and was
elected to the same positions with The PMI Group in January 1995. Prior thereto,
he held various executive positions since 1991. Mr. Smith joined PMI in 1979.
Mr. Smith is a member of The PMI Group's Board of Directors.
CLAUDE J. SEAMAN, 55, has been President International and Strategic Investments
of The PMI Group and PMI since February 2001. Prior thereto, he was Group
Executive Vice President Strategic Investments of The PMI Group and PMI since
February 1999. Prior thereto, he was Executive Vice President of Insurance
Operations of PMI since May 1994, and was elected to the same positions with The
PMI Group in January 1995. Prior thereto, he was PMI's Senior Vice President of
Insurance Operations from March 1993 to May 1994.
JOHN M. LORENZEN, Jr., 57, has been Executive Vice President of PMI since May
1994 and Chief Financial Officer of PMI since April 1989, and was elected to the
same positions with The PMI Group in January 1995. Mr. Lorenzen joined the
Company in 1985.
BRADLEY M. SHUSTER, 47, has been Executive Vice President Corporate Development
of The PMI Group and PMI since February 1999. Prior thereto, he was Senior Vice
President, Treasurer and Chief Investment Officer of PMI since August 1995, and
was elected to the same position with The PMI Group, in September 1995. Prior
thereto, he was an audit partner with the accounting firm of Deloitte & Touche
LLP from May 1988 to July 1995.
VICTOR J. BACIGALUPI, 58, has been Executive Vice President, General Counsel and
Secretary of The PMI Group and PMI since August 1999. Prior thereto he was
Senior Vice President, General Counsel and Secretary of The PMI Group and PMI
since November 1996. Prior to joining The PMI Group, he was a partner in the law
firm of Bronson, Bronson & McKinnon LLP, San Francisco, California since
February 1992.
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JOHN H. FULFORD, 52, has been Executive Vice President, National Sales of The
PMI Group and PMI since August 2001. Prior thereto Mr. Fulford was Senior Vice
President, National Sales of The PMI Group and PMI since August 1997. Prior to
joining The PMI Group, he served as Senior Vice President, Marketing at Fannie
Mae from February 1996 to March 1997. Prior thereto, Mr. Fulford was a Vice
President at Fannie Mae since 1983.
DANIEL L. ROBERTS, 51, has been Executive Vice President, Chief Information
Officer of The PMI Group and PMI since March 1, 2000. Prior thereto he was
Senior Vice President, Chief Information Officer of The PMI Group and PMI since
December 1997. Prior to joining The PMI Group, he was Vice President and Chief
Information Officer of St. Joseph Health System, a position he held since he
joined the company in October 1994. Prior thereto, he was Vice President,
Information Services and Chief Information Officer for a division of Catholic
Healthcare West, positions he held since joining the company in December 1990.
Mr. Roberts was a consulting partner with the accounting firm of Deloitte &
Touche from July 1985 to December 1990.
DAVID H. KATKOV, 46, has been Executive Vice President, Product Development and
Pricing of The PMI Group and PMI since August 2001. Mr. Katkov is also
responsible for the portfolio management functions within PMI. He commenced his
employment with PMI in 1992 and has held executive positions in marketing and
related functions. Prior to joining PMI, Mr. Katkov was a Vice President of
First Bank National Association.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Common Stock
The PMI Group is listed on the New York Stock Exchange and the Pacific Exchange
under the trading symbol PMI. As of December 31, 2001 there were 44,581,302
shares issued and outstanding. As of February 28, 2002, there were 44,746,841
shares issued and outstanding held by approximately 39 stockholders of record
and approximately 8,400 beneficial owners of shares held by brokers and
fiduciaries.
The following table shows the high, low and closing common stock prices by
quarter from the New York Stock Exchange Composite Listing for the two years
ended December 31, 2001 and 2000:
2001 2000
--------------------- ---------------------
High Low Close High Low Close
----- ----- ----- ----- ----- -----
First quarter $67.69 $48.38 $64.98 $48.81 $33.50 $47.44
Second quarter 74.50 58.00 72.66 54.75 44.19 47.52
Third quarter 72.76 54.10 62.39 72.38 48.75 67.75
Fourth quarter 67.58 54.05 67.01 74.94 56.50 67.69
The Board of Directors of The PMI Group has proposed that stockholders approve
an amendment to The PMI Group's Restated Certificate of Incorporation to
increase the number of shares of authorized common stock of The PMI Group from
125,000,000 to 250,000,000 shares. On February 20, 2002, the Board of Directors
indicated its intent to declare a 2-for-1 stock split in the form of a stock
dividend if, and only if, the proposed amendment to the Restated Certificate of
Incorporation is approved by the stockholders at The PMI Group's Annual Meeting
on May 16, 2002.
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Preferred Stock
The PMI Group's Board of Directors is authorized to issue up to 5,000,000 shares
of preferred stock of The PMI Group 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 that has voting, dividend or
liquidation rights superior to the common stock and which may adversely affect
the rights of the holders of common stock. The Company has reserved for issuance
under the Rights Plan described below up to 400,000 shares of preferred stock.
Preferred Share Purchase Rights Plan
On January 13, 1998, the Company adopted a Preferred Share Purchase Rights Plan
("Rights Plan"). Under the Rights Plan, all shareholders of record as of January
26, 1998 received rights to purchase shares of a new series of preferred stock
on the basis of one right for each common stock held on that date. However,
rights issued under the Rights Plan will not be exercisable initially. The
rights will trade with the Company's common stock and no certificates will be
issued until certain triggering events occur. The Rights Plan has a 10-year term
from the record date, but the Company's Board of Director's will review the
merits of redeeming or continuing the Rights Plan not less than once every three
years. 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. If a person or group acquires 10% or
more of the Company's common stock, all rightholders except the buyer will be
entitled to acquire the Company's common stock at a discount and/or under
certain circumstances to purchase shares of the acquiring company at a discount.
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.
Payment of Dividends and Policy
Payment of future dividends is subject to a declaration by The PMI Group's Board
of Directors. The dividend policy is also dependent on the ability of PMI to pay
dividends to The PMI Group, which is subject to, among other factors, regulatory
restrictions by the Arizona Department of Insurance and The PMI Group's credit
agreements and the Runoff Support Agreement. (See Part I, Item 1.B(9),
"Regulation" and Part II, Item 8, Financial Statement Note 14 - "Dividends and
Shareholders' Equity".)
During the second quarter of 1995, The PMI Group's Board of Directors declared
its first dividend on common stock of $0.05 per share (pre-split basis), and has
declared and paid a quarterly dividend of $0.05 per share (pre-split basis)
through the second quarter of 1999. In connection with the Company's 3-for-2
stock split on August 16, 1999, the quarterly dividend was adjusted to $0.04 per
share for the third and fourth quarters of 1999 and continued to be $0.04 per
share for 2000 and 2001.
As described above, the Board of Directors has indicated its intent to declare a
2-for-1 stock split in the form of a stock dividend if, and only if, the
proposed amendment to the Restated Certificate of Incorporation is approved by
the stockholders at The PMI Group's Annual Meeting on May 16, 2002. In this
event, it is the Board of Directors' intention that the additional stock
representing the dividend will be distributed on June 17, 2002, to record
holders of common stock as of the close of business on May 31, 2002. The Board
of Directors also has indicated its intent to increase the cash dividend,
effective with the third quarter 2002 dividend declaration, to $0.10 cents per
share from $0.08 cents on a post-split basis, subject to shareholder approval of
the proposal to amend the Restated Certificate of Incorporation.
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Item 6. Selected Financial Data
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 2001 Annual Report to Stockholders under the heading
"Eleven-Year Summary of Financial Data" filed as part of Exhibit 13.1.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 2001 Annual Report to Stockholders under the heading
"Management's Discussion and Analysis" as part of Exhibit 13.1.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
At December 31, 2001, the average duration of the Company's fixed income
investment portfolio was 5.9 years, and the Company had no derivative financial
instruments in its investment portfolio. The result of a 100 basis points
increase in interest rates would be a 5.6% decrease in the value of the
Company's investment portfolio, while the result of a 100 basis points decrease
in interest rates would be a 4.7% increase in the value of the Company's
investment portfolio.
Item 8. Financial Statements and Supplementary Data
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 2001 Annual Report to Stockholders as part of Exhibit
13.1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information concerning The PMI Group's Directors as required by this Item is
incorporated by reference from The PMI Group's Proxy Statement for its 2002
Annual Meeting of Stockholders under the captions "Nominees For Director of The
PMI Group" and "Section 16(a) Beneficial Ownership Reporting Compliance."
Information regarding Executive Officers of The PMI Group is included in a
separate item captioned "Executive Officers of Registrant" in Part I of this
report.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference from The PMI
Group's Proxy Statement for its 2002 Annual Meeting of Stockholders under the
captions "Directors-Compensation and Benefits," "Executive Compensation" and
"Compensation Committee Interlocks and Insider Participants."
46
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is incorporated by reference from The PMI
Group's Proxy Statement for its 2002 Annual Meeting of Stockholders under the
caption "Security Ownership of Certain Beneficial Owners and Management".
Item 13. Certain Relationships and Related Transactions
None.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements: The financial statements listed in the
accompanying Index to Consolidated Financial Statements and Financial
Statement Schedules are filed as part of this Form 10-K.
2. Financial Statement Schedules: The financial statement schedules listed
in the accompanying Index to Consolidated Financial Statements and
Financial Statement Schedules are filed as part of the Form 10-K. All other
schedules are omitted because of the absence of conditions under which they
are required or because the required information is included in the
consolidated financial statements or notes thereto.
3. Exhibits: Exhibits listed in the accompanying Index to Exhibits are
filed as part of this Form 10-K.
(b) Reports on Form 8-K:
(i) On November 2, 2001, we filed with the SEC a report on Form 8-K
relating to our financial results for the quarter ended September 30,
2001.
(ii) On November 5, 2001, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to our estimated operating
earnings for 2002.
(iii) On November 8, 2001, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to our estimated domestic primary
claims paid and domestic losses in 2002.
(iv) On January 24, 2002, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to our estimated operating
earnings for 2002.
(v) On March 29, 2002, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to PMI's claims paid in January
and February 2002.
47
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
[Item 14(a) 1 and 2]
Consolidated Financial Statements
- ---------------------------------
(all contained in Exhibit 13.1)
Consolidated Statements of Operations for the years ended December 31, 2001,
2000 and 1999
Consolidated Balance Sheets as of December 31, 2001 and 2000
Consolidated Statements of Shareholders' Equity for the years ended December 31,
2001, 2000 and 1999
Consolidated Statements of Cash Flows for the years ended December 31, 2001,
2000 and 1999
Notes to Consolidated Financial Statements
Reports of Independent Auditors
Financial Statement Schedules
- -----------------------------
(schedules immediately follow Form 10-K signature pages; reports contained in
Exhibits 23.1 and 23.3)
Reportsof independent auditors on financial statement schedules as of and for
the specified years in the three-year period ended December 31, 2001:
Schedule I - Summary of investments other than in related parties
Schedule II - Condensed financial information of Registrant
Schedule III -Supplementary insurance information
Schedule IV - Reinsurance
48
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San
Francisco, State of California, on the 29th day of March, 2002.
The PMI Group, Inc.
BY: /s/ W. Roger Haughton
-------------------------------------------------
W. Roger Haughton
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Name Title
---- -----
/s/ W. Roger Haughton Chairman of the Board and
- --------------------- Chief Executive Officer
W. Roger Haughton
/s/ John M. Lorenzen, Jr.
- -------------------------
John M. Lorenzen, Jr. Executive Vice President,
Chief Financial Officer, and
Assistant Secretary
(Principal Financial Officer)
/s/ Brian P. Shea Vice President, Controller and
---------------- Assistant Secretary
Brian P. Shea (Controller and Principal
Accounting Officer)
/s/ L. Stephen Smith Director, President and Chief
- -------------------- Operating Officer
L. Stephen Smith
/s/ Mariann Byerwalter Director
- ----------------------
Mariann Byerwalter
/s/ James C. Castle Director
- -------------------
Dr. James C. Castle
/s/ Donald C. Clark Director
- -------------------
Donald C. Clark
/s/ Wayne E. Hedien Director
- -------------------
Wayne E. Hedien
/s/ Louis G. Lower II Director
- ---------------------
Louis G. Lower II
49
<PAGE>
/s/ Raymond L. Ocampo Jr. Director
- -------------------------
Raymond L. Ocampo Jr.
/s/ John D. Roach Director
- -----------------
John D. Roach
/s/ Kenneth T. Rosen Director
- --------------------
Dr. Kenneth T. Rosen
/s/ Richard L. Thomas Director
- ---------------------
Richard L. Thomas
/s/ Mary Lee Widener Director
- --------------------
Mary Lee Widener
/s/ Ronald H. Zech Director
- ------------------
Ronald H. Zech
50
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE 1 - SUMMARY OF INVESTMENTS
The information required by this schedule is incorporated by reference from
portions of The PMI Group, Inc. 2001 Annual Report to Stockholders under the
heading "Notes to Consolidated Financial Statements" as part of Exhibit 13.1.
51
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
PARENT COMPANY ONLY
December 31, 2001 and 2000
<TABLE>
<CAPTION>
2001 2000
----------- -----------
(Dollars in thousands)
<S> <C> <C>
Investments available-for-sale, at fair value:
Fixed income securities (cost: $328,840; $63,645) $ 330,553 $ 58,342
Short-term investments 4,540 39,117
----------- -----------
Total investments 335,093 97,459
Cash 372 7,918
Investment in subsidiaries, at equity in net assets 1,912,698 1,582,906
Other assets 31,575 27,916
----------- -----------
Total Assets $ 2,279,738 $ 1,716,199
=========== ===========
Liabilities:
Long-term debt $ 422,950 $ 100,000
Accounts payable - affiliates 15,292 5,567
Other liabilities 6,308 11,812
----------- -----------
Total liabilities 444,550 116,988
----------- -----------
Commitments and contingent liabilities (Note A):
Junior subordinated deferrable interest debenture
held solely by subsidiary trust 48,500 100,000
Shareholders' equity:
Common stock - $0.01 par value; 125,000,000 shares
authorized and 52,793,777 shares issued 528 528
Additional paid-in capital 267,762 267,762
Accumulated other comprehensive income 40,791 62,501
Retained earnings 1,811,839 1,511,751
Treasury stock, at cost (8,212,475 and 8,484,082 shares) (334,232) (343,331)
----------- -----------
Total shareholders' equity 1,786,688 1,499,211
----------- -----------
Total liabilities and shareholders' equity $ 2,279,738 $ 1,716,199
=========== ===========
</TABLE>
See accompanying supplementary notes to Parent company condensed financial
statements.
52
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
PARENT COMPANY ONLY
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
2001 2000 1999
--------- --------- ---------
(In thousands)
<S> <C> <C> <C>
Revenues
Equity in undistributed net income of subsidiaries $ 277,611 $ 273,501 $ 112,029
Subsidiary dividends 52,500 3,000 97,339
Investment income 14,328 6,174 8,913
Net realized investment (gains) and losses (141) 807 329
--------- --------- ---------
Total revenues 344,298 283,482 218,610
--------- --------- ---------
Expenses
Operating expenses 19,107 13,257 6,456
Interest expense 12,569 7,486 7,244
Distributions on preferred capital securities 7,861 8,566 8,566
--------- --------- ---------
Total expenses 39,537 29,309 22,266
--------- --------- ---------
Income before income taxes and extraordinary item 304,761 254,173 196,344
Income tax benefit 7,256 6,039 8,122
--------- --------- ---------
Income before extraordinary item 312,017 260,212 204,466
Extraordinary loss on early extinguishment of debt,
net of income tax benefit of $2,588 4,805 - -
--------- --------- ---------
Net income $ 307,212 $ 260,212 $ 204,466
========= ========= =========
</TABLE>
See accompanying supplementary notes to Parent company condensed financial
statements
53
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
PARENT COMPANY ONLY
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
2001 2000 1999
--------- --------- ---------
(In thousands)
<S> <C> <C> <C>
Net income $ 307,212 $ 260,212 $ 204,466
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising during
period, net of tax (11,324) 50,575 (53,945)
Reclassification adjustment for realized gains
included in net income, net of tax (7) (281) (331)
Currency translation adjustment (10,379) (7,979) -
--------- --------- ---------
Other comprehensive income (loss), net of tax (21,710) 42,315 (54,276)
--------- --------- ---------
Comprehensive income $ 285,502 $ 302,527 $ 150,190
========= ========= =========
</TABLE>
See accompanying supplementary notes to Parent company condensed financial
statements.
54
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
PARENT COMPANY ONLY
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
2001 2000 1999
----------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 307,598 $ 260,212 $ 204,466
Adjustments to reconcile net income to net cash
used in operating activities:
Extraordinary loss on early extinguishment of debt 7,393 - -
Net realized capital (gains) and losses 141 (807) (329)
Equity in earnings of affiliates (330,111) (276,501) (209,368)
Amortization 1,410 99 278
Payable to affiliates 9,725 3,937 (48)
Other (9,623) 3,908 (6,471)
---------- ---------- ----------
Net cash used in operating activities (13,467) (9,152) (11,472)
---------- ---------- ----------
Cash flows from investing activities:
Proceeds from sales of fixed income securities 44,205 10,680 22,110
Proceeds from sale of equity securities 4,819 - -
Investment purchases:
Fixed income securities (309,667) (40,771) (3,887)
Equity securities - (5,569) (14,840)
Net (increase) decrease in short-term investments 34,577 21,856 (57,251)
Investment in affiliates (78,445) - (2,038)
Dividends from subsidiaries (Note B) 52,500 3,000 97,339
Return of capital from subsidiaries (Note B) - 50,000 -
---------- ---------- ----------
Net cash provided by (used in) investing activities (252,011) 39,196 41,433
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 351,900 - -
Repayment of long-term debt (39,974) - -
Extinguishment of Capital Securities (55,969) - -
Purchase of common stock - (24,017) (27,469)
Issuance of treasury stock 9,099 8,577 2,641
Dividends paid to shareholders (7,124) (7,093) (5,199)
---------- ---------- ----------
Net cash provided by (used in) financing activities 257,932 (22,533) (30,027)
---------- ---------- ----------
Net increase (decrease) in cash (7,546) 7,511 (66)
Cash at beginning of year 7,918 407 473
---------- ---------- ----------
Cash at end of year $ 372 $ 7,918 $ 407
========== ========== ==========
</TABLE>
See accompanying supplementary notes to Parent company condensed financial
statements.
55
<PAGE>
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
SUPPLEMENTARY NOTES
Note A
The accompanying Parent Company ("The PMI Group") financial statements should be
read in conjunction with the Consolidated Financial Statements and Notes to
Consolidated Financial Statements (including Notes 10, 11 and 12 related to
long-term obligations, commitments and contingent liabilities and the junior
subordinated debenture) appearing in The PMI Group, Inc. 2001 Annual Report to
Shareholders.
Note B
During 2001, 2000 and 1999, The PMI Group received $52.5 million, $53.0 million
and $97.3 million, respectively, of ordinary and extraordinary cash
dividends/returns of capital from subsidiaries.
Note C
Certain prior year amounts have been reclassified to conform to the current year
presentation.
56
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
As of and for the Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
Reserve for
Losses and Investment Losses and Amortization
Deferred Loss Net Income and Loss Of Deferred Other
Acquisition Adjustment Unearned Premiums Premiums Equity Adjustment Acquisition Operating
Segment Costs Expenses Premiums Written Earned Earnings Expenses Costs Expenses
- -------------- ----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
2001
MI (1) $ 64,345 $ 289,432 $ 87,112 $544,055 $553,407 $ 101,261 $ 102,856 $ 76,586 $ 60,667
Internat'l (2) 13,558 14,383 121,468 56,233 43,813 24,467 9,287 5,196 7,852
Title - 10,775 - 157,551 157,551 2,061 5,905 - 141,929
Other (3) - - - - - 22,198 - - 57,967
----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
Total $ 77,903 $ 314,590 $208,580 $757,839 $754,771 $ 149,987 $ 118,048 $ 81,782 $ 268,415
=========== =========== ======== ======== ======== ========== ========== ============ =========
2000
MI (1) $ 63,295 $ 281,704 $ 96,561 $498,255 $503,750 $ 96,585 $ 95,308 $ 77,337 $ 54,362
Internat'l (2) 3,714 5,384 74,305 36,823 6,628 11,475 5,684 - 7,220
Title - 8,001 - 103,984 103,984 1,890 2,087 - 94,302
Other (3) - - - - - 9,249 - - 33,887
----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
Total $ 67,009 $ 295,089 $170,866 $639,062 $634,362 $ 119,199 $ 103,079 $ 77,337 $ 189,771
=========== =========== ======== ======== ======== ========== ========== ============ =========
1999
MI (1) $ 67,281 $ 269,931 $102,022 $459,065 $447,214 $ 80,922 $ 110,465 $ 80,252 $ 54,017
Internat'l (2) 2,298 3,714 80,067 12,071 11,291 3,673 1,213 - 4,472
Title - 8,355 - 100,118 100,118 1,634 1,004 - 88,244
Other (3) - - - - - 8,913 - - 23,506
----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
Total $ 69,579 $ 282,000 $182,089 $571,254 $558,623 $ 95,142 $ 112,682 $ 80,252 $ 170,239
=========== =========== ======== ======== ======== ========== ========== ============ =========
</TABLE>
(1) Represents Domestic Mortgage Insurance Operations.
(2) Represents International Mortgage Insurance Operations.
(3) Represents ancillary services and parent company investment income.
57
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
Percentage
Assumed Ceded of Amount
Gross From Other To Other Net Assumed
Premiums earned Amount Companies Companies Amount To Net
- ------------------------ -------- --------- --------- -------- ----------
(In thousands except percentages)
<S> <C> <C> <C> <C> <C>
2001
Mortgage Guaranty $661,054 $ 3,950 $ 67,784 $597,220 0.7%
Title 157,892 4 345 157,551 0.0
-------- -------- -------- --------
Total $818,946 $ 3,954 $ 68,129 $754,771 0.7
======== ======== ======== ========
2000
Mortgage Guaranty $567,258 $ 1,800 $ 38,680 $530,378 0.3%
Title 104,344 - 360 103,984 0.0
-------- -------- -------- --------
Total $671,602 $ 1,800 $ 39,040 $634,362 0.3
======== ======== ======== ========
1999
Mortgage Guaranty $486,235 $ 6,443 $ 34,173 $458,505 1.4%
Title 100,355 2 239 100,118 0.0
-------- -------- -------- --------
Total $586,590 $ 6,445 $ 34,412 $558,623 1.2
======== ======== ======== ========
</TABLE>
58
<PAGE>
INDEX TO EXHIBITS
[Item 14(a) 3]
Exhibit
Number Description of Exhibits
- -------- -------------------------------------------------------------------
3.1(b) Restated Certificate of Incorporation of the Registrant.
3.2(g) By-laws of the Registrant as amended and restated September 15,
1998.
4.1(b) Specimen common stock Certificate.
4.2(d) Indenture dated as of November 19, 1996 between The PMI Group,
Inc. and the Bank of New York, as Trustee in connection with sale
of $100,000,000 aggregate principal amount of 6 3/4% Notes due
November 15, 2006.
4.3(e) The Junior Subordinated Indenture dated February 4, 1997 between
The PMI Group, Inc. and The Bank of New York, Inc., as Trustee.
4.4(e) Form of Right Certificate, relating to Rights Agreement dated as
of January 26, 1998.
4.5(j) Credit Agreement, dated as of August 3, 1999 by and among PMI
Mortgage Insurance Australia (Holdings) Pty Limited, The PMI Group,
Inc., and Bank of America, N.A. The Company agrees to furnish to
the Securities and Exchange Commission, upon request, copies of all
instruments defining the rights of holders of long-term debt of the
Company where the total amount of securities authorized under each
issue does not exceed ten percent of the Company's total assets.
4.6(j) Credit Agreement, dated as of February 13, 1996, between The PMI
Group, Inc., and Bank of America National Trust and Savings
Association, as amended. The Company agrees to furnish to the
Securities and Exchange Commission, upon request, copies of all
instruments defining the rights of holders of long-term debt of the
Company where the total amount of securities authorized under each
issue does not exceed ten percent of the Company's total assets.
4.7(n) Indenture dated as of July 16, 2001 between The PMI Group, Inc.
and The Bank of New York, as Trustee.
4.8(n) Resale Registration Rights Agreement, dated as of July 16, 2001,
among The PMI Group, Inc., Bank of America Securities LLC and
Lehman Brothers Inc.
10.1(i)* PMI Mortgage Insurance Co. Bonus Incentive Plan dated as of
February 18, 1999.
10.2(o)* The PMI Group, Inc. Amended and Restated Equity Incentive Plan,
effective as of June 1, 2000.
10.3(o)* Amendment No. 1 to The PMI Group, Inc. Amended and Restated Equity
Incentive Plan, dated June 11, 2001.
10.4(l)* The PMI Group, Inc. Stock Plan for Non-Employee Directors
(restated as of August 16, 1999).
10.5(m)* Amendment No. 1 to The PMI Group, Inc. Stock Plan for Non-Employee
Directors (restated as of August 16, 1999).
10.6(o)* Amendment No. 2 to The PMI Group, Inc. Stock Plan for Non-Employee
Directors (restated as of August 16, 1999).
10.7(k) The PMI Group, Inc. Directors Deferred Compensation Plan. (amended
and restated as of July 21, 1999).
10.8(a) Form of 1984 Master Policy of PMI Mortgage Insurance Co.
59
<PAGE>
10.9(a) Form of 1994 Master Policy of PMI Mortgage Insurance Co.
10.10(a) CMG Shareholders Agreement dated September 8, 1994 between CUNA
Mutual Investment Corporation and PMI Mortgage Insurance Co.
10.11(b) Runoff Support Agreement dated October 28, 1994 between Allstate
Insurance Company, the Registrant and PMI Mortgage Insurance Co.
10.12(b) Form of Tax Sharing Agreement among the Registrant, the
Registrant's subsidiaries, The Allstate Corporation, Allstate
Insurance Company and Sears, Roebuck and Co.
10.13(a) Mortgage Insurance Variable Quota Share Reinsurance Treaty
effective January 1, 1991 issued to PMI Mortgage Insurance Co. by
Hannover Ruckversicherungs-Aktiengesellschaft ("Hannover").
10.14(a) First Amendment to Mortgage Insurance Variable Quota Share
Reinsurance Treaty made as of January 1, 1992 between Hannover and
PMI Mortgage Insurance Co.
10.15(j) Supplemental Employee Retirement Plan (amended and restated as of
May 20, 1999).
10.16(a) First Amendment to the Quota Share Primary Mortgage Reinsurance
Agreement (No. 15031-940) made as of October 1, 1994 between PMI
Mortgage Insurance Co. and Capital Mortgage Reinsurance Company.
10.17(a) Form of Indemnification Agreement between the Registrant and its
officers and directors.
10.18(a) Per Mortgage Excess of Loss Reinsurance Treaty effective January
1, 1994 issued to PMI Mortgage Insurance Co. by Hannover.
10.19(j) The PMI Group, Inc. Additional Benefit Plan, dated as of February
18, 1999.
10.20(e) The Guarantee Agreement, dated February 4, 1997 between The PMI
Group, Inc. (As Guarantor) and The Bank of New York (as Trustee).
10.21(e) Amended and Restated Trust Agreement dated as of February 4, 1997
among The PMI Group, Inc., as Depositor, The Bank of New York, as
Property Trustee, and The Bank of New York (Delaware), as Delaware
Trustee.
10.22(e) Form of Change of Control Employment Agreement.
10.23(k) The PMI Group, Inc. Officer Deferred Compensation Plan (amended
and restated as of September 16, 1999).
10.24(l) Excess of Loss Reinsurance Treaty effective August 20, 1999 issued
by PMI Mortgage Insurance Co. to KRE Reinsurance Ltd, National
Union Fire Insurance Company of Pittsburgh and Federal Insurance
Co. The Company agrees to furnish to the Securities and Exchange
Commission, upon request, copies of all agreements defining the
rights of reinsurers of pool insurance contracts where the total
amount of premiums paid does not exceed ten percent of the
Company's total assets.
11.1 Statement re: computation of per share earnings.
12.1 Statement re: computation of earnings to fixed charges.
13.1 Selected Financial Data, Management's Discussion and Analysis of
Financial Condition and Results of Operations and Financial
Statements and Supplementary Data portions of The PMI Group, Inc.'s
2001 Annual Report to Shareholders, Reports of Independent
Auditors.
60
<PAGE>
21.1 Subsidiaries of the Registrant.
23.1 Consent of Independent Auditors (Ernst & Young LLP, March 26,
2002).
23.2 Independent Auditors' Consent (Deloitte & Touche LLP, March 26,
2002).
23.3(p) Independent Auditors' Report (Deloitte & Touche LLP, January 20,
2000).
(a) Previously filed with the Company's Form S-1 Registration Statement (No.
33-88542), which became effective in April 1995 ("Form S-1").
(b) Previously filed with Amendment No. 1 to Form S-1, filed with the SEC on
March 2, 1995.
(c) Previously filed with Amendment No. 2 to Form S-1, filed with the SEC on
March 13, 1995.
(d) Previously filed with Form 8-K, filed with the SEC on November 25, 1996.
(e) Previously filed with Form 10-K, filed with the SEC on March 27, 1998.
(f) Previously filed with Form 10-Q, filed with the SEC on August 13, 1998.
(g) Previously filed with Form 8-K, filed with the SEC on September 29, 1998.
(h) Previously filed with the Company's Form S-3 Registration Statement (No.
33-66829) which became effective in November 1998.
(i) Previously filed with Form 10-K, filed with the SEC on March 30, 1999.
(j) Previously filed with Form 10-Q, filed with the SEC on August 16, 1999.
(k) Previously filed with the Company's Form S-8 Registration Statement (No.
333-32190) which became effective on March 10, 2000.
(l) Previously filed with the Form 10-K, filed with the SEC on March 30, 2000.
(m) Previously filed with the Form 10-Q, filed with the SEC on August 11, 2000.
(n) Previously filed with the Form 8-K, filed with the SEC on July 18, 2001.
(o) Previously filed with the Form S-8 Registration Statement (No. 333-63122)
which became effective on June 15, 2001.
(p) Previously filed with the Form 10-K, filed with the SEC on March 31, 2001.
* Compensatory or benefit plan in which certain executive officers or
Directors of The PMI Group, Inc. or its subsidiaries are eligible to
participate.
61
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-11.1
<SEQUENCE>3
<FILENAME>dex111.txt
<DESCRIPTION>STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TEXT>
<PAGE>
EXHIBIT 11.1
------------
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF RESTATED NET INCOME PER SHARE (1)
Years Ended December 31, 2001, 2000 and 1999
<TABLE>
<CAPTION>
2001 2000 1999
--------- ---------- ---------
(Dollars in thousands except per share data)
<S> <C> <C> <C>
Basic net income per common share:
Net income $ 307,212 $ 260,212 $ 204,466
Average common shares outstanding 44,444 44,254 44,893
--------- ---------- ---------
Basic net income per common share $ 6.91 $ 5.88 4.55
========= ========== =========
Diluted net income per common share:
Net Income $ 307,212 $ 260,212 $ 204,466
--------- ---------- ---------
Average common shares outstanding 44,444 44,254 44,893
Net shares to be issued upon exercise of dilutive
stock option after applying treasury stock method 890 765 351
--------- ---------- ---------
Average shares outstanding 45,334 45,019 45,244
--------- ---------- ---------
Diluted net income per common share $ 6.78 $ 5.78 $ 4.52
========= ========== =========
</TABLE>
(1) Restated to conform with Statement of Financial Accounting Standards
No. 128, Earnings per Share.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-12.1
<SEQUENCE>4
<FILENAME>dex121.txt
<DESCRIPTION>STATEMENT RE: COMPUTATION OF EARNINGS TO FIXED
<TEXT>
<PAGE>
EXHIBIT 12.1
------------
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF RATIO OF PROFIT TO FIXED CHARGES
<TABLE>
<CAPTION>
Years Ended December 31,
2001 2000 1999 1998 1997
-------------- ------------ -------------- ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Income from continuing operations before income
taxes and extraordinary item $ 446,966 $ 373,866 $ 290,086 $ 266,948 $ 242,867
============== ============ ============== ============= =============
Fixed Charges:
Rentals - at computed interest * $ 4,351 $ 3,756 $ 2,760 $ 2,959 $ 2,549
Interest Expense 14,148 10,210 8,554 7,029 6,766
Distribution on redeemable capital securities 7,604 8,309 8,311 8,311 7,617
-------------- ------------ -------------- ------------- -------------
Total fixed charges $ 26,103 $ 22,275 $ 19,625 $ 18,299 $ 16,932
============== ============ ============== ============= =============
Profit before taxes plus fixed charges $ 473,069 $ 396,107 $ 309,711 $ 285,247 $ 259,799
============== ============ ============== ============= =============
Ratio of adjusted profit to fixed charges 18.1 17.8 15.8 15.6 15.3
============== ============ ============== ============= =============
</TABLE>
* Those portions of rent expense that are representative of interest cost
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13.1
<SEQUENCE>5
<FILENAME>dex131.txt
<DESCRIPTION>SELECTED FINANCIAL DATA OF ANNUAL REPORT
<TEXT>
<PAGE>
EXHIBIT 13.1
------------
ITEM 6. SELECTED FINANCIAL DATA
THE PMI GROUP, INC. AND SUBSIDIARIES
ELEVEN-YEAR SUMMARY OF FINANCIAL DATA
<TABLE>
<CAPTION>
(Dollars in thousands, except per share data or otherwise noted Year ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Summary of consolidated operations
Net premiums written $ 757,839 $ 639,062 $ 571,253 $ 489,100 $ 432,052 $ 403,020
==================================================================================
Premiums earned $ 754,771 $ 634,362 $ 558,623 $ 491,226 $ 453,948 $ 412,738
Investment income 149,987 119,199 95,142 84,681 83,136 67,442
Net realized capital gains 11 432 509 24,636 19,584 14,296
Other Income 32,194 8,578 15,850 20,366 7,979 6,948
----------------------------------------------------------------------------------
Total revenues 936,963 762,572 670,124 620,909 564,647 501,424
Total losses and expenses (1) 489,997 388,706 380,038 353,961 321,780 279,318
----------------------------------------------------------------------------------
Income from continuing operations 446,966 373,866 290,086 266,948 242,867 222,106
Income (loss) from discontinued operations - - - - - -
Income tax (benefit) (2) 134,949 113,654 85,620 76,588 67,558 64,188
Extraordinary loss on early
extinguishment of debt, net of income
tax benefit of $2,588 4,805 - - - - -
----------------------------------------------------------------------------------
Net Income $ 307,212 $ 260,212 $ 204,466 $ 190,360 $ 175,309 $ 157,918
==================================================================================
U.S Mortgage Insurance Operating Ratios
Loss ratio 18.6% 18.9% 24.7% 32.8% 38.2% 41.9%
Net expense ratio (3) 25.2% 25.3% 29.2% 25.5% 22.7% 18.4%
----------------------------------------------------------------------------------
Combined ratio 43.8% 44.2% 53.9% 58.3% 60.9% 60.3%
==================================================================================
Consolidated Balance Sheet Data
Total assets $ 2,989,952 $ 2,392,657 $ 2,100,762 $ 1,777,870 $ 1,686,603 $ 1,509,919
Reserve for losses and loss adjustment expenses $ 314,590 $ 295,089 $ 282,000 $ 215,259 $ 202,387 $ 199,774
Long-term debt $ 422,950 $ 136,819 $ 145,367 $ 99,476 $ 99,409 $ 99,342
Preferred capital securities of
subsidiary trust $ 48,500 $ 99,109 $ 99,075 $ 99,040 $ 99,006 $ -
Shareholders' equity $ 1,786,688 $ 1,499,211 $ 1,217,268 $ 1,097,515 $ 1,061,180 $ 986,862
Shares outstanding 44,581,302 44,309,922 44,702,080 45,417,902 48,691,871 51,764,729
<CAPTION>
(Dollars in thousands, except per share data or otherwise noted
- -------------------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Summary of consolidated operations
Net premiums written $ 314,021 $ 277,747 $ 291,089 $ 208,602 $ 143,305
===============================================================
Premiums earned $ 328,756 $ 296,345 $ 268,554 $ 173,039 $ 120,195
Investment income 62,041 56,774 45,733 40,847 40,402
Net realized capital gains 11,934 3,064 1,229 686 1,335
Other Income 2,309 3,802 - - -
---------------------------------------------------------------
Total revenues 405,040 359,985 315,516 214,572 161,932
Total losses and expenses (1) 224,499 221,434 202,543 119,912 39,879
---------------------------------------------------------------
Income from continuing operations before taxes 180,541 138,551 112,973 94,660 122,053
Income (loss) from discontinued operations - - (28,863) 6,726 3,709
Income tax (benefit) (2) 45,310 32,419 24,305 (10,911) 69,661
Extraordinary loss on early
extinguishment of debt, net of income
tax benefit of $2,588 - - - - -
---------------------------------------------------------------
Net Income $ 135,231 $ 106,132 $ 59,805 $ 112,297 $ 56,101
===============================================================
U.S Mortgage Insurance Operating Ratios
Loss ratio 38.5% 40.5% 41.4% 33.2% 3.1%
Net expense ratio (3) 24.9% 30.1% 28.2% 27.0% 25.3%
---------------------------------------------------------------
Combined ratio 63.4% 70.6% 69.6% 60.2% 28.4%
===============================================================
Consolidated Balance Sheet Data
Total assets $ 1,304,440 $ 1,097,421 $ 985,129 $ 815,136 $ 663,215
Reserve for losses and loss adjustment
expenses $ 192,087 $ 173,885 $ 135,471 $ 94,002 $ 78,045
Long-term debt $ - $ - $ - $ - $ -
Preferred capital securities of
subsidiary trust $ - $ - $ - $ - $ -
Shareholders' equity $ 870,503 $ 687,178 $ 575,300 $ 513,583 $ 399,489
Shares outstanding 52,514,841 52,500,000 52,500,000 52,500,000 52,500,000
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Per Share Data (4)
Net income
Operating (3) $ 6.88 $ 5.85 $ 4.51 $ 3.69 $ 3.23
Basic $ 6.91 $ 5.88 $ 4.55 $ 4.04 $ 3.50
Diluted $ 6.78 $ 5.78 $ 4.52 $ 4.02 $ 3.49
Shareholders' equity $ 40.08 $ 33.83 $ 27.23 $ 24.16 $ 21.79
Price/Earnings Ratio (5) 9.7 11.6 10.8 8.9 14.9
Stock price (6) : Close 67.01 67.69 48.81 32.92 48.20
High 74.50 74.94 55.50 57.00 49.32
Low 48.38 33.50 26.67 22.00 31.83
Cash dividends declared $ 0.16 $ 0.16 $ 0.14 $ 0.13 $ 0.13
PMI Operating and Statutory Data
Number of policies in force 905,906 820,213 749,985 714,210 698,831
Default rate 2.86% 2.21% 2.12% 2.31% 2.38%
Persistency 63.0% 80.3% 71.9% 68.0% 80.8%
Direct primary insurance in force $ 109,158 $ 96,914 $ 86,729 $ 80,682 $ 77,787
(in millions)
Direct primary risk in force (in $ 25,772 $ 23,559 $ 21,159 $ 19,324 $ 18,092
millions)
Statutory capital $ 1,900,709 $ 1,617,519 $ 1,372,273 $ 1,193,899 $ 1,114,342
Risk-to-capital ratio 13.0:1 14.1:1 14.8:1 14.9:1 14.6:1
New insurance written $48,089,327 $27,294,908 $28,732,505 $27,820,065 $15,307,147
Policies issued 335,213 206,493 219,038 211,161 119,190
New insurance written market share 17.0% 16.7% 16.3% 14.8% 12.7%
Return on equity 19.6% 19.9% 18.5% 19.0% 18.3%
Tax rate 30.1% 30.4% 29.5% 28.7% 27.8%
Total employees 1,235 1,117 1,113 1,016 916
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Per Share Data (4)
Net income
Operating (3) $ 2.83 $ 2.43 $ 1.98 $ 1.12 $ 2.13 $ 1.05
Basic $ 3.01 $ 2.58 $ 2.02 $ 1.14 $ 2.14 $ 1.07
Diluted $ 3.00 $ 2.57 $ 2.02 $ 1.14 $ 2.14 $ 1.07
Shareholders' equity $ 19.06 $ 16.58 $ 13.09 $ 10.96 $ 9.78 $ 7.61
Price/Earnings Ratio (5) 13.0 12.5 - - - -
Stock price (6) : Close 36.92 30.17 - - - -
High 40.00 35.67 - - - -
Low 26.58 24.00 - - - -
Cash dividends declared $ 0.13 $ 0.10 $ - $ - $ - $ -
PMI Operating and Statutory Data
Number of policies in force 700,084 657,800 612,806 543,924 428,745 347,232
Default rate 2.19% 1.98% 1.88% 1.81% 2.03% 2.38%
Persistency 83.3% 86.4% 83.6% 70.0% 74.6% 85.2%
Direct primary insurance in force $ 77,312 $ 71,43 $ 65,982 $ 56,991 $ 43,698 $ 31,982
(in millions)
Direct primary risk in force (in $ 17,336 $ 15,130 $ 13,243 $ 11,267 $ 8,676 $ 6,481
millions)
Statutory capital $ 988,475 $ 824,156 $ 659,402 $ 494,621 $ 456,931 $ 372,568
Risk-to-capital ratio 15.9:1 15.8:1 17.7:1 20.8:1 19.0:1 18.8:1
New insurance written $17,882,702 $14,459,260 $18,441,612 $25,469,907 $19,463,000 $8,663,000
Policies issued 142,900 119,631 156,055 207,356 161,893 75,095
New insurance written market share 14.1% 13.2% 14.0% 18.6% 19.4% 15.9%
Return on equity 17.8% 18.1% 17.3% 11.0% 24.6% 15.2%
Tax rate 28.9% 25.1% 23.4% 21.5% -11.5% 57.1%
Total employees 586 578 586 632 529 410
</TABLE>
- ----------
(1) In 1991, the Company significantly revised its estimate for losses and loss
adjustment expense, reducing total losses by $42.1 million and the loss
ratio by 35 percentage points, and increasing income from continuing
operations by $27.8 million.
(2) During 1991, the Company increased its tax liabilities and income tax
expense by $40.9 million in light of an unfavorable judgment by the U.S.
Tax Court. In 1992, the 1991 judgment was overturned, and the company
re-evaluated its tax balances and reduced its tax liabilities and income
tax expense by $30.9 million.
(3) Excluded a pre-tax litigation settlement charge of $5.7 million and an
after tax extraordinary loss of $4.8 million in 2001.
(4) Per Share Data and shares outstanding adjusted to reflect 3-for-2 stock
split
(5) Based on the closing price as of December 31, and on trailing twelve-month
operating earnings.
(6) Closing price as of December 31. High and low price for trailing
twelve-month period.
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT
Written and oral statements made or incorporated by reference from
time to time by us or our representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, or are preceded by, followed by or
that include the words "believes," "expects," "anticipates," "estimates," or
similar expressions, and that relate to future plans, events or performance are
"forward-looking" statements within the meaning of the federal securities laws.
Forward-looking statements in this Item 7 include:
. our anticipation that negotiated bulk transactions in 2002 will
continue to be a significant portion of the total insurance
originated in the private mortgage insurance market;
. our belief that PMI's persistency rate will increase in the second
half of 2002 as a result of anticipated rising interest rates;
. our belief that the percentage of PMI's risk in force related to
risk-sharing programs will continue to increase as a percentage of
total risk in force in 2002;
. our anticipation that contract underwriting services will continue
to account for a significant portion of PMI's acquisition costs;
. our belief that the use of electronic origination and delivery of
our products will continue to increase in 2002; and
. our belief that we have sufficient cash to meet all of our short-
and medium-term obligations and that we maintain adequate liquidity
to support our operations.
When a forward-looking statement includes an underlying assumption, we caution
that, while we believe the assumption to be reasonable and make it in good
faith, assumed facts almost always vary from actual results, and the difference
between assumed facts and actual results can be material. Where, in any
forward-looking statement, we express an expectation or belief as to future
results, there can be no assurance that the expectation or belief will result.
Our actual results may differ materially from those expressed in any
forward-looking statements made by us. Forward-looking statements involve a
number of risks of uncertainties including, but not limited to, the risks
described under the heading "Investment Considerations." All forward-looking
statements are qualified by and should be read in conjunction with those risk
factors. Except as may be required by applicable law, we undertake no obligation
to publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise.
<PAGE>
RESULTS OF OPERATIONS
Summary
The following chart presents highlights of our consolidated financial results
for 2001, 2000 and 1999.
<TABLE>
<CAPTION>
Percentage change
-----------------
2001 2000
vs. vs.
(In millions except per share data and percentages) 2001 2000 1999 2000 1999
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net income $ 307 $ 260 $ 204 18% 27%
Per share data:*
Net income $6.78 $5.78 $4.52 17% 28%
Operating income $6.88 $5.85 $4.51 18% 30%
Revenues $ 937 $ 763 $ 670 23% 14%
</TABLE>
* Earnings per share calculations are based on diluted shares outstanding.
The increases in our consolidated net income and net income per share for the
year ended December 31, 2001 were due to increases in premiums earned, net
investment income and other income, partially offset by increases in other
underwriting and operating expenses, losses and loss adjustment expenses and
amortization of deferred policy acquisition costs. The increases in our
consolidated net income and net income per share in 2000 were due to increases
in premiums earned and net investment income, partially offset by increases in
other underwriting and operating expenses. Our net income for 2001 included an
after tax extraordinary loss of $4.8 million as a result of our early
extinguishment of certain debt. Our net income for 2000 included a pre-tax
litigation settlement charge of $5.7 million.
Operating income represents net income excluding realized investment gains and
losses, and non-recurring expenses. Diluted operating income per share in 2001
excluded realized investment gains of less than $0.01 per share and
extraordinary losses of $0.10 per share, while 2000 diluted operating income per
share excluded realized investment gains of $0.01 per share and a litigation
charge of $0.08 per share. We believe operating income and operating income per
share are meaningful measurements of our underlying profit and they are used
to measure our management's performance for annual bonus purposes. Consolidated
revenues growth in 2001 and 2000 were due primarily to significant increases in
the amount of primary new insurance written, the growth in our insurance
portfolio, and increases in net investment income. New insurance written is the
total principal amount of mortgages newly insured by us. 2001 revenues also
included investment income generated from the proceeds of the $360.0 million
Senior Convertible Debentures offered in July 2001.
U.S. Mortgage Insurance Operations
Our primary operating subsidiary, PMI Mortgage Insurance Co., or PMI, provides
private mortgage insurance in the United States to residential mortgage lenders
and investors. Private mortgage insurance insures lenders and investors against
potential losses in the event of borrower default. Private mortgage insurance is
also purchased by lenders and investors seeking additional protection against
default risk, capital relief, or credit enhancement for secondary market
mortgage transactions. Although PMI's revenues have increased in each of the
last three years, PMI generated 69% of our consolidated revenues in 2001,
compared to 79% in 2000 and 90% in 1999. The change in proportion is the result
of the implementation of corporate diversification strategies.
Primary insurance and new insurance written - PMI issues primary insurance
coverage on individual loans at specified coverage percentages and PMI is in the
first loss position when a borrower defaults on
<PAGE>
an insured mortgage. PMI's new insurance written does not include pool insurance
written (see Pool Insurance below), primary mortgage insurance placed
upon loans more than twelve months after loan origination, or loans where the
insurance coverage exceeds 50%. The following table shows the total new
insurance written by PMI; combined new insurance written by PMI and CMG; total
new insurance written for the private mortgage insurance industry as reported by
the industry's trade association, Mortgage Insurance Companies of America, or
MICA; and the total residential mortgage originations as reported by Mortgage
Bankers Association of America, or MBA:
<TABLE>
<CAPTION>
Percentage change
-----------------
2001 2000
vs. vs.
2001 2000 1999 2000 1999
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PMI new insurance written (in millions) $ 48,089 $ 27,295 $ 28,733 76% (5)%
PMI and CMG new insurance written (in millions) $ 52,050 $ 29,519 $ 31,146 76% (5)%
MICA total new insurance written (in millions) * $283,233 $163,147 $188,868 N/A N/A
Residential mortgage originations (in billions) $ 2,100 $ 1,073 $ 1,284 96% (16)%
</TABLE>
* As of August 2001, MICA modified the definitions used to compile their
monthly statistical reports to better reflect industry activity. As a
result, MICA total new insurance written for 2001 is not necessarily
comparable to prior years.
We believe that PMI's increase in new insurance written in 2001 was due to
higher levels of residential mortgage origination activity and the growth in the
private mortgage insurance market. A decrease in new insurance written in 2000
was due to lower residential mortgage origination volume and a decline in the
private mortgage insurance market. The private mortgage insurance industry's
market share is the total new insurance written by private mortgage insurance
companies, as reported by MICA, as a percentage of total insured loans including
insurance offered by private mortgage insurers, the Federal Housing Authority
and the Veterans Administration.
The total residential mortgage originations in 2001 reached a record level and
nearly double the volume in 2000, as estimated by the MBA. The increase in total
mortgage originations in 2001 was primarily driven by heavy refinancing activity
as a result of declining mortgage interest rates in 2001. The decrease in total
mortgage originations in 2000 was attributed to lower refinancing activity due
to rising interest rates during the first half of 2000. Residential mortgage
originations in connection with refinancing transactions represented
approximately 56% of total mortgage originations during 2001 compared with
approximately 19% during 2000 and approximately 36% during 1999, according to
the MBA. PMI's new insurance written from refinancing activity as a percentage
of total insurance written increased to 34% in 2001, compared to 10% in 2000 and
22% in 1999.
PMI engages in negotiated bulk transactions, primarily in the secondary mortgage
market, through a bidding process to obtain new business. Insurance issued in
negotiated bulk transactions includes primary insurance, pool insurance, or a
combination of both. We anticipate that in 2002 bulk transactions will continue
to be a significant portion of the total insurance originated in the private
mortgage insurance market. Bulk transactions often include non-traditional
loans, which refer to Alternative A, Alternative A- and less than A quality
loans. PMI also insures non-traditional loans outside of its bulk transaction
activities. Non-traditional loans accounted for 19% of PMI's new insurance
written in 2001 compared to 20% in 2000 and 7% in 1999. At December 31, 2001,
non-traditional loans composed 15% of PMI's insurance in force compared to 9% at
year-end 2000 and 7% at year-end 1999. Loan characteristics, credit quality,
loss development, pricing structures and persistency related to non-traditional
loans can vary significantly from PMI's traditional primary business. We expect
higher delinquencies and default rates for non-traditional loans and incorporate
these assumptions into our pricing. However, mortgage insurance on
non-traditional loans may not generate the same returns as the traditional
primary business, and the premiums earned may not adequately offset the
associated risk.
<PAGE>
In August 2001, MICA, on behalf of the private mortgage insurance industry,
revised and standardized several categories of insurance that are reported by
mortgage insurers to MICA. These categories include new insurance written,
traditional primary insurance, bulk primary insurance and pool insurance. PMI
implemented the definitional change effective for the third quarter of 2001 and
the new insurance written reported for the second half of 2001 was based upon
these newly defined categories. As a result, for the year ended December 31,
2001, PMI reported approximately $1.8 billion of additional primary new
insurance written that previously would have been included in pool insurance. We
believe that this new definitional change does not materially impact PMI's
previously reported new insurance written.
Primary insurance and risk in force - PMI's primary insurance in force refers to
the principal balance of all mortgage loans with primary insurance as of a given
date. PMI's primary risk in force is the dollar amount equal to the sum of each
individual insured mortgage loan's current principal balance multiplied by the
percentage specified in the policy of the insurance coverage. Primary insurance
in force and risk in force for PMI, and on a combined basis with CMG, are
presented in the table below:
<TABLE>
<CAPTION>
Percentage change
-----------------
2001 2000
As of December 31, vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Primary insurance in force, PMI $109,158 $ 96,914 $86,729 13% 12%
Primary insurance in force, PMI and CMG $118,111 $103,987 $92,524 14% 12%
Primary risk in force, PMI $ 25,772 $ 23,559 $21,159 9% 11%
Primary risk in force, PMI and CMG $ 27,902 $ 25,306 $22,581 10% 12%
</TABLE>
PMI's growth in primary insurance in force and risk in force in 2001 and 2000
were largely due to increases in new insurance written, partially offset by
policy cancellations. In recent years, cancellation levels were significantly
impacted by the refinance market and the movements in interest rates. Policy
cancellations in 2001 increased 110% to $35.8 billion due to heavy refinance
activity in 2001. Cancellations decreased to $17.1 billion in 2000 from $22.2
billion in 1999 due to lower refinance levels in 2000. Consequently, PMI's
persistency rate was 63.0% at December 31, 2001, 80.3% at year-end 2000 and
71.9% at year-end 1999. PMI's persistency rate refers to the percentage of
insurance policies at the beginning of a period that remains in force at the end
of the twelve-month period. We presently believe that our persistency rate will
increase in the second half of 2002 as a result of anticipated rising interest
rates.
Pool insurance - PMI offers pool insurance coverage in response to lender or
investor requests. Pool insurance is typically issued in negotiated
transactions, as part of the restructuring of primary mortgage insurance or to
provide an additional layer of coverage. Pool insurance may be attractive to
lenders and investors seeking capital relief or the reduction of default risk
beyond the protection provided by existing primary mortgage insurance.
PMI offers traditional pool insurance that covers all losses on any individual
loan held within a group of insured loans up to an agreed aggregated amount for
the entire pool. PMI's traditional pool products include GSE Pool, which
represents mortgage loans held by, or sold to, Fannie Mae and Freddie Mac, or
the GSEs. PMI wrote $19.5 million of GSE Pool risk in 2001 compared to $106.0
million in 2000 and $230.9 million in 1999. GSE Pool risk in force at December
31, 2001 was $801.5 million, $785.6 million at year-end 2000 and $681.4 million
at year-end 1999. Another of PMI's traditional pool products is Old Pool, which
is the capital markets pool product that PMI offered and insured prior to 1994.
We believe that this portfolio has past its peak claim period. Old Pool risk in
force was $1.11 billion as of December 31, 2001, $1.39 billion as of December
31, 2000 and $1.41 billion as of December 31, 1999. PMI also
<PAGE>
provides various other traditional pool insurance to state housing authorities,
lenders and investors. The risk written for those pool products was immaterial
in 2001. PMI is not actively offering traditional pool insurance.
PMI offers modified pool insurance products, primarily to the GSEs, which have
exposure limits on each individual loan in addition to having a stated aggregate
loss limit for the pool. Modified pool insurance may be used as an alternative
to primary insurance, used to cover loans that do not require primary mortgage
insurance, or used as an additional credit enhancement for secondary market
mortgage transactions. Modified pool insurance written may be included in PMI's
new insurance written or pool risk written, depending upon a number of factors
including whether primary mortgage insurance coverage was previously placed on
the mortgage loans and the percentages of coverage offered by the modified pool
policy. The additional $1.8 billion of primary new insurance written, or $66
million primary risk written, noted above was in the form of modified pool
coverage. In 2001, PMI wrote $414.7 million of modified pool risk, compared to
$85.7 million in 2000. Modified pool risk in force was $554.1 million at
December 31, 2001.
Premiums written and earned - PMI's net premiums written refers to the amount of
premiums received during a given period, net of refunds and premiums ceded under
reinsurance arrangements, including captive reinsurance arrangements. Captive
reinsurance is a reinsurance product in which PMI shares portions of its risk
written on loans originated by certain lenders with captive reinsurance
companies affiliated with such lenders. In return, a proportionate amount of
PMI's gross premiums written is ceded to the captive reinsurance companies. The
components of PMI's net premiums written and premiums earned for the last three
years are as follows:
Percentage change
-----------------
2001 2000
vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- --------------------------------------------------------------------------------
Gross premiums written $623 $545 $500 14% 9%
Ceded premiums 61 36 25 69% 44%
Refunded premiums 18 11 16 64% (31)%
---- ---- ----
Net premiums written $544 $498 $459 9% 8%
==== ==== ====
Premiums earned $553 $504 $447 10% 13%
In 2001 and 2000, increases in net premiums written were due largely to the
growth of PMI's primary insurance in force and pool risk in force as discussed
above. The increase in ceded premiums in 2001 and 2000 were the result of
increases in captive reinsurance agreements and, with respect to 2001, the heavy
volume of refinance activity. During 2001, 43% of new insurance written and 8%
of total premiums were subject to captive agreements; 34% of new insurance
written and 6% of total premiums were subject to captive agreements during 2000;
and approximately 25% of new insurance written and 5% of total premiums were
subject to captive agreements during 1999. We anticipate that higher levels of
captive reinsurance cessions will continue to reduce our net premiums written
and earned due to the increasing percentage of new insurance written associated
with captive reinsurance agreements. Primary risk in force under all reinsurance
arrangements, including captive agreements, with PMI's customers represented 38%
of primary risk in force at December 31, 2001 compared to 33% at December 31,
2000 and 28% at December 31, 1999. We anticipate that the percentage of PMI's
risk in force related to reinsurance arrangements will continue to increase as a
percentage of total risk in force due to the increasing captive reinsurance
agreements.
The increase in refunded premiums in 2001 and decrease in refunded premiums in
2000 were driven by the levels of policy cancellations, as discussed above. The
amount of premiums recognized as revenue
<PAGE>
for accounting purposes, or premiums earned, increased in 2001 and 2000. These
increases were primarily attributable to increases in premiums written related
to the growth of our insurance portfolio.
Losses and loss adjustments expenses - PMI's losses and loss adjustment expenses
reflects amounts paid on insurance claims and increases or decreases in loss
reserves during the corresponding period. We establish loss reserves based upon
estimated claim rates and average claim sizes for the default inventory and
defaults incurred but not reported. PMI's losses and loss adjustment expenses
and related claims data are shown in the following table:
<TABLE>
<CAPTION>
Percentage change
-----------------
2001 2000
vs. vs.
2001 2000 1999 2000 1999
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Losses and loss adjustment expenses (in millions) $ 103 $ 95 $ 111 8% (14)%
Primary claims paid (in millions) $ 77 $ 67 $ 80 15% (16)%
Number of primary claims paid 3,695 3,518 3,945 5% (11)%
Average primary claim size (in thousands) $ 21 $ 19 $ 20 11% (5)%
Primary loans in default 25,907 18,093 15,893 43% 14%
</TABLE>
The increases in losses and loss adjustment expenses and total primary claims
paid in 2001 were due, in part, to the economic downturn in 2001 and the
maturation of our 1996 through 1999 books of business, which we believe are in
their peak delinquency years. The 1996 through 1999 books of business accounted
for approximately 36% of our total primary loans in force at December 31, 2001.
In 2001, the average size of primary claims paid increased as a result of the
economic slowdown offset, in part, by relatively stable home prices in many
regions of the United States and PMI's continued loss mitigation efforts. PMI's
loss mitigation efforts, which focus on selecting the optimal claim settlement
on a case-by-case basis, could be limited in the future by any deterioration in
housing prices or by the weakening economy. The declines in losses and loss
adjustment expenses and primary claims paid in 2000 were primarily due to the
favorable housing market and strong home prices nationwide during that period.
The increases in PMI's primary loans in default in 2000 and 2001 were primarily
due to the maturation of the 1996 through 1999 books of business and the
addition of non-traditional loans to PMI's insurance portfolio in 2000 and 2001.
Non-traditional loans are often insured through negotiated bulk transactions,
and are generally riskier than loans in PMI's traditional primary insurance
portfolio. As of December 31, 2001, 58% of our primary loans in force generated
from bulk transactions were non-traditional loans, compared to 53% in 2000 and
3% in 1999. PMI's delinquency rate, the percentage of insured loans in force
that are in default at a given time, for bulk loans was 5.55% at December 31,
2001. PMI's primary insurance loan delinquency rate, excluding bulk loans, was
2.54% at December 31, 2001. PMI's primary insurance loan delinquency rate,
including bulk loans, was 2.86% at December 31, 2001 compared to 2.21% at
December 31, 2000 and 2.12% at December 31, 1999.
Total operating expenses - Total operating expenses reported in the current
period can be divided into two categories: (i) amortization of deferred policy
acquisition costs, which relate to incurred costs for acquiring, underwriting
and processing new business, are recorded as assets and amortized principally
over a two-year period; and (ii) other underwriting and operating expenses and
corporate overhead, which are all other costs that are not accounted for as
acquisition costs and are recorded as expenses when incurred. The composition of
PMI's total operating expenses for the last three years is shown below:
<PAGE>
<TABLE>
<CAPTION>
Percentage change
-----------------
2001 2000
vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Amortization of deferred policy acquisition costs $ 76 $ 77 $ 80 (1)% (4)%
Other underwriting and operating expenses 61 55 54 11% 1%
---- ---- ----
Total operating expenses $137 $132 $134 4% (1)%
==== ==== ====
Policy acquisition costs incurred and deferred $ 78 $ 75 $ 86 4% (13)%
</TABLE>
The amortization of deferred policy acquisition costs is determined by the
proportion of the policy acquisition costs deferred in the current year and the
remaining balance of deferred acquisition costs from the prior year. The
amortization for deferred policy acquisition costs is accelerated in the first
year due to different depreciation methods used for the two-year period. Other
non-acquisition related operating costs increased in 2001 and 2000 primarily due
to increases in payroll and related expenses.
Policy acquisition costs - PMI's policy acquisition costs are deferred and
include all underwriting, contract underwriting, field operations and sales
related expenses. These costs are amortized to expenses based on the estimated
gross profits. An increase in policy acquisition costs incurred and deferred in
2001 was due to the growth in new insurance written, partially offset by the use
of PMI's electronic origination and delivery methods. A decrease in policy
acquisition costs incurred and deferred in 2000 was due to lower new insurance
written coupled with the use of electronic origination and delivery methods.
During 2001, electronic delivery accounted for 52% of PMI's insurance
commitments, excluding bulk transactions, compared to 23% in 2000 and 15% in
1999. We believe that the use of electronic origination and delivery of our
products will increase in 2002.
A large part of PMI's policy acquisition costs relates to the business processed
and underwritten through our contract underwriting services. PMI provides
contract underwriting services to our customers for both mortgage loans which
PMI insures and for loans which PMI does not insure. New policies processed by
contract underwriters represented 26% of new insurance written during 2001
compared to 23% during 2000 and 36% during 1999. We anticipate that costs
incurred by contract underwriting will continue to account in 2002 for a
significant portion of PMI's acquisition costs as our customers continue to
outsource mortgage loan underwriting activities.
Ratios - PMI's loss, expense and combined ratios for the last three years are
shown in the following table:
Variance
-------------------
2001 2000
vs. vs.
2001 2000 1999 2000 1999
- --------------------------------------------------------------------------------
Loss ratio 18.6% 18.9% 24.7% (0.3)% (5.8)%
Expense ratio 25.2 25.3 29.2 (0.1)% (3.9)%
----- ----- -----
Combined ratio 43.8% 44.2% 53.9% (0.4)% (9.7)%
===== ===== =====
The loss ratio is the ratio of losses and loss adjustment expenses to premiums
earned. The expense ratio is the ratio of amortization of acquisition costs and
other underwriting and operating expenses, excluding interest expense, to the
net amount of premiums written during a given period. The combined ratio is the
sum of the loss ratio and the expense ratio.
<PAGE>
International Mortgage Insurance Operations
International Mortgage Insurance operations include the results of PMI Mortgage
Insurance Ltd, or PMI Ltd, and PMI Indemnity Limited, collectively referred to
as PMI Australia; as well as PMI Mortgage Insurance Company Limited, or PMI
Europe. The financial results of international operations are subject to
currency rate adjustments in translation to U.S. dollar reporting.
The reported results of PMI Ltd were affected by the devaluation in the
Australian dollar from 1999 to 2001. The average AUD/USD exchange rate was 0.520
in 2001, 0.585 in 2000, and 0.645 from September through December 1999. We
acquired PMI Indemnity Limited in September 2001, and its results were included
in the 2001 fourth quarter results of our Australian operations. The results of
our Australian operations for 2000 reflect eleven months of activity of PMI Ltd
due to the one-month lag reporting period, whereas 2001 results reflect thirteen
months of activity as we began to report our foreign subsidiaries on the same
calendar month as U.S. operations. Because we commenced operations in Australia
in August 1999 through the acquisition of PMI Ltd, the 1999 results represent
operations from the date of acquisition. Accordingly, the results of our
Australian operations for 2001 are not comparable to the prior years.
The table below summarizes the reported results of our Australian operations
from August 1999 through the end of 2001:
(In millions) 2001 2000 1999
- --------------------------------------------------------------------------------
Net income $ 32 $ 16 $ 7
Net premiums written $ 56 $ 37 $ 12
Premiums earned $ 44 $ 27 $ 11
Net investment income $ 23 $ 12 $ 5
Losses and loss adjustment expenses $ 9 $ 6 $ 1
Underwriting and other expenses $ 11 $ 7 $ 3
New insurance written $11,293 $ 6,841 $ 2,149
Insurance in force $43,340 $20,057 $20,370
Risk in force $38,129 $19,080 $19,419
PMI Europe commenced operations in February 2001 and generated $5.5 million of
net income in 2001, including currency translation gains of $4.6 million and
investment income. Financial results for the operations in Hong Kong were
immaterial during 2001, 2000 and 1999.
Title Insurance Operations
The following table sets forth the results of our title insurance subsidiary,
American Pioneer Title Insurance Company, or APTIC:
<TABLE>
<CAPTION>
Percentage change/variance
--------------------------
2001 2000
vs. vs.
(In millions except percentages) 2001 2000 1999 2000 1999
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net income $ 9 $ 6 $ 8 50% (25)%
Premiums earned $ 158 $ 104 $ 100 52% 4%
Underwriting and other expenses $ 142 $ 94 $ 88 51% 7%
Combined ratios 93.8% 92.7% 89.1% 1.1% 3.6%
</TABLE>
The increase in 2001 premiums earned was due to an increase in total residential
mortgage originations and continued geographic expansion of our title insurance
operations. The increase in premiums earned
<PAGE>
in 2000 compared to 1999 was due to the geographic expansion, offset by a
decline in residential mortgage originations. In 2001, 51% of APTIC's premiums
earned was generated in Florida compared to 64% in 2000 and 73% in 1999. APTIC
wrote title insurance policies in 39 states in 2001 compared to 35 states in
2000 and 33 states in 1999. The increases in underwriting and other expenses in
2001 and 2000 were primarily due to increases in agency fees and commissions
related to higher premiums earned and to the costs associated with expansion
efforts.
Other
Other income, which was generated by PMI Mortgage Services Co., or MSC, and our
holding company, or TPG, was $27.8 million in 2001, $8.2 million in 2000 and
$15.9 million in 1999. The increase in 2001 was primarily attributed to
increased contract underwriting activity in connection with higher mortgage
origination volume, and to an increase in the billing rates for contract
underwriting services. The decrease in 2000 was due to a decline in contract
underwriting activity in 2000 and to interest on an IRS tax refund received in
1999. Other expenses, which were incurred by TPG and MSC, increased to $59.5
million in 2001 compared to $33.9 million in 2000 and $24.8 million in 1999.
These increases were due to the increased expenses related to international
expansion and diversification efforts for both 2001 and 2000, and to the
increased expenses associated with higher contract underwriting activity in
2001.
Corporate
Investment income - Our consolidated net investment income, excluding realized
investment gains and losses, was $150.0 million in 2001, a 26% increase from
2000. This increase was due primarily to the cash flows our insurance operations
contributed to the investment portfolio growth, and to the investment income on
the proceeds from the $360.0 million Convertible Debentures offering in July
2001. Our consolidated net investment income, excluding realized investment
gains and losses, was $119.2 million in 2000, a 25% increase from 1999, largely
due to the growth in our investment portfolio. The pre-tax current book yield
was 5.9% in 2001, 5.9% in 2000 and 6.0% in 1999.
Net realized investment gains & losses - Net realized investment gains of $0.01
million for 2001 included a realized loss of $0.8 million resulted from
termination of an interest rate swap associated with the repayment of a bank
loan obtained to finance the PMI Ltd acquisition. Net realized investment gains
were $0.4 million in 2000 and $0.5 million in 1999.
Interest expense - We incurred $14.1 million of interest expense in 2001
compared to $10.2 million in 2000, due to the interest expense and accrual on
higher average debt outstanding during 2001 including the $360.0 million
Convertible Debentures that bear an interest rate of 2.5% per annum.
Approximately $130 million of the net proceeds from the Convertible Debentures
offering were used to repay and extinguish portions of our higher interest rate
debt. The interest expense for 2000 increased by $1.7 million over 1999, due to
a full year of interest incurred on the bank loan.
Taxes - Our effective tax rate was 30.1% in 2001 compared to 30.4% in 2000 and
29.5% in 1999. Our effective tax rate fluctuates from year to year primarily due
to the proportion of tax-exempt earnings relative to total pre-tax income.
Additionally, variations in the effective tax rate are due to changes in
statutory tax rates of countries in which foreign subsidiaries generate taxable
profits, and to fluctuations in the taxable earnings of those foreign
subsidiaries relative to total taxable earnings as a whole.
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
TPG's principal sources of funds are dividends from two of its subsidiaries, PMI
and APTIC, investment income, and funds that may be raised from time to time in
the capital markets. PMI generates substantial cash flow from premiums written
on its insurance business and from investment returns on its investment
portfolio.
PMI's ability to pay dividends to TPG is affected by state insurance laws,
credit agreements, credit rating agencies and the discretion of insurance
regulatory authorities. The laws of Arizona, the state of PMI's domicile for
insurance regulatory purposes, provide that PMI may pay out of any available
surplus account without prior approval of the Director of the Arizona Department
of Insurance dividends during any twelve-month period an amount not to exceed
the lesser of 10% of policyholders' surplus as of the preceding year end or the
last calendar year's investment income. In addition to Arizona, other states may
limit or restrict PMI's ability to pay shareholder dividends. For example,
California, New York and Illinois prohibit mortgage insurers from declaring
dividends except from undivided profits remaining on hand over and above the
aggregate of their paid-in capital, paid-in surplus and contingency reserves.
Under Arizona law, based on the amount of its policyholders' surplus, PMI would
be able to pay dividends of approximately $16.0 million in 2002 without prior
approval of the Director of the Arizona Department of Insurance. In 2001, PMI
paid an extraordinary dividend of $50.0 million to TPG, which was approved by
the Arizona Department of Insurance.
The laws of Florida limit the payment of dividends by APTIC to TPG in any one
year to 10% of available and accumulated surplus derived from realized net
operating profits and net realized capital gains. As with PMI, the various
credit rating agencies and insurance regulatory authorities have broad
discretion to affect the payment of dividends to TPG by APTIC. Under Florida
law, APTIC would be able to pay dividends of $3.0 million in 2002 without prior
permission from the Florida Department of Insurance. APTIC declared and paid a
cash dividend of $2.5 million to TPG in 2001.
TPG's principal uses of funds are the payments of dividends to shareholders,
common stock repurchases, investments and acquisitions, and interest payments.
Our board of directors authorized a stock repurchase program in the amount of
$100.0 million in 1998. No common stock was repurchased during 2001, and $45.3
million remained available under the 1998 authorization as of December 31, 2001.
TPG had $335.5 million of available funds at December 31, 2001, an increase from
the December 31, 2000 balance of $108.3 million, due primarily to the $360.0
million Convertible Debentures offering in July 2001.
We believe that we have sufficient cash to meet all of our short- and
medium-term obligations, and that we maintain adequate liquidity to support our
operations. Our investment portfolio holds primarily investment grade securities
comprised of readily marketable fixed income and equity securities. As of
December 31, 2001, the fair value of our consolidated investment portfolio,
excluding investments in affiliates, increased to $2.4 billion from $1.9 billion
at year-end 2000.
We manage our capital resources based on our cash flow, total capital and rating
agency requirements. In July 2001, we issued $360.0 million of 2.50% Senior
Convertible Debentures in a private offering. We used the proceeds for working
capital and other general corporate purposes, as well as to repay and extinguish
portions of our long-term debt. Approximately $130 million of the net proceeds
were used to repay an outstanding bank loan in the amount of $35.7 million with
Bank of America, to repurchase $37.1 million of the $100.0 million 6.75% Senior
Notes, resulting in an extraordinary loss of $2.9 million, net of tax, and to
retire $51.5 million of the $100.0 million 8.309% Capital Securities, resulting
in an extraordinary loss of $1.9 million, net of tax.
<PAGE>
We have a bank credit line in the amount of $25.0 million with Bank of America.
The agreement has recently been extended to December 30, 2002. There are no
outstanding borrowings under the credit line. This financial instrument contains
certain financial covenants and restrictions, including risk-to-capital ratios,
and minimum capital and dividend restrictions.
As of December 31, 2001, our total shareholders' equity was $1.8 billion. Our
long-term debt and other capital securities outstanding at December 31, 2001 was
$471.5 million, which was comprised of the following:
. $360.0 million 2.50% Senior Convertible Debentures due July 15, 2021. We
may not redeem the Debentures prior to July 15, 2006;
. $63.0 million 6.75% Notes due November 15, 2006; and
. $48.5 million 8.309% Capital Securities mature on February 1, 2027. The
Capital Securities are redeemable after February 1, 2007.
As of December 31, 2001, a schedule of our contractual obligations and
commercial commitments is as follows:
Payments Due by Period
----------------------------------------------------------
Less than After five
(In millions) Total one year 1 - 3 years 4 - 5 years years
- --------------------------------------------------------------------------------
Long-term Debt $423 -- -- $63 $360
Capital Securities $ 49 -- -- -- $ 49
Operating Leases $ 34 $12 $18 $ 3 $ 1
The 2.50% Senior Convertible Debentures included in our long-term debt are
redeemable at our option beginning in 2006. The holders of the Debentures may
require us to repurchase the Debentures on July 15, 2004, 2006, 2008, 2011 or
2016, and in certain other circumstances, at a price equal to the principal
amount thereof plus any accrued and unpaid interest, including contingent
interest and additional interest, if any, to the date of purchase. We may chose
to pay the purchase price in cash, common stock, or a combination of cash and
shares of common stock. If we elect to pay all or a portion of the purchase
price in common stock, the shares of common stock will be valued at 97.5% of the
average sale price for the twenty trading days ending on the third day prior to
the repurchase date. Holders of the Debentures may convert their Debentures
prior to stated maturity under certain circumstances. For additional information
about the terms of the Debentures, including the circumstances under which
contingent interest will be payable, see the Company's Current Report on Form
8-K, filed with the SEC on July 18, 2001, including the exhibits attached
thereto.
Included in the operating leases is the lease agreement for our current
corporate offices in San Francisco. We are scheduled to move to a new
headquarters location in Walnut Creek, California, in 2002, which we currently
intend to acquire on an unencumbered basis. Charges associated with the lease
abandonment and relocation costs will be reflected in our results in 2002.
Our consolidated reserves for losses and loss adjustment expenses with respect
to claim losses increased from December 31, 2000 by $19.5 million to $314.6
million at December 31, 2001, due primarily to an increase in the reserve
balances for the primary insurance books of business as a result of higher
levels of defaults.
PMI's claims-paying ability ratings from certain national rating agencies have
been based in part on the third party reinsurance arrangements and on various
capital support commitments from Allstate Insurance Company, or Allstate, PMI's
former parent company. Under the terms of a runoff support agreement
<PAGE>
with Allstate, in the event (i) PMI's risk-to-capital ratio exceeds 23 to 1,
(ii) PMI's statutory policyholder surplus is less than $15.0 million, or (iii) a
third party beneficiary brings a claim under the runoff support agreement, then
Allstate may, at its option, in satisfaction of certain obligations it may have
under such agreement (a) pay to PMI (or to TPG for contribution to PMI) an
amount equal to claims relating to policies written prior to termination of the
Allstate support arrangements which are not paid by PMI or (b) pay such claims
directly to the policyholder. In the event Allstate makes any payment
contemplated by the runoff support agreement (which possibility we believe is
remote and, in the event unexpected losses or unforeseen events cause the
risk-to-capital ratio to increase, there are several courses of action available
to us to maintain PMI's risk-to-capital ratio below 23 to 1), Allstate will be
entitled to receive, at its option, subordinated debt or preferred stock of PMI
or TPG, as applicable, in return.
In 1997, PMI entered into a capital support commitment to Duff & Phelps Credit
Rating Co. ("Fitch"), under which it agreed to contribute to APTIC amounts
necessary to maintain APTIC's capital and surplus at a level no less than 100%
of Fitch's risk adjusted capital requirements to attain a Fitch claims paying
ability rating of not less than "AA-" at the end of each year. PMI also entered
into a cancellation agreement with APTIC that provides that, in the event PMI
provides notice of its intent to cancel the capital support commitment, APTIC
will immediately submit a request to Fitch to be rated on a stand-alone basis
and sign an agreement canceling APTIC's rights under the capital support
commitment.
In 2001, PMI executed a capital support agreement, superseding a prior capital
support agreement, whereby it agreed to contribute funds, under specified
conditions, to maintain CMG's risk-to-capital at or below 18.0 to 1. PMI's
obligation under the agreement is limited to an aggregate amount of $37.7
million, exclusive of capital contributions made prior to April 10, 2001. On
December 31, 2001, CMG's risk-to capital ratio was 14.8 to 1.
PMI has entered into various capital support agreements with its European and
Australian subsidiaries for ratings agency purposes that could require PMI to
make additional capital contributions to those subsidiaries. In a capital
support agreement with its Australian subsidiary, PMI Ltd, PMI agreed to
maintain PMI Ltd's net assets, as defined by Australian insurance law, at a
prudent level of capital but, in any event, not less than 2% of PMI Ltd's net
aggregate risk, as that term is defined by the agreement, plus AUD$50,000,000.
For rating agency purposes, PMI has agreed that the support required by the
phrase, a "prudent level of capital," is all amounts necessary to maintain PMI
Ltd's stand-alone financial strength rating at not less than "A." In addition,
PMI agreed to provide funds to PMI Ltd to ensure that PMI Ltd is able to meet
its obligations under its insurance policies. The agreement continues
indefinitely but may be terminated by mutual agreement of PMI and PMI Ltd at any
time, subject to not adversely affecting the interests of PMI Ltd policyholders.
In a capital support agreement with its Australian subsidiary, PMI Indemnity,
PMI agreed to maintain PMI Indemnity's net assets at a prudent level of capital
but, in any event, not less than 2% of PMI Indemnity's net aggregate risk. For
rating agency purposes, PMI has agreed that the support required by the phrase,
a "prudent level of capital," is all amounts necessary to maintain PMI
Indemnity's stand-alone financial strength rating at not less than "A-." PMI
also agreed to provide funds to PMI Indemnity to ensure that it is able to meet
its obligations under its insurance policies. The agreement with PMI Indemnity
continues indefinitely but may be terminated upon terms similar to those
contained in the PMI Ltd capital support agreement.
Under the terms of PMI's capital support agreement with PMI Europe, PMI agreed
to provide funds, as necessary, to ensure that PMI Europe is able to meet its
obligations in respect of all contracts of reinsurance when such obligations are
due and to maintain PMI Europe's minimum capital at an amount sufficient to
maintain its S&P and Moody's ratings at "AA-" and "Aa3." The agreement may be
terminated or amended by written agreement of PMI and PMI Europe, but no
amendment that shall
<PAGE>
adversely affect insureds shall be effective as to insurance contracts entered
into prior to such amendment. TPG guarantees the obligations of PMI under its
capital support agreements with PMI Ltd, PMI Indemnity and PMI Europe.
On February 20, 2002, the Office of Federal Housing Enterprise Oversight
finalized a risk-based capital rule that treats credit enhancements issued by
private mortgage insurance companies with claims-paying ability ratings of "AAA"
more favorably than those issued by mortgage insurance companies with "AA"
ratings. The rule also provides capital guidelines for the GSEs in connection
with their use of other types of credit protection counter parties in addition
to mortgage insurers. We are currently rated "AA+" by Standard & Poor's, but do
not have a "AAA" rating and may need to obtain such a rating as a result of the
rule. To obtain a claims-paying ability rating of "AAA" we may need to dedicate
significant capital to the mortgage insurance business that we might use in
other ways, and we would also have additional costs that we would not otherwise
incur. Two of our direct competitors have "AAA" claims-paying ratings, with the
remainder being rated "AA." While we are currently considering various options
to address the rule, we cannot be sure either that we will be able to implement
any of these options in a timely manner, or if these options implemented, will
be effective to address the capital differential contained in the rule. If we
are unable to address the capital differential contained in the rule in a timely
manner, or at all, our business could be seriously harmed. It is not clear at
this point whether the final ruling will result in the GSEs increasing their use
of either AAA-rated mortgage insurers instead of AA-rated entities or credit
counterparties other than mortgage insurers.
PMI's ratio of net risk in force to statutory capital, or statutory
risk-to-capital ratio, at December 31, 2001 was 13.0 to 1 compared to 14.1 to 1
at December 31, 2000.
The holding company's consolidated ratio of earnings to fixed charges for the
year ended December 31, 2001, was 18.1. For purposes of the ratio of earnings to
fixed charges, "earnings" represent income from continuing operations before
income taxes plus fixed charges. "Fixed charges" represent interest expense plus
that portion of rent expense that, in our opinion, approximates the interest
factor included in rent expense plus distributions on Preferred Capital
Securities. As of the date of this report, we have no preferred stock
outstanding.
<PAGE>
CRITICAL ACCOUNTING POLICIES
The "Management's Discussion and Analysis of Financial Condition and Results of
Operation," as well as disclosures included elsewhere in this Annual Report on
Form 10-K, are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosure of contingencies.
Actual results may differ significantly from these estimates under different
assumptions or conditions. We believe that the following critical accounting
policies involved the more significant judgments and estimates used in the
preparation of our financial statements.
Revenue Recognition - We generate a significant portion of our revenues from
mortgage insurance premiums paid by lenders and investors, on either a monthly,
annual or single payment basis. Monthly premiums are earned as coverage is
provided. Annual premiums are earned on a monthly pro rated basis over the year
of coverage. Single premiums are initially deferred as unearned premiums and
earned over the expected policy terms. The earning cycle for single premium
products is based on a range of seven- to eight-year cycle, which reflects the
timing and the severity of default or claims event for a policy year, and rates
used to determine the earnings are estimates based on the expiration of
corresponding risk. Earning pattern calculation is an estimation process and,
accordingly, we review our premium earning cycle regularly and any adjustments
to the estimates are reflected in the current period's operating results.
Reserves For Losses and Loss Adjustment Expenses - In establishing losses and
loss adjustment expenses ("LAE") reserves, we review information that is company
specific and industry related, as well as general economic conditions. Losses
and LAE reserves are determined by the estimates of ultimate claim rates and
average claim sizes for notices of default received and the estimated number of
defaults not reported prior to the close of an accounting period. These
estimates are based on assumptions primarily derived from analysis of historical
default and recovery experience. Significant assumptions used in the estimation
process, including expected claim rates, average claim sizes, claim severity,
and expected costs to settle claims, could have significant effects on the
reserve balances. We regularly evaluate the life cycle of claims based on our
historical experience and other available market data. We do not rely on a
single estimate to determine our loss reserves. To ensure the reasonableness of
the best estimates, we developed scenarios using generally recognized actuarial
projection methodologies that result in a range of possible losses and LAE
reserves. Each scenario in the loss reserve model is assigned different
weightings to actual claims experience in prior years to project the current
liability. Our best estimate was at slightly above the midpoint of this range
for 2001, which represented the most reasonable estimate based on our analysis
and assessment of current economic conditions. We monitor the reasonableness of
the judgments made in our prior year estimation process and adjust our current
year assumptions as appropriate. However, the loss reserving process is complex
and subjective and, therefore, the ultimate liability may vary significantly
from our estimates.
Deferred Policy Acquisition Costs - Our policy acquisition costs are related to
the issuance of primary mortgage insurance policies, including acquiring,
underwriting and processing new business, as well as sales related expenses. We
defer policy acquisition costs when incurred and amortize these costs over a
two-year period, which is based on estimated gross profits in order to match
costs and revenues. We review our estimation process on a regular basis and any
adjustments made to the estimates are reflected in the current period's
operating results.
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The fair value of certain investments in our investment portfolio are interest
rate sensitive and are subject to change based on potential interest rate
movements. The result of a 100 basis points increase in interest rates would be
a 5.6% decrease in the value of our investment portfolio, while the result of a
100 basis points decrease in interest rates would be a 4.7% increase in the
value of our investment portfolio. As of December 31, 2001, the effective
duration of our investment portfolio was 5.9 years.
At December 31, 2001, $288.6 million of our invested assets were held by PMI
Australia and were denominated in Australian dollars, which has experienced
devaluation during 2001 compared to 2000 and 1999. At December 31 2001, $77.9
million of our invested assets were held by PMI Europe of which $61.3 million
were denominated in Euros, which has experienced appreciation in values during
2001.
<PAGE>
INVESTMENT CONSIDERATIONS
General economic factors may adversely affect our loss experience and the demand
for mortgage insurance.
Losses result from events, such as unemployment, that reduce a borrower's
ability to continue to make mortgage payments. The amount of the loss, if any,
depends in part on whether the home of a borrower who defaults on a mortgage can
be sold for an amount that will cover unpaid principal and interest and the
expenses of the sale. Favorable economic conditions generally reduce the
likelihood that borrowers will lack sufficient income to pay their mortgages and
also favorably affect the value of homes, reducing and in some cases even
eliminating a loss from a mortgage default. We believe that our loss experience
could materially increase as a result of:
. national or regional economic recessions;
. declining values of homes;
. higher unemployment rates;
. deteriorating borrower credit;
. interest rate volatility;
. shortages of electric power in California or other states; or
. combinations of these factors
These factors could also materially reduce the demand for housing and,
consequently, the demand for mortgage insurance.
The United States has been experiencing an economic downturn. If this economic
downturn continues or worsens, our loss experience could suffer and demand for
mortgage insurance could decline.
If interest rates decline, home values increase or mortgage insurance
cancellation requirements change, the length of time that our policies remain in
force and our revenues could decline.
A significant percentage of the premiums we earn each year is generated from
insurance policies that we have written in previous years. As a result, the
length of time insurance remains in force is an important determinant of our
revenues. The policy owner or servicer of the loan may cancel insurance coverage
at any time. In addition, the Homeowners Protection Act of 1998 provides for the
automatic termination or cancellation of mortgage insurance upon a borrower's
request if specified conditions are satisfied. Factors that tend to reduce the
length of time our insurance remains in force include:
. current mortgage interest rates falling below the rates on the
mortgages underlying our insurance in force, which frequently
results in borrowers refinancing their mortgages and canceling their
existing mortgage insurance;
. the rate of appreciation in home values experienced by the homes
underlying the mortgages of the insurance in force, which can result
in the cancellation of mortgage insurance; and
. changes in the mortgage insurance cancellation policies of mortgage
lenders and investors.
Although we have a history of expanding our business during periods of low
interest rates, the resulting increase of new insurance written may not be
adequate to compensate us for our loss of insurance in force arising from policy
cancellations.
<PAGE>
If the volume of low down payment home mortgage originations declines, the
amount of insurance that we write could also decline, which could result in a
decline in our future revenue.
The factors that affect the volume of low down payment mortgage originations
include:
. the level of home mortgage interest rates;
. the health of the domestic economy as well as conditions in regional
and local economies;
. consumer confidence, which may be adversely affected by economic
instability, war or terrorist events such as the attacks on the
World Trade Center and the Pentagon;
. housing affordability;
. population trends, including the rate of household formation;
. the rate of home price appreciation, which in times of heavy
refinancing affects whether refinance loans have loan-to-value
ratios that require private mortgage insurance; and
. government housing policy encouraging loans to first-time
homebuyers.
A decline in the volume of low down payment housing could reduce the demand for
private mortgage insurance and, therefore, our revenues.
We cannot cancel mortgage insurance policies or adjust renewal premiums to
protect from unanticipated claims, which could harm our financial performance.
We cannot cancel the mortgage insurance coverage that we provide. In addition,
we generally establish renewal premium rates for the life of the mortgage
insurance policy when the policy is issued. As a result, the impact of
unanticipated claims generally cannot be offset by premium increases on policies
in force or limited by nonrenewal of insurance coverage. The premiums we charge
may not be adequate to compensate us for the risks and costs associated with the
insurance coverage we provide to our customers.
The risk-based capital rule issued by the Office of Federal Housing Enterprise
Oversight could require us to obtain a claims-paying ability rating of "AAA" and
could cause our business to suffer.
On February 20, 2002, the Office of Federal Housing Enterprise Oversight
finalized a risk-based capital rule that treats credit enhancements issued by
private mortgage insurance companies with claims-paying ability ratings of "AAA"
more favorably than those issued by mortgage insurance companies with "AA"
ratings. The rule also provides capital guidelines for the GSEs in connection
with their use of other types of credit protection counterparties in addition to
mortgage insurers. We have a "AA+" rating and may need to obtain a "AAA" rating
as a result of the rule. To obtain a claims-paying ability rating of "AAA" we
may need to dedicate significant capital to the mortgage insurance business that
we might use in other ways and we would also have additional costs that we would
not otherwise incur. Two of our direct competitors have "AAA" claims paying
ratings, with the balance being rated "AA." While we are currently considering
options to address the rule, we cannot be sure that we will be able to implement
any of the options that we have under consideration to address the risk-based
capital rule in a timely manner, or at all, or that these options, if
implemented, will be effective to address the capital differential contained in
the rule. If we are unable to address the capital differential contained in the
rule in a timely manner, or at all, our business could be seriously harmed. It
is not clear at this point whether the finalized rule will result in the GSEs
increasing their use of either AAA-rated mortgage insurers instead of AA-rated
entities or credit counterparties other than mortgage insurers. Changes in the
preferences of Fannie Mae and Freddie Mac, or the GSEs, for private mortgage
insurance to other forms of credit enhancement,
<PAGE>
or a tiering of mortgage insurers based on their credit rating, as a result of
the OFHEO rule could harm our financial condition and results of operations.
Because we compete with private mortgage insurers, governmental agencies and
others in an industry that is highly competitive, our revenues and profits could
decline substantially as we respond to competition or if we lose market share.
The principal sources of our direct and indirect competition include:
. other private mortgage insurers, some of which are subsidiaries of
well capitalized, diversified public companies with direct or
indirect capital reserves that provide them with potentially greater
resources than we have;
. federal and state governmental and quasi-governmental agencies,
principally the Federal Housing Administration, or FHA, and to a
lesser degree the Veterans Administration, or VA;
. mortgage lenders that choose not to insure against borrower default,
self-insure through affiliates, or offer residential mortgage
products that do not require mortgage insurance; and
. captive reinsurance subsidiaries of national banks, savings
institutions and bank holding companies and other mortgage lenders.
We cannot be sure that we will be able to compete successfully with our direct
or indirect competitors. If we are unable to compete successfully, our business
will suffer.
If mortgage lenders and investors select alternatives to private mortgage
insurance, the amount of insurance that we write could decline significantly,
which could reduce our revenues and profits.
Alternatives to private mortgage insurance include:
. government mortgage insurance programs, including those of the FHA
and the VA;
. member institutions providing credit enhancement on loans sold to a
Federal Home Loan Bank;
. investors holding mortgages in their portfolios and self-insuring;
. mortgage lenders maintaining lender recourse or participation with
respect to loans sold to the GSEs;
. investors using credit enhancements other than private mortgage
insurance or using other credit enhancements in conjunction with
reduced levels of private mortgage insurance coverage; and
. mortgage lenders structuring mortgage originations to avoid private
mortgage insurance, such as a first mortgage with an 80%
loan-to-value ratio and a second mortgage with a 10% loan-to-value
ratio, which is referred to as an 80-10-10 loan, rather than a first
mortgage with a 90% loan-to-value ratio. The loan-to-value ratio is
the ratio of the original loan amount to the value of the property.
These alternatives, or new alternatives to private mortgage insurance that may
develop, could reduce the demand for private mortgage insurance and cause our
revenues and profitability to decline.
The OFHEO risk-based capital rule may allow large financial entities such as
banks, financial guarantors, insurance companies, and brokerage firms to provide
or arrange for products that may efficiently substitute for some of the capital
relief provided to the GSEs by private mortgage insurance. Many of
<PAGE>
these entities have significantly more capital than we have and a few have "AAA"
ratings. The ability of these companies to offer or arrange for the products
described above will be dependent upon, among other things, how the OFHEO
risk-based capital rule is interpreted and administered and the willingness of
the GSEs to utilize such forms of credit enhancement. Our financial condition
and results of operations could be harmed if the GSEs were to use these products
in lieu of mortgage insurance.
Legislation and regulatory changes may reduce demand for private mortgage
insurance, which could harm our business.
Increases in the maximum loan amount or other features of the FHA mortgage
insurance program can reduce the demand for private mortgage insurance.
Legislative and regulatory changes have caused, and may cause in the future,
demand for private mortgage insurance to decrease and this could harm our
financial condition and results of operations.
As a result of the enactment of The Gramm-Leach-Bliley Act, we expect to
experience increased competition from mortgage insurance companies owned by
large, well capitalized financial services companies, which could significantly
harm our business.
The Gramm-Leach-Bliley Act allows bank holding companies to engage in a
substantially broader range of activities, including insurance underwriting,
than those companies could previously engage in and allows insurers and other
financial service companies to acquire banks. Bank holding companies are now
permitted to form insurance subsidiaries that issue insurance products,
including mortgage insurance, directly to consumers. We expect that, over time,
consumers will have the ability to shop for their insurance, banking and
investment needs at one financial services company. We believe that this new law
may lead to increased competition in the mortgage insurance industry by
facilitating the development of new savings and investment products, resulting
in mortgage lenders offering mortgage insurance directly to home borrowers
rather than through captive reinsurance arrangements with us and encouraging
large, well-capitalized financial service companies to enter the mortgage
insurance business.
We depend on a small number of customers and our business and financial
performance could suffer if we were to lose the business of a major mortgage
lender.
We are dependent on a small number of customers. Our top ten customers were
responsible for 38% of our new insurance written as of December 31, 2001. The
concentration of business with our customers may increase as a result of mergers
or other factors. These customers may reduce the amount of business currently
given to us or cease doing business with us altogether. Our master policies and
related lender agreements do not, and by law cannot, require our lenders to do
business with us. The loss of business from any major customer could seriously
harm our business and results of operations.
We acquire a significant percentage of our new business through negotiated bulk
transactions with a limited number of parties. Negotiated transactions are
transactions in which we insure a large group of loans or commit to insure new
loans on agreed-upon terms. Our business could be harmed if these investors
substitute other types of credit enhancement for private mortgage insurance.
We could lose premium revenue if Fannie Mae or Freddie Mac continue to reduce
the level of private mortgage insurance coverage required for low down payment
mortgages.
Fannie Mae and Freddie Mac are the beneficiaries on a substantial majority of
the insurance policies we issue as a result of their purchases of home loans
from lenders or investors. Fannie Mae and Freddie Mac offer programs that
require less mortgage insurance coverage on mortgages approved by their
automated underwriting systems. Fannie Mae and Freddie Mac might further reduce
coverage requirements. If the
<PAGE>
reduction in required levels of mortgage insurance becomes widely accepted by
mortgage lenders, our premium revenue would decline and our financial condition
and results of operations could suffer.
New products introduced by Fannie Mae or Freddie Mac, if widely accepted, could
harm our profitability.
Fannie Mae and Freddie Mac have separately introduced new products for which
they will, upon receipt from lenders of loans with primary mortgage insurance,
restructure the mortgage insurance coverage by reducing the amount of primary
insurance coverage and adding a second layer of insurance coverage, usually in
the form of pool insurance. Pool insurance is a type of mortgage insurance that
covers all or a percentage of a loss on individual mortgage loans held within a
group or pool of loans up to an agreed aggregate limit for the pool. Under these
programs, Fannie Mae and Freddie Mac may provide services to the mortgage
insurer and the mortgage insurer may be required to pay fees to Fannie Mae or
Freddie Mac for the reduced insurance coverage or the services provided. These
new products may prove to be less profitable than PMI's traditional mortgage
insurance business. If these products prove to be less profitable than PMI's
traditional mortgage insurance business, and become widely accepted, our
financial condition and operating results could seriously suffer.
Efforts by Fannie Mae and Freddie Mac to reduce the need for private mortgage
insurance could reduce our revenues.
Freddie Mac has made several announcements that it would pursue a permanent
charter amendment that would allow it to utilize alternative forms of default
loss protection or otherwise forego the use of private mortgage insurance on
higher loan-to-value mortgages. Such a result could severely harm our financial
condition and results of operation. In October 2000, Fannie Mae announced its
intention to increase its share of revenue associated with the management of
mortgage credit risk and interest rate risk during the next three years by
retaining mortgage credit risk previously borne by a number of other parties,
including mortgage insurers. Part of any attempt by Fannie Mae to increase its
share of revenue associated with mortgage credit risk could include a reduction
in the use or level of mortgage insurance, which could reduce our revenue.
Lobbying activities by large mortgage lenders calling for expanded federal
oversight and legislation relating to the role of Fannie Mae and Freddie Mac in
the secondary mortgage market could damage our relationships with those mortgage
lenders, Fannie Mae and Freddie Mac.
Together with Fannie Mae, Freddie Mac and mortgage lenders, we jointly develop
and make available various products and programs. These arrangements involve the
purchase of our mortgage insurance products and frequently feature cooperative
arrangements between the three parties. In 1999, a coalition of financial
services and housing related trade associations, including the Mortgage
Insurance Companies of America and several large mortgage lenders, formed FM
Watch, a lobbying organization that supports expanded federal oversight and
legislation relating to the role of Fannie Mae and Freddie Mac in the secondary
mortgage market. Fannie Mae and Freddie Mac have criticized, and lobbied
against, FM Watch. These lobbying activities could, among other things, polarize
Fannie Mae, Freddie Mac and members of FM Watch as well as our customers and us.
As a result of this polarization, our relationships with Fannie Mae and Freddie
Mac may limit our opportunities to do business with some mortgage lenders,
particularly the large mortgage lenders that have formed FM Watch. Conversely,
our relationships with these large mortgage lenders may limit our ability to do
business with Fannie Mae and Freddie Mac. Either of these outcomes could
seriously harm our financial condition and results of operations.
<PAGE>
If we are unable to introduce and successfully market new products and programs,
our competitive position could suffer.
From time to time we introduce new mortgage insurance products or programs. Our
competitive position and financial performance could suffer if we experience
delays in introducing competitive new products and programs or if these products
or programs are less profitable than our existing products and programs.
Our settlement in the Baynham litigation contains a three year injunction,
terminating on December 31, 2003. The injunction relates, in part, to the terms
upon which we offer certain products and services, including contract
underwriting, reinsurance agreements with reinsurance affiliates of lenders and
mortgage insurance restructuring transactions. Some, but not all, of our
competitors in the mortgage insurance industry have agreed to abide by the terms
of the injunction. Our compliance with the injunction could inhibit our ability
to compete with respect to the offering of new products and structures and this
could have a material adverse effect upon our financial condition and results of
operations.
Mortgage lenders increasingly require us to reinsure a portion of the mortgage
insurance default risk on mortgages that they originate with their captive
mortgage reinsurance companies, which will reduce our net premiums written.
Our customers have indicated an increasing demand for captive mortgage
reinsurance arrangements. Under these arrangements, a reinsurance company, which
is usually an affiliate of the mortgage lender, assumes a portion of the
mortgage insurance default risk on mortgage loans originated by the lender in
exchange for a portion of the insurance premiums. An increasing percentage of
our new insurance written is being generated by customers with captive
reinsurance companies, and we expect that this trend will continue. An increase
in captive mortgage reinsurance arrangements will decrease our net premiums
written, which may negatively impact the yield that we obtain on net premiums
earned for customers with captive mortgage reinsurance arrangements. If we do
not provide our customers with acceptable risk-sharing structured transactions,
including potentially increasing levels of premium cessions in captive mortgage
reinsurance arrangements, our competitive position may suffer.
Our primary risk in force consists of mortgage loans with high loan-to-value
ratios, which generally result in more claims than mortgage loans with lower
loan-to-value ratios.
At December 31, 2001:
. 43% of our primary risk in force consisted of mortgages with
loan-to-value ratios greater than 90% but less than or equal to 95%,
which we refer to as 95s. Risk in force is the dollar amount equal
to the product of each individual insured mortgage loan's current
principal balance and the percentage specified in the insurance
policy of the claim amount that would be payable if a claim were
made. In our experience, 95s have claims frequency rates
approximately one and a half times that of mortgages with
loan-to-value ratios greater than 85% but less than or equal to 90%,
which we refer to as 90s.
. 6% of our primary risk in force consisted of mortgages with
loan-to-value ratios greater than 95% but less than or equal to 97%,
which we refer to as 97s. In our experience 97s have higher claims
frequency rates than 95s. We also insure mortgages with
loan-to-value ratios greater than 97%, which we believe have claims
frequency rates higher than 97s.
. 9% of our primary risk in force consisted of adjustable rate
mortgages, which we refer to as ARMs. In our experience ARMs,
although priced higher, have claims frequency rates that exceed the
rates associated with our book of business as a whole.
<PAGE>
The premiums we charge for mortgage insurance on non-traditional loans, and the
associated investment income, may not be adequate to compensate us for future
losses from these products.
Our new insurance written includes Alternative A and Alternative A- loans and
less than A loans, which we refer to as non-traditional loans. Non-traditional
loans represented approximately 19% of our primary new insurance written in
2001. Loan characteristics, credit quality, loss development, pricing structures
and persistency, which is the percentage of insurance policies at the beginning
of a period that remain in force at the end of the period, on non-traditional
loans can be significantly different than our traditional prime business. In
addition, non-traditional loans generally do not meet the standard underwriting
guidelines of Fannie Mae and Freddie Mac. We expect higher default rates, which
is the percentage of insured loans in force that are in default, for
non-traditional loans. We cannot be sure that this book of business will
generate the same returns as our standard business or that the premiums that we
charge on non-traditional loans will adequately offset the associated risk.
Paying a significant number of claims under the pool insurance we write could
harm our financial performance.
We offer pool insurance that is generally used as an additional credit
enhancement for secondary market mortgage transactions. Pool insurance provides
coverage for conforming and non-conforming loans, and is generally considered
riskier than primary insurance. The premiums that we charge for pool insurance
may not adequately compensate us if we experience higher delinquency and default
rates than we anticipate at the time we set the premiums for the policies. If we
are required to pay a significant number of claims under our pool insurance,
then our financial condition and results of operations could be seriously
harmed.
The concentration of primary insurance in force in relatively few states could
increase claims and losses and harm our financial performance.
In addition to being affected by nationwide economic conditions, we could be
particularly affected by economic downturns in specific regions of the United
States where a large portion of our business is concentrated. As of December 31,
2001:
. 13% of our primary risk in force was on mortgages for homes located
in California, where the percentage of insured loans in force that
were in default, or default rate, on our policies was 2.6% on that
date;
. 9% of our primary risk in force was on mortgages for homes located
in Florida, where the default rate on our policies was 3.03% on that
date; and
. 7% of our primary risk in force was on mortgages for homes located
in Texas, where the default rate on our policies was 2.86% on that
date.
This compares with a nationwide default rate on our policies of 2.86% as of
December 31, 2001. Continued and prolonged adverse economic conditions in any of
these states could result in high levels of claims and losses. In addition,
refinancing of mortgage loans can have the effect of concentrating our insurance
in force in economically weaker areas, because mortgages in areas experiencing
appreciation of home values are less likely to require mortgage insurance at the
time of refinancing than are mortgages in areas experiencing limited or no
appreciation of home values.
We delegate underwriting authority to mortgage lenders that may cause us to
insure unacceptably risky mortgage loans, which could increase claims and
losses.
<PAGE>
The majority of our new insurance written is underwritten pursuant to a
delegated underwriting program. Once a mortgage lender is accepted into our
delegated underwriting program, that mortgage lender may determine whether
mortgage loans meet our program guidelines and may commit us to issue mortgage
insurance. We expect to continue offering delegated underwriting to approve
lenders and may expand the availability of delegated underwriting to additional
customers. If an approved lender commits us to insure a mortgage loan, we may
not refuse to insure, or rescind coverage on, that loan even if we reevaluate
that loan's risk profile or the lender failed to follow our delegated
underwriting guidelines, except in very limited circumstances. In addition, our
ability to take action against an approved lender that fails to follow our
program guidelines and requirements is limited by access to data that would be
needed to assess the lender's compliance with those guidelines and requirements.
Therefore, an approved lender could cause us to insure a material amount of
mortgage loans with unacceptable risk profiles prior to our termination of the
lender's delegated underwriting authority.
In addition, mortgage insurers, such as PMI, issue mortgage insurance on
mortgage loans determined by the GSEs to be eligible for purchase by the GSEs.
As a result, the GSEs' underwriting standards which determine what loans are
eligible for purchase affect the quality of the risk insured by mortgage
insurers and the availability of mortgage loans. Any broadening by the GSEs of
their underwriting standards could cause us to insure riskier mortgage loans,
which could increase our claims and losses.
We expect our loss experience to increase as our policies continue to age.
The majority of claims under private mortgage insurance policies have
historically occurred during the third through the sixth years after issuance of
the policies. As of December 31, 2001, approximately 82% of our risk in force
was written after December 31, 1997. This means that less than half of our risk
in force has reached the beginning of the expected peak claims period. As a
result, our loss experience is expected to increase significantly as our
policies continue to age. If the claim frequency, which is the percentage of
loans insured that have resulted in a paid claim, on our risk in force
significantly exceeds the claim frequency that was assumed in setting our
premium rates, our financial condition and results of operations and cash flows
would be seriously harmed.
Our loss reserves may be insufficient to cover claims paid and loss-related
expenses incurred.
We establish loss reserves to recognize the liability for unpaid losses related
to insurance in force on mortgages that are in default. These loss reserves are
based upon our estimates of the claim rate and average claim amounts, as well as
the estimated costs, including legal and other fees, of settling claims. These
estimates are regularly reviewed and updated using currently available
information. Any adjustments, which may be material, resulting from these
reviews are reflected in our then current consolidated results of operations.
Our reserves may not be adequate to cover ultimate loss development on incurred
defaults. Our financial condition and results of operations could be seriously
harmed if our reserve estimates are insufficient to cover the actual related
claims paid and loss-related expenses incurred.
If we fail to properly underwrite mortgage loans under our contract underwriting
services, we may be required to assume the cost of repurchasing those loans.
We provide contract underwriting services for a fee. These services help enable
our customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting to us. As a part of
our contract underwriting services, we provide monetary and other remedies to
our customers in the event that we fail to properly underwrite a mortgage loan.
Such remedies may include:
<PAGE>
. the purchase of additional or "deeper" mortgage insurance;
. assumption of some or all of the costs of repurchasing insured and
uninsured loans from the GSEs and other investors; or
. issuance of indemnifications to customers in the event that the
loans default for varying reasons including, but not limited to,
underwriting errors.
Generally, the scope of these remedies is in addition to those contained in
PMI's master primary insurance policies. Worsening economic conditions or other
factors that could lead to increases in PMI's default rate could also cause the
number and severity of the remedies that must be offered by MSC to increase.
Such an increase could have a material effect on our financial condition. There
are limitations on the number of available underwriting personnel and heavy
price competition among mortgage insurance companies. Our inability to recruit
and maintain a sufficient number of qualified underwriters or any significant
increase in the cost we incur to satisfy our underwriting services obligations
could harm our financial condition and results of operations.
If our claims-paying ability is downgraded, then mortgage lenders and the
mortgage securitization market may not purchase mortgages or mortgage-backed
securities insured by us, which could materially harm our financial performance.
The claims-paying ability of PMI Mortgage Insurance Co., our largest wholly
owned subsidiary, which we refer to as "PMI", is currently rated "AA+"
(excellent) by Standard and Poor's, "Aa2" (excellent) by Moody's and "AA+" (very
strong) by Fitch. These ratings may be revised or withdrawn at any time by one
or more of the rating agencies. These ratings are based on factors relevant to
PMI's policyholders and are not applicable to our common stock or outstanding
debt. The rating agencies could lower or withdraw our ratings at any time as a
result of a number of factors, including:
. underwriting or investment losses;
. the necessity to make capital contributions to our subsidiaries
pursuant to capital support agreements;
. other adverse developments in PMI's financial condition or results
of operations; or
. changes in the views of rating agencies.
If PMI's claims-paying ability rating falls below "AA-" from Standard and Poor's
or "Aa3" from Moody's, then investors, including Fannie Mae and Freddie Mac,
will not purchase mortgages insured by us, which would seriously harm our
financial condition and results of operations.
Our ongoing ability to pay dividends to our stockholders and meet our
obligations primarily depends upon the receipt of dividends and returns of
capital from our insurance subsidiaries and our investment income.
Our principal sources of funds are dividends from our subsidiaries, investment
income and funds that may be raised from time to time in the capital markets.
Factors that may affect our ability to maintain and meet our capital and
liquidity needs include:
. the level and severity of claims experienced by our insurance
subsidiaries;
. the performance of the financial markets;
<PAGE>
. standards and factors used by various credit rating agencies;
. financial covenants in our credit agreements; and
. standards imposed by state insurance regulators relating to the
payment of dividends by insurance companies.
Any significant change in these factors could prevent us from being able to
maintain the capital resources required to meet our business needs.
An increase in PMI's risk-to-capital ratio could prevent it from writing new
insurance, which would seriously harm our financial performance.
The State of Arizona, PMI's state of domicile for insurance regulatory purposes,
and other states limit the amount of insurance risk that may be written by PMI,
based on a variety of financial factors, primarily the ratio of net risk in
force to statutory capital, or the risk-to-capital ratio.
Other factors affecting PMI's risk-to-capital ratio include:
. limitations under the runoff support agreement with Allstate
Insurance Company, or Allstate, our former parent company, which
prohibit PMI from paying any dividends if, after the payment of the
dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1;
. our credit agreement; and
. capital requirements necessary to maintain our credit rating and
PMI's claims-paying ability ratings.
Generally, the methodology used by the rating agencies to assign credit or
claims-paying ability ratings permits less capital leverage than under statutory
or other requirements. Accordingly, we may be required to meet capital
requirements that are higher than statutory or other capital requirements to
satisfy rating agency requirements.
PMI has several alternatives available to help control its risk-to-capital
ratio, including:
. obtaining capital contributions from The PMI Group;
. obtaining third party credit enhancements; and
. reducing the amount of new business written.
We may not be able to raise additional funds, or to do so on a timely basis, in
order to make a capital contribution to PMI. In addition, third party credit
enhancements may not be available to PMI or, if available, may not be available
on satisfactory terms. A material reduction in PMI's statutory capital, whether
resulting from underwriting or investment losses or otherwise, or a
disproportionate increase in risk in force, could increase its risk-to-capital
ratio. An increase in PMI's risk-to-capital ratio could limit its ability to
write new business, impair PMI's ability to pay dividends to The PMI Group and
seriously harm our financial condition and results of operations.
Our international insurance subsidiaries subject us to numerous risks associated
with international operations.
<PAGE>
We have subsidiaries in Australia and Europe and may commit significant
resources to expand our international operations. Accordingly, we are subject to
a number of risks associated with international business activities. These risks
include:
. the need for regulatory and third party approvals;
. challenges attracting and retaining key foreign-based employees,
customers and business partners in international markets;
. economic downturns in the foreign mortgage origination markets
targeted, particularly the economies of Australia and Europe;
. interest rate volatility in a variety of countries;
. unexpected changes in foreign regulations and laws;
. burdens of complying with a wide variety of foreign laws;
. potentially adverse tax consequences;
. restrictions on the repatriation of earnings;
. foreign currency exchange rate fluctuations;
. potential increases in the level of defaults and claims on policies
insured by foreign-based subsidiaries;
. the need to integrate our domestic insurance subsidiaries' risk
management technology systems and products with those of our foreign
operations;
. the need to successfully develop and market products appropriate to
the foreign market, including the development and marketing of
credit enhancement products to European lenders and mortgage
securitizations;
. risks related to global economic turbulence; and
. political instability.
In September 2001, we completed our acquisition of the Australian mortgage
insurance company, CGU Lenders Mortgage Insurance Limited (renamed PMI Indemnity
Limited). We are integrating PMI Indemnity Limited's operations into our
existing Australian subsidiary and the success of our acquisition of PMI
Indemnity Limited will be dependent upon the success of this integration, among
other factors.
The performance of our strategic investments could harm our financial results.
At December 31, 2001, we had investments in affiliates of $204.9 million. The
performance of our strategic investments in affiliates could be harmed by:
. changes in the real estate, mortgage lending, mortgage servicing,
title and financial guaranty markets;
. future movements in interest rates;
. those operations' future financial condition and performance;
. the ability of those entities to execute future business plans; and
. our dependence upon management to operate those companies in which
we do not own a controlling share.
<PAGE>
In addition, our ability to engage in additional strategic investments is
subject to the availability of capital and maintenance of our claims-paying
ability ratings by rating agencies.
Our inability to keep pace with the technological demands of our customers or
with the technology-related products and services offered by our competitors
could significantly harm our business and financial performance.
Participants in the mortgage lending and mortgage insurance industries
increasingly rely on e-commerce and other technology to provide and expand their
products and services. An increasing number of our customers require that we
provide our products and services electronically via the Internet or electronic
data transmission, and the percentage of our new insurance written delivered
electronically is increasing. We expect this trend to continue and, accordingly,
believe that it is essential that we continue to invest substantial resources on
maintaining electronic connectivity with our customers and, more generally, on
e-commerce and technology. Our business will suffer if we do not satisfy all
technological demands of our customers and keep pace with the technological
capabilities of our competitors.
If we are not reimbursed by our insurance carriers for costs incurred by us in
connection with our settlement of the Baynham litigation, we will be required to
take an additional charge against earnings.
To account for our settlement of the Baynham litigation, we took an after-tax
charge against fourth quarter 2000 earnings of $3.7 million, and incurred an
additional $1.0 million charge, net of tax, in the third quarter of 2001.
These charges represent our estimate of the cost of settlement less our estimate
of insurance payments we will receive from our insurance carriers as
reimbursement for costs incurred by us in connection with our defense and
settlement of the action. We have participated in non-binding mediation with our
insurance carriers with respect to the amount of the payments to be reimbursed
to us without achieving settlement and now must commence litigation to obtain
reimbursement from our carriers. If we do not realize our estimated amount of
insurance proceeds, we will be required to take an additional charge against
earnings and this could harm our results of operations.
<PAGE>
Consolidated Statements of Operations
The PMI Group Inc. and Subsidiaries
<TABLE>
<CAPTION>
Years Ended December 31,
(Dollars in thousands except per share data) 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues Premiums earned $ 754,771 $634,362 $558,623
Investment income 149,987 119,199 95,142
Net realized investment gains 11 432 509
Other 32,194 8,579 15,850
--------- -------- --------
Total revenues 936,963 762,572 670,124
--------- -------- --------
Losses and Losses and loss adjustment expenses 118,048 103,079 112,682
Expenses Amortization of deferred policy acquisition costs 81,782 77,337 80,252
Other underwriting and operating expenses 268,415 189,771 170,239
Interest expense 14,148 10,210 8,554
Distributions on preferred capital securities 7,604 8,309 8,311
--------- -------- --------
Total losses and expenses 489,997 388,706 380,038
--------- -------- --------
Income before income taxes and extraordinary item 446,966 373,866 290,086
Income taxes 134,949 113,654 85,620
--------- -------- --------
Income before extraordinary item 312,017 260,212 204,466
Extraordinary loss on early extinguishment of debt,
net of income tax benefit of $2,588 4,805 -- --
--------- -------- --------
Net income $ 307,212 $260,212 $204,466
========= ======== ========
Per Share Data Basic:
Income before extraordinary item $ 7.02 $ 5.88 $ 4.55
Extraordinary loss, net of income tax benefit (0.11) -- --
--------- -------- --------
Basic net income $ 6.91 $ 5.88 $ 4.55
========= ======== ========
Diluted:
Income before extraordinary item $ 6.88 $ 5.78 $ 4.52
Extraordinary loss, net of income tax benefit (0.10) -- --
--------- -------- --------
Diluted net income $ 6.78 $ 5.78 $ 4.52
========= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Consolidated Balance Sheets
The PMI Group, Inc. and Subsidiaries
<TABLE>
<CAPTION>
As of December 31,
(Dollars in thousands except per share data) 2001 2000
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Assets Investments:
Available for sale, at fair value:
Fixed income securities
(amortized cost: $2,010,114; $1,536,291) $ 2,078,875 $ 1,613,330
Equity securities:
Common (cost: $53,015; $53,315) 69,264 81,726
Preferred (cost: $89,192; $108,743) 92,266 111,743
Common stock of affiliates, at underlying book value 204,886 131,849
Short-term investments, at fair value 137,469 139,577
----------- -----------
Total investments 2,582,760 2,078,225
Cash 21,735 21,969
Accrued investment income 35,480 23,494
Premiums receivable 57,510 41,362
Reinsurance receivable and prepaid premiums 47,079 42,117
Reinsurance recoverable 6,068 9,211
Deferred policy acquisition costs 77,903 67,009
Property and equipment, net 68,188 53,475
Other assets 93,229 55,795
----------- -----------
Total assets $ 2,989,952 $ 2,392,657
=========== ===========
Liabilities Reserves for losses and loss adjustment expenses $ 314,590 $ 295,089
Unearned premiums 208,580 170,866
Long-term debt 422,950 136,819
Reinsurance payable 31,201 26,581
Deferred income taxes 63,852 74,981
Other liabilities and accrued expenses 113,591 89,110
----------- -----------
Total liabilities 1,154,764 793,446
----------- -----------
Commitments and contingencies:
Company-obligated mandatorily redeemable preferred capital
securities of subsidiary trust holding solely junior
subordinated deferrable interest debenture of the Company 48,500 100,000
Shareholders' Preferred stock - $0.01 par value; 5,000,000 shares authorized,
Equity and none issued or outstanding -- --
Common stock - $0.01 par value; 125,000,000 shares authorized,
and 52,793,777 shares issued 528 528
Additional paid-in capital 267,762 267,762
Accumulated other comprehensive income 40,791 62,501
Retained earnings 1,811,839 1,511,751
Treasury stock, at cost (8,212,475 and 8,436,761 shares) (334,232) (343,331)
----------- -----------
Total shareholders' equity 1,786,688 1,499,211
----------- -----------
Total liabilities and shareholders' equity $ 2,989,952 $ 2,392,657
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Shareholders' Equity
The PMI Group, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Years Ended December 31,
(Dollars in thousands) 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Balance, beginning of year $ 528 $ 528 $ 352
Stock 3 for 2 stock split in the form of a stock dividend -- -- 176
----------- ----------- -----------
Balance, end of year 528 528 528
----------- ----------- -----------
Additional Balance, beginning of year 267,762 265,828 265,040
Paid-in 3 for 2 stock split in the form of a stock dividend -- -- (176)
Capital Stock grants and exercise of stock options -- 1,934 964
----------- ----------- -----------
Balance, end of year 267,762 267,762 265,828
----------- ----------- -----------
Accumulated Balance, beginning of year 62,501 20,186 74,462
Other Change in unrealized gains (losses) on investments,
Comprehensive net of tax (benefit) of ($6,830), $28,176, and
Income ($28,629) (11,331) 50,294 (54,276)
Change in currency translation (10,379) (7,979) --
----------- ----------- -----------
Other comprehensive income (loss), net of tax (21,710) 42,315 (54,276)
----------- ----------- -----------
Balance, end of year 40,791 62,501 20,186
----------- ----------- -----------
Retained Balance, beginning of year 1,511,751 1,258,617 1,060,724
Earnings Net income 307,212 260,212 204,466
Dividends declared (7,124) (7,078) (6,573)
----------- ----------- -----------
Balance, end of year 1,811,839 1,511,751 1,258,617
----------- ----------- -----------
Treasury Balance, beginning of year (343,331) (327,891) (303,063)
Stock Repurchase of common stock -- (24,017) (27,469)
Issuance of treasury stock 9,099 8,577 2,641
----------- ----------- -----------
Balance, end of year (334,232) (343,331) (327,891)
----------- ----------- -----------
Total shareholders' equity $ 1,786,688 $ 1,499,211 $ 1,217,268
=========== =========== ===========
Comprehensive Net income $ 307,212 $ 260,212 $ 204,466
Income Other comprehensive income (loss), net of tax (21,710) 42,315 (54,276)
----------- ----------- -----------
Comprehensive income $ 285,502 $ 302,527 $ 150,190
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Cash Flows
The PMI Group, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Years Ended December 31,
(Dollars in thousands) 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash Net income $ 307,212 $ 260,212 $ 204,466
Flows Adjustments to reconcile net income to net cash provided by
From operating activities:
Operating Extraordinary loss on early extinguishment of debt 7,393 -- --
Activities Net realized capital gains (11) (432) (509)
Equity in earnings of affiliates (18,153) (11,643) (7,061)
Depreciation and amortization 13,107 24,092 13,243
Deferred income taxes (4,804) (28,834) 7,539
Changes in:
Accrued investment income (11,986) (1,436) (1,903)
Deferred policy acquisition costs (6,397) 2,570 (7,973)
Premiums receivable (16,148) (10,703) (6,292)
Reinsurance receivable 942 (1,673) 62,764
Reinsurance recoverable 3,143 2,224 (4,653)
Reserves for losses and loss adjustment expenses 14,628 13,089 18,649
Unearned premiums (213) (11,223) 13,526
Income taxes payable 8,608 10,391 (3,834)
Other 3,702 (22,734) 27,769
--------- --------- ---------
Net cash provided by operating activities 301,023 223,900 315,729
--------- --------- ---------
Cash Proceeds from sales and maturities of fixed income securities 321,036 193,141 231,673
Flows Proceeds from sales of equity securities 119,090 53,370 42,647
From Investment purchases:
Investing Fixed income securities (718,561) (267,346) (332,046)
Activities Equity securities (104,775) (145,258) (31,940)
Net (increase) decrease in short-term investments 1,168 5,516 (84,508)
Investments in affiliates (54,841) (26,827) (25,634)
Acquisitions of wholly-owned subsidiaries (60,166) -- (100,872)
Capital expenditures (26,408) (20,070) (12,528)
--------- --------- ---------
Net cash used in investing activities (523,457) (207,474) (313,208)
--------- --------- ---------
Cash Proceeds from issuance of long-term debt 351,900 -- 45,825
Flows Repayments of long-term debt (75,706) -- --
From Extinguishment of preferred Capital Securities (55,969) -- --
Financing Repurchases of common stock -- (24,017) (27,469)
Activities Issuance of treasury stock 9,099 8,577 2,641
Dividends paid to shareholders (7,124) (7,093) (5,199)
--------- --------- ---------
Net cash provided by (used in) financing activities 222,200 (22,533) 15,798
--------- --------- ---------
Net increase (decrease) in cash (234) (6,107) 18,319
Cash at beginning of year 21,969 28,076 9,757
--------- --------- ---------
Cash at end of year $ 21,735 $ 21,969 $ 28,076
========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
NOTE 1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of The
PMI Group, Inc. ("TPG"), a Delaware corporation; its direct and indirect
wholly-owned subsidiaries, PMI Mortgage Insurance Co. ("PMI"), an Arizona
corporation; American Pioneer Title Insurance Company ("APTIC"), a Florida
corporation; PMI Mortgage Insurance Ltd ("PMI Ltd"), an Australian mortgage
insurance company; PMI Mortgage Insurance Company Limited ("PMI Europe"), an
Irish corporation; and other insurance, reinsurance and non-insurance
subsidiaries. TPG and its subsidiaries are collectively referred to as the
"Company". The Company has equity interests in CMG Mortgage Insurance Company
("CMG"), which conducts residential mortgage insurance business; Fairbanks
Capital Holding Corp. ("Fairbanks"), a special servicer of single-family
residential mortgages; and two financial guaranty reinsurance companies based in
Bermuda, RAM Holdings Ltd. and Ram Holdings II Ltd., collectively referred to as
"Ram Re". The Company's percentage ownership of CMG, Fairbanks, and Ram Re are
50%, 45.7% and 24.9% respectively, and accordingly, they are accounted for on
the equity method of accounting in the Company's consolidated financial
statements. All material intercompany transactions and balances have been
eliminated in consolidation.
NOTE 2. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - The Company, through its subsidiaries, primarily writes residential
mortgage guaranty insurance, or primary mortgage insurance, and mortgage pool
insurance. In addition, the Company writes title insurance through its title
insurance subsidiary, APTIC. Primary insurance and pool insurance provide
protection to mortgage lenders against losses in the event of borrower default
and assist lenders and investors in selling mortgage loans in the secondary
market. Title insurance protects the mortgagors and lenders against losses
resulting from title defects, liens, and encumbrances in existence as of the
effective date of the policy. Significant accounting policies are as follows:
Basis of Accounting - The financial statements have been prepared on the basis
of accounting principles generally accepted in the United States ("GAAP"), which
vary from statutory accounting practices prescribed or permitted by insurance
regulatory authorities. The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements, as well as the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
Investments - The Company has designated its entire portfolio of fixed income
and equity securities as available-for-sale. These securities are recorded at
fair value with unrealized gains and losses, net of deferred income taxes, and
accounted for as a component of accumulated other comprehensive income in
shareholders' equity. The Company evaluates its investments regularly to
determine whether there are declines in value and whether any such declines meet
the definition of other-than-temporary impairment in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Market value of a security below cost
or amortized cost for two consecutive quarters is a potential indicator of an
other-than-temporary impairment. When the Company determines a security has
suffered an other-than-temporary impairment, the impairment loss is recognized,
to the extent of the decline, as a realized investment loss in the current
period's earnings.
The Company's short-term investments have maturities of less than twelve months
when purchased and are carried at fair value. Investments in 20% to 50% owned
affiliates are accounted for on the equity method of accounting, and investments
in less than 20% owned affiliates are accounted for on the cost method of
accounting. The Company reports the equity earnings of its unconsolidated
affiliates, Fairbanks on a one-month lag and Ram Re on a quarter lag basis. The
investment in Fairbanks includes a
<PAGE>
goodwill component of approximately $27 million. Realized gains and losses on
sales of investments are determined on a specific-identification basis.
Investment income consists primarily of interest and dividends. Interest income
is recognized on an accrual basis and dividend income is recorded on the date of
declaration.
Property and Equipment - Property and equipment, including software, are carried
at cost and are depreciated using the straight-line method over the estimated
useful lives of the assets, ranging from three to ten years. Accumulated
depreciation on property and equipment was $70.6 million as of December 31,
2001, $59.3 million as of December 31, 2000 and $51.4 million as of December 31,
1999.
Revenue Recognition - Primary mortgage insurance policies are contracts that are
non-cancelable by the insurer, are renewable at a fixed price at the insured's
option, and provide payment of premiums on a monthly, annual or single basis.
Upon renewal by the insured, the Company is not able to re-underwrite or
re-price its policies. SFAS No. 60, Accounting and Reporting for Insurance
Enterprises, specifically excludes mortgage guaranty insurance from its guidance
relating to the earning of insurance premiums. Premiums written on a monthly
basis are earned as coverage is provided. Monthly premiums accounted for
approximately 63% of gross premiums written in 2001, compared with 66% in 2000
and 61% in 1999. Premiums written on an annual premium basis are amortized on a
monthly pro rata basis over the year of coverage. Premiums written on policies
covering more than one year, or single premium policies, are initially deferred
as unearned premiums and earned over the expected life of the policy, a range of
seven to eight years. Rates used to determine the earning of single premiums are
estimates based on the expiration of risk. Accordingly, the unearned premiums
represent the portion of premiums written that is applicable to the estimated
unexpired risk of insured policies.
In 2001, the Company refined the loss reserve estimation process of its
international operations to be based upon a default model consistent with U.S.
subsidiaries. In connection with the refinement in the provisioning policy and
premium earning estimates, the Company updated the assumptions used to determine
the rates of premiums earned and shortened the duration of the expected policy
life of single premium products, which resulted in an acceleration of earnings
in the first two years. The new methodology and estimates are consistent with
those applied to the U.S. operations.
Title insurance premiums are recognized as revenue on the effective date of the
title insurance policy. Fee income of the non-insurance subsidiaries is earned
as the services are provided including contract underwriting. Contract
underwriting revenue is recorded in other income.
Deferred Policy Acquisition Costs - The Company defers certain costs in its
mortgage insurance operations relating to the acquisition of new insurance and
amortizes these costs against related premium revenue in order to match costs
and revenues. These costs are primarily associated with the acquisition,
underwriting and processing of new business, including contract underwriting and
sales related activities. To the extent the Company is compensated by customers
for contract underwriting, those underwriting costs are not deferred. Costs
related to the issuance of mortgage insurance are initially deferred and
reported as deferred policy acquisition costs ("DPAC"). SFAS 60 specifically
excludes mortgage guaranty insurance from its guidance relating to the
amortization of DPAC. Amortization of these costs for each underwriting year
book of business is charged against revenue in proportion to estimated gross
profits over a two-year period. The estimates for each underwriting year are
updated regularly to reflect actual experience and any changes to key
assumptions such as persistency or loss development.
<PAGE>
DPAC is summarized as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 2001 2000 1999
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Beginning DPAC balance $ 67,009 $ 69,579 $ 61,605
Policy acquisition costs incurred and deferred 88,179 74,767 88,226
Amortization of deferred costs (81,782) (77,337) (80,252)
Acquisitions of wholly-owned subsidiaries 4,497 -- --
-------- -------- --------
Ending DPAC balance $ 77,903 $ 67,009 $ 69,579
======== ======== ========
</TABLE>
Income Taxes - The Company accounts for income taxes using the liability method
in accordance with SFAS No. 109, Accounting for Income Taxes. The liability
method measures the expected future tax consequences of temporary differences at
the enacted tax rates applicable for the period in which the deferred asset or
liability is expected to be realized or settled. Temporary differences are
differences between the tax basis of an asset or liability and its reported
amount in the financial statements that will result in taxable or deductible
amounts in future years.
Special Purpose Entities - Certain insurance transactions entered into by PMI
Europe require the use of foreign Special Purpose Entities ("SPEs"). These SPEs
are wholly-owned subsidiaries of the Company, and accordingly, are consolidated
in the Company's financial statements. The Company is not affiliated with any
SPEs that qualify for off-balance sheet treatment.
Derivatives - Derivative financial instruments are reported at fair value.
Changes in the fair value of derivatives are recorded each period in earnings or
other comprehensive income, depending on whether the derivative is designated
and effective as part of a hedged transaction, and on the type of hedge
transaction. Gains or losses on derivative instruments reported in other
comprehensive income are reclassified to earnings in the period which earnings
are affected by the underlying hedged item, and the ineffective portion of
hedges are recognized in earnings in the current period.
The Company's use of derivative financial instruments is generally limited to
reducing its exposure to interest rate risk and currency exchange risk by
utilizing interest rate and currency swap agreements that are accounted for as
hedges. Hedge accounting requires a high correlation between changes in fair
value or cash flows of the derivative instrument and the specific item being
hedged, both at inception and throughout the life of the hedge. In 1999, the
Company entered into an interest rate swap to hedge interest rate risk
associated with the debt obtained to finance the PMI Ltd acquisition. This
interest rate swap was terminated in July 2001 when the Company repaid the
associated debt, and the termination of the swap resulted in a realized loss of
$0.8 million. The Company did not have any derivative instruments as of December
31, 2001.
Foreign currency translation - The financial statements of foreign subsidiaries
have been translated into U.S. dollars in accordance with SFAS No. 52, Foreign
Currency Translation. Assets and liabilities denominated in non-U.S. dollar
currencies are translated into U.S. dollar equivalents using either the year-end
spot exchange rates or historical rates. Revenues and expenses are translated
mostly at weighted-average exchange rates. The effects of translating operations
with a functional currency other than the reporting currency are reported as a
component of accumulated other comprehensive income included in shareholders'
equity.
Earnings Per Share - Basic earnings per share ("EPS") excludes dilution and is
based on net income available to common shareholders and the weighted-average
common shares that are outstanding during the period. Diluted EPS is based on
net income available to common shareholders and the weighted-average of dilutive
common shares outstanding during the period. Weighted-average dilutive common
shares reflect the potential increase of common shares if outstanding securities
were converted into
<PAGE>
common stock, or if contracts to issue common stock, including stock options
issued by the Company that have a dilutive impact, were exercised. Net income
available to common shareholders is the same for computing basic and diluted
EPS. Weighted-average common shares outstanding for the years ended December 31,
2001, 2000 and 1999 are as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Weighted-Average Shares Outstanding
For basic EPS 44,443,748 44,253,619 44,893,250
For diluted EPS 45,333,984 45,018,501 45,244,060
Stock-Based Compensation - The Company accounts for stock-based compensation to
employees and directors using the intrinsic value method prescribed in
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued
to Employees, and its related interpretations. Under APB 25, compensation cost
for stock-based awards is measured as the excess, if any, of the market price of
the underlying stock on the grant date over the employees' exercise price of the
stock options. As all options have been granted with an exercise price equal to
the fair value at the date of the grants, no compensation expense has been
recognized for the Company's stock option program. SFAS No. 123, Accounting for
Stock-Based Compensation, requires the pro-forma disclosure of net income and
earnings per share using the fair value method, and provides that the employers
may continue to account for the stock-based compensation under APB 25. The
Company adopted the pro-forma disclosure requirements of SFAS 123 and details
are disclosed in Note 16, Incentive Plans.
Reclassifications - Certain items in the prior period's financial statements
have been reclassified to conform to the current period's presentation.
NOTE 3. NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, and No. 142, Goodwill and Other Intangible Assets,
effective for fiscal years beginning after December 15, 2001. Under SFAS 141,
the use of the pooling-of-interest method is no longer permitted for all
business combinations initiated after June 30, 2001, and the purchase method of
accounting is required. Under SFAS 142, goodwill and intangible assets deemed to
have an indefinite useful life will no longer be amortized but will be subject
to an annual review for impairment.
The Company adopted SFAS 142 effective January 1, 2002, and wrote off the
remaining balance of the negative goodwill, recorded in connection with the
purchase of PMI Ltd in 1999, of $7.6 million as a change in accounting method.
NOTE 4. ACQUISITIONS
In September 2001, the Company completed its acquisition of CGU Lenders Mortgage
Insurance Limited (renamed PMI Indemnity Limited), an Australian mortgage
insurance company. The purchase price of this acquisition remains subject to
post-closing adjustments, but is expected to be approximately $41 million. The
acquisition was accounted for under the purchase method of accounting and there
was no related goodwill. PMI Indemnity Limited's operations are being merged
into the Company's existing Australian subsidiary, and its financial results
were included in the Company's fourth quarter results of operations.
In December 1999, the Company acquired all of the outstanding common stock of
Pinebrook Mortgage Insurance Company ("Pinebrook"), which was a wholly-owned
subsidiary of Allstate Insurance Company
<PAGE>
("Allstate"), for $22.6 million in cash. The purchase price approximated the
book value of Pinebrook, which did not differ significantly from fair value.
This transaction was accounted for under the purchase method of accounting.
In August 1999, the Company acquired all of the outstanding common stock of PMI
Ltd for approximately $78.3 million. The acquisition was accounted for under the
purchase method of accounting. The excess of the estimated fair value of net
assets acquired over the purchase price of approximately $22 million was
recorded as negative goodwill to be amortized over eight years. The remaining
balance of this negative goodwill has been written off upon the Company's
adoption of SFAS 142 effective January 1, 2002.
The pro-forma unaudited results of operations for the year ended December 31,
1999, assuming the purchase of PMI Ltd had been consummated as of January 1,
1999, are as follows:
(Dollars in thousands, except per share amounts) 1999
- --------------------------------------------------------------------------------
Revenues $692,585
Net income 220,679
Basic net income per common share 4.92
Diluted net income per common share 4.87
NOTE 5. INVESTMENTS
Fair Values and Net Unrealized Gains and Losses on Investments - The cost or
amortized cost, estimated fair value, based on quoted market prices, and net
unrealized gains and losses on investments are shown in the table below:
<TABLE>
<CAPTION>
Cost or Gross Unrealized Net
Amortized Fair ---------------------- Unrealized
(Dollars in thousands) Cost Value Gains (Losses) Gains/(Losses)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
December 31, 2001:
Fixed income securities
U.S. government and agencies $ 73,127 $ 72,249 $ 1,774 $ (2,652) $ (878)
Mortgage-backed securities 112,301 113,666 1,386 (21) 1,365
Municipal bonds 1,418,805 1,487,335 77,325 (8,795) 68,530
Corporate bonds 405,881 405,625 5,427 (5,683) (256)
---------- ---------- -------- -------- --------
Total fixed income securities 2,010,114 2,078,875 85,912 (17,151) 68,761
Equity securities
Common stocks 53,015 69,264 19,553 (3,304) 16,249
Preferred stocks 89,192 92,266 3,741 (667) 3,074
---------- ---------- -------- -------- --------
Total equity securities 142,207 161,530 23,294 (3,971) 19,323
Investments in affiliates 203,883 204,886 1,059 (56) 1,003
Short-term investments 135,058 137,469 2,417 (6) 2,411
---------- ---------- -------- -------- --------
Total $2,491,262 $2,582,760 $112,682 $(21,184) 91,498
========== ========== ======== ========
Deferred income taxes (32,349)
--------
Unrealized gains, net of deferred taxes $ 59,149
========
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
December 31, 2000:
Fixed income securities
U.S. government and agencies $ 42,189 $ 43,512 $ 2,173 $ (850) $ 1,323
Mortgage-backed securities 59,399 59,576 331 (154) 177
Municipal bonds 1,268,775 1,349,160 82,692 (2,307) 80,385
Corporate bonds 165,928 161,082 2,400 (7,246) (4,846)
---------- ---------- -------- -------- --------
Total fixed income securities 1,536,291 1,613,330 87,596 (10,557) 77,039
Equity securities
Common stocks 53,315 81,726 32,543 (4,132) 28,411
Preferred stocks 108,743 111,743 3,216 (216) 3,000
---------- ---------- -------- -------- --------
Total equity securities 162,058 193,469 35,759 (4,348) 31,411
Investments in affiliates 130,747 131,849 1,102 -- 1,102
Short-term investments 139,470 139,577 113 (6) 107
---------- ---------- -------- -------- --------
Total $1,968,566 $2,078,225 $124,570 $(14,911) 109,659
========== ========== ======== ========
Deferred income taxes (39,179)
--------
Unrealized gains, net of deferred taxes $ 70,480
========
</TABLE>
The difference between the cost and fair value of the investments in affiliates
reflects the Company's shares of net unrealized gains and losses on the
affiliates' investment portfolio. The stated fair value does not represent the
fair value of the affiliates' common stock held by the Company.
Included in the Company's short-term investments is commercial paper with a face
value of $10.0 million issued by Pacific Gas and Electric Company ("PG&E"),
which is currently in default. In the second quarter of 2001, the Company
determined that the investment's $3.2 million decline in market value was an
other-than-temporary impairment as prescribed in SFAS 115, and recognized a
realized loss of $3.2 million. Subsequently, the Company recorded an
unrealized gain of $2.4 million due to the increase in the fair value of this
investment during the second half of 2001.
Scheduled Maturities - The following table set forth the amortized cost and fair
value of fixed income securities by contractual maturity at December 31, 2001:
Amortized Fair
(Dollars in thousands) Cost Value
- --------------------------------------------------------------------------------
Due in one year or less $ 54,675 $ 54,800
Due after one year through five years 316,837 319,087
Due after five years through ten years 354,588 358,884
Due after ten years 1,171,713 1,232,438
Mortgage-backed securities 112,301 113,666
---------- ----------
Total fixed income securities $2,010,114 $2,078,875
========== ==========
Actual maturities may differ from those scheduled as the result of calls or
prepayments by the issuers prior to the maturity.
<PAGE>
Investment Income - Investment income consists of:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Fixed income securities $ 109,425 $ 94,794 $ 82,256
Equity securities 10,785 4,841 2,400
Investments in affiliates 18,153 11,643 7,061
Short-term investments 13,055 9,223 4,793
--------- --------- --------
Investment income before expenses 151,418 120,501 96,510
Investment expense (1,431) (1,302) (1,368)
--------- --------- --------
Net investment income $ 149,987 $ 119,199 $ 95,142
========= ========= ========
Realized Investment Gains and Losses - Net realized gains and losses on
investments are composed of:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Fixed income securities
Gross gains $ 11,129 $ 1,657 $ 535
Gross losses (1,722) (9,734) (3,610)
-------- -------- -------
Net gains (losses) 9,407 (8,077) (3,075)
Equity securities:
Gross gains 12,503 17,768 7,210
Gross losses (18,698) (9,474) (3,636)
-------- -------- -------
Net gains (losses) (6,195) 8,294 3,574
Short-term investments
Gross gains -- 453 10
Gross losses (3,201) (238) --
-------- -------- -------
Net gains (losses) (3,201) 215 10
-------- -------- -------
Net realized gains before income taxes 11 432 509
Income taxes (4) (151) (178)
-------- -------- -------
Total realized gains after income taxes $ 7 $ 281 $ 331
======== ======== =======
Unrealized Investment Gains and Losses - The change in net unrealized gains and
losses consists of:
<TABLE>
<CAPTION>
(Dollars in thousands) 2001 2000 1999
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed income securities $ (6,559) $ 53,948 $(61,376)
Equity securities (7,048) (5,586) 8,758
Investments in affiliates (101) 1,905 (1,662)
Short-term investments 2,377 27 4
-------- -------- --------
Change in unrealized gains (losses), net of deferred taxes (11,331) 50,294 (54,276)
Realized gains, net of income taxes 7 281 331
-------- -------- --------
Total $(11,324) $ 50,575 $(53,945)
======== ======== ========
</TABLE>
Investment Concentrations and Other Items - The Company maintains a diversified
portfolio of municipal bonds. The following states represent the largest
concentrations in the municipal bond portfolio, expressed as a percentage of the
carrying value of all municipal bond holdings. Holdings in states that exceed 5%
of the municipal bond portfolio at December 31, for the respective years are
presented below:
2001 2000
- --------------------------------------------------------------------------------
Illinois 16.5% 14.1%
Texas 12.8 12.6
Washington 10.8 11.2
New York 8.8 9.7
Massachusetts 7.7 7.5
District of Columbia 5.7 4.2
<PAGE>
At December 31, 2001, fixed income and short-term securities with a market value
of $19.6 million were on deposit with regulatory authorities as required by law.
NOTE 6. LOSSES AND LOSS ADJUSTMENT EXPENSES RESERVES
The reserves for losses and loss adjustment expenses ("LAE") are the estimated
claim settlement on notices of default that have been received by the Company,
as well as loan defaults that have been incurred but have not been reported by
the lenders. SFAS 60 specifically excludes mortgage guaranty insurance from its
guidance relating to the reserves for losses. Consistent with industry
accounting practices, the Company does not establish loss reserves for future
claims on insured loans that are not currently in default. The Company
establishes loss reserves on a case-by-case basis when insured loans are
identified as currently in default using estimated claim rates and average claim
sizes for each report year, net of salvage recoverable. The Company also
reserves for defaults that have been incurred but have not been reported to the
Company prior to the close of an accounting period, using estimated claim rates
and claim sizes for the estimated number of defaults not reported.
The Company's reserving process is based upon the assumptions of past
experience, adjusted for the anticipated effect of current economic conditions
and projected future economic trends, including the real estate market, housing
values, unemployment rates and their effect on recent claim rates and claim
severity. Therefore, the reserves are necessarily based on estimates and the
ultimate liability may vary from such estimates. Management regularly reviews
the evaluation of the loss reserves utilizing current information and updates
the assumptions in the estimation process accordingly. Any resulting adjustments
are reflected in the current period's earnings. Management believes that the
reserves for losses and loss adjustment expenses at December 31, 2001 were
appropriately established on an aggregate basis and were adequate to cover the
ultimate net cost of settling reported and unreported claims.
The following table provides a reconciliation of the beginning and ending
reserves for losses and loss adjustment expenses for each of the last three
years:
<TABLE>
<CAPTION>
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at January 1 $ 295,089 $ 282,000 $ 215,259
Reinsurance recoverable (9,211) (11,435) (6,782)
--------- --------- ---------
Net balance at January 1 285,878 270,565 208,477
Losses and loss adjustment expenses incurred (principally
with respect to defaults occurring in)
Current year 242,493 191,904 159,293
Prior years (124,445) (88,825) (46,611)
--------- --------- ---------
Total incurred 118,048 103,079 112,682
Losses and loss adjustment expenses payments (principally
with respect to defaults occurring in)
Current year (8,723) (4,825) (1,798)
Prior years (91,554) (82,941) (96,890)
--------- --------- ---------
Total payments (100,277) (87,766) (98,688)
Acquisitions of wholly-own subsidiaries 4,873 -- 48,094
--------- --------- ---------
Net balance at December 31 308,522 285,878 270,565
Reinsurance recoverable 6,068 9,211 11,435
--------- --------- ---------
Balance at December 31 $ 314,590 $ 295,089 $ 282,000
========= ========= =========
</TABLE>
The increase in 2001 losses and loss adjustment expenses incurred was due, in
part, to the economic downturn in 2001 and corresponding increases in claims
paid. Primary insurance default inventory increased from 18,093 at December 31,
2000 to 25,907 at December 31, 2001. The default rate was
<PAGE>
2.86% at year-end 2001 compared to 2.21% at year-end 2000. Generally it takes
approximately twelve months from the receipt of a default notice to result in a
claim payment; therefore, most losses paid related to default notices received
in prior years. The provision for losses and loss adjustment expenses for
default events in prior years decreased by $124.4 million in 2001 and $88.8
million in 2000, due primarily to the impact of favorable real estate market and
home prices on lost mitigation activities.
NOTE 7. INCOME TAXES
The components of income tax expense are as follows:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Current $ 40,969 $ 37,565 $ 6,942
Deferred 91,392 76,089 78,678
-------- -------- -------
Total income tax expense $132,361 $113,654 $85,620
======== ======== =======
The components of the income tax expense for 2001 included a foreign provision
for current tax expense of $15.1 million and a deferred tax benefit of $1.0
million primarily related to PMI Australia and PMI Europe. The Company paid
income taxes of $11.6 million in 2001, $12.5 million in 2000 and $10.5 million
in 1999.
Section 832(e) of the Internal Revenue Code permits mortgage guaranty insurers
to deduct, within certain limitations, additions to statutory contingency
reserves. This provision allows mortgage guaranty insurers to increase statutory
unassigned surplus through the purchase of non-interest bearing "tax and loss
bonds" from the federal government. The tax and loss bonds purchased are limited
to the tax benefit of the deduction for additions to the contingency reserves.
The Company purchased tax and loss bonds of $99.0 million in 2001, $103.4
million in 2000 and $73.5 million in 1999.
The components of the deferred income tax assets and liabilities at December 31
are as follows:
(Dollars in thousands) 2001 2000
- --------------------------------------------------------------------------------
Deferred tax assets:
Discount on loss reserves $ 8,658 $ 6,597
Unearned premium reserves 179 1,265
Alternative minimum tax credit carryforward 57,289 49,414
Pension costs and deferred compensation 9,221 6,302
Other assets 14,866 8,625
-------- --------
Total deferred tax assets 90,213 72,203
Deferred tax liabilities:
Statutory contingency reserves 63,626 61,905
Deferred policy acquisition costs 23,218 22,154
Unrealized gains on investments 33,944 36,976
Equity earnings of unconsolidated affiliates 10,723 6,640
Other liabilities 22,554 19,509
-------- --------
Total deferred tax liabilities 154,065 147,184
-------- --------
Net deferred tax liability $ 63,852 $ 74,981
======== ========
<PAGE>
A reconciliation of the statutory federal income tax rate to the effective tax
rate reported on income before income taxes is shown in the following table:
2001 2000 1999
- --------------------------------------------------------------------------------
Statutory federal income tax rate 35.0% 35.0% 35.0%
Tax-exempt interest (5.2) (6.0) (6.8)
State income tax 0.4 0.4 0.5
Foreign income tax (1.0) (0.3) 0.2
Other 0.9 1.3 0.6
------ ------ ------
Effective income tax rate 30.1% 30.4% 29.5%
====== ====== ======
NOTE 8. BUSINESS SEGMENTS
The Company's reportable operating segments include U.S. Mortgage Insurance,
International Mortgage Insurance and Title Insurance. The Other segment includes
the income and expenses of TPG, PMI Mortgage Services Co. and an inactive
broker-dealer.
Transactions between segments are not significant. The Company evaluates
performance primarily based on segment net income. The following tables present
information for reported segment income or loss and segment assets as of and for
the periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31, 2001
U.S. International
Mortgage Mortgage Title Consolidated
(Dollars in thousands) Insurance Insurance Insurance Other Total
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Premiums earned, investment income
and other income $ 650,685 $ 73,889 $ 162,528 $ 49,861 $ 936,963
Losses and loss adjustment expenses (102,856) (9,287) (5,905) -- (118,048)
Other underwriting and operating expenses (137,207) (11,515) (141,929) (59,546) (350,197)
Interest expense (46) (1,533) -- (20,173) (21,752)
----------- --------- --------- --------- -----------
Income (loss) before income taxes 410,576 51,554 14,694 (29,858) 446,966
Income (tax) benefit (127,521) (13,798) (5,294) 11,665 (134,949)
Extraordinary loss on early extinguishment
of debt, net of income tax benefit -- -- -- (4,805) (4,805)
----------- --------- --------- --------- -----------
Net income (loss) $ 283,054 $ 37,756 $ 9,400 $ (22,998) $ 307,212
=========== ========= ========= ========= ===========
Total assets $ 2,087,600 $ 415,518 $ 63,662 $ 423,172 $ 2,989,952
=========== ========= ========= ========= ===========
<CAPTION>
Year Ended December 31, 2000
U.S. International
Mortgage Mortgage Title Consolidated
(Dollars in thousands) Insurance Insurance Insurance Other Total
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Premiums earned, investment income
and other income $ 599,850 $ 38,517 $ 105,907 $ 18,298 $ 762,572
Losses and loss adjustment expenses (95,308) (5,684) (2,087) -- (103,079)
Other underwriting and operating expenses (131,700) (7,220) (94,302) (33,885) (267,108)
Interest expense (19) (2,705) -- (15,795) (18,519)
----------- --------- --------- --------- -----------
Income (loss) before income tax expense 372,823 22,908 9,518 (31,382) 373,866
Income tax benefit (expense) (114,234) (6,501) (3,274) 10,355 (113,654)
----------- --------- --------- --------- -----------
Net income (loss) $ 258,588 $ 16,407 $ 6,244 $ (21,027) $ 260,212
=========== ========= ========= ========= ===========
Total assets $ 2,052,814 $ 174,006 $ 53,275 $ 112,562 $ 2,392,657
=========== ========= ========= ========= ===========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31, 1999
U.S. International
Mortgage Mortgage Title Consolidated
(Dollars in thousands) Insurance Insurance Insurance Other Total
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Premiums earned, investment income
and other income $ 531,824 $ 15,902 $ 101,778 $ 20,620 $ 670,124
Losses and loss adjustment expenses (110,465) (1,213) (1,004) -- (112,682)
Other underwriting and operating expenses (134,264) (3,168) (88,244) (24,815) (250,491)
Interest expense (3) (1,307) -- (15,555) (16,865)
----------- --------- --------- --------- -----------
Income (loss) before income tax expense 287,092 10,214 12,530 (19,750) 290,086
Income tax benefit (expense) (88,628) (3,469) (4,422) 10,899 (85,620)
----------- --------- --------- --------- -----------
Net income (loss) $ 198,464 $ 6,745 $ 8,108 $ (8,851) $ 204,466
=========== ========= ========= ========= ===========
Total assets $ 1,764,125 $ 182,586 $ 46,484 $ 107,567 $ 2,100,762
=========== ========= ========= ========= ===========
</TABLE>
Included in the results of international mortgage insurance are the results of
the Australian and European operations. We commenced operations in Europe in
February 2001. The Australian operating results for 2000 reflect eleven months
of activity of PMI Ltd due to the one-month lag reporting period, whereas 2001
results reflect thirteen months of activity as we began to report our foreign
subsidiaries on the same calendar month as U.S. operations. The Australian
operating results for 2001 also includes four months of PMI Indemnity Limited's
activity. The 1999 results represent operations from the date of acquisition of
PMI Ltd in August 1999.
NOTE 9. LONG-TERM DEBT
Senior Convertible Debentures - In July 2001, the Company issued $360.0 million
of 2.50% Senior Convertible Debentures in a private offering to qualified
institutional buyers, and subsequently filed a shelf registration statement for
the resale of the Debentures and the common stock of TPG issuable upon
conversion of the Debentures. The Company has used a portion of the net proceeds
of $351.9 million for the repayment or retirement of existing indebtedness and
for general corporate purposes. The Debentures are due on July 15, 2021 and bear
interest at a rate of 2.50% per annum. The Company pays interest on the
Debentures on January 15 and July 15 of each year, beginning January 15, 2002,
and additional contingent interest under certain circumstances. The Debentures
may be convertible at the registered holders' option, prior to stated maturity,
into shares of the Company's common stock at an initial conversion price of
$88.31 per share, subject to adjustments in specified circumstances. The Company
may redeem some or all of the Debentures on or after July 15, 2006 for a price
equal to the principal amount of the Debentures plus any accrued and unpaid
interest. The holders may put the Debentures to the Company on July 15, 2004,
2006, 2008, 2111 and 2116. Upon a change of control of the Company, holders may
also require the Company, subject to certain conditions, to repurchase all or a
portion of the Debentures. The Company may repurchase the Debentures with cash,
common stock, or a combination of cash and shares of common stock.
Bank Loan - In August 1999, the Company entered into a credit agreement with
Bank of America, N.A. ("Bank"). The Company borrowed $45.8 million (AUD $70.5
million) at a six-month adjustable interest rate which equals the Australia Bank
Bill Buying Rate plus a specified margin that is dependent on the TPG's senior
debt rating ("Loan"). The proceeds of the Loan were used to finance the
acquisition of PMI Ltd. Concurrently, the Company entered into an interest rate
swap transaction ("Swap") with the Bank. The Swap effectively fixed the interest
rate on the Loan to 7.0%. The net interest effect of the Swap is reported as an
adjustment to interest expense. Effective January 1, 2001, upon adoption of SAFS
No. 133, Accounting for Derivative Instruments and Hedging Activities, the
Company recorded a $1.0 million liability for the fair value of the Swap in the
consolidated balance sheet. In July 2001, the Company repaid the Loan in the
amount of $35.7 million (AUD $70.5 million). Correspondingly, the
<PAGE>
Company terminated the Swap, resulting in a realized loss of $0.8 million. The
Company made interest payments on the Loan of $1.5 million in 2001 and $3.0
million in 2000. No interest payments were made during 1999.
Senior Notes - In November 1996, the Company issued unsecured debt securities in
the face amount of $100.0 million ("Notes"). The Notes mature and are payable on
November 15, 2006 and are not redeemable prior to maturity. No sinking fund is
required or provided for prior to maturity. Interest on the Notes is 6.75% and
is payable semiannually. In 2001, the Company repurchased $37.1 million of the
Notes, resulting in an extraordinary loss of $1.9 million, net of tax. The
Company made interest payments on the Notes of $6.5 million in 2001, $6.8
million in 2000 and 1999.
NOTE 10. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL SECURITIES
OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST
DEBENTURE OF THE COMPANY
In February 1997, TPG, through a wholly-owned trust, privately issued $100.0
million of 8.309% preferred Capital Securities, Series A (the "Capital
Securities"). The Capital Securities are redeemable after February 1, 2007 at a
premium or upon occurrence of certain tax events and mature on February 1, 2027.
The net proceeds of $99.0 million were used for general corporate purposes,
including common stock repurchases and additions to the investment portfolio.
The Capital Securities were issued by PMI Capital I ("Issuer Trust"). The sole
asset of the Issuer Trust consists of $103.1 million principal amount of a
junior subordinated debenture issued by TPG to the Issuer Trust. The
subordinated debenture bears interest at the rate of 8.309% per annum and
matures on February 1, 2027. The amounts due to the Issuer Trust under the
subordinated debenture and the related transactions have been eliminated in the
Company's consolidated financial statements. Distributions on the Capital
Securities occur on February 1 and August 1 of each year. The obligations of TPG
under the subordinated debenture and a related guarantee and expense agreement
constitute a full and unconditional guarantee by TPG of the Issuer Trust's
obligations under the Capital Securities. The Capital Securities are subject to
mandatory redemption under certain circumstances. In 2001, the Company retired
$51.5 million of the Capital Securities. The early extinguishment of a portion
of this debt resulted in an extraordinary loss of $2.9 million, net of tax. The
Company made distribution payments of $7.6 million in 2001, and $8.3 million in
2000 and 1999.
NOTE 11. FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets and incurs various financial liabilities. The estimated fair value of the
liabilities indicated below has been determined by quoted market price.
<TABLE>
<CAPTION>
As of December 31, 2001 As of December 31, 2000
----------------------- -----------------------
Carrying Estimated Carrying Estimated
(Dollars in thousands) Value Fair Value Value Fair Value
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
2.50% Senior Convertible Debentures $360,000 $383,400 $ -- $ --
6.75% Notes 62,950 66,814 99,609 99,859
8.309% Capital Securities 48,500 51,161 99,109 94,992
7.0% Bank Loan -- -- 37,210 39,000
</TABLE>
The estimated fair value is based on available market information and
appropriate valuation methodologies. However, considerable judgment is required
in interpreting market data to develop the estimates of fair value and,
accordingly, the estimates presented herein are not necessarily indicative of
the amounts that could be realized in a current market exchange.
<PAGE>
A number of the Company's significant assets and liabilities, including deferred
policy acquisition costs, property and equipment, loss reserves, unearned
premiums and deferred income taxes are not considered financial instruments.
NOTE 12. COMMITMENTS AND CONTINGENCIES
Leases - The Company leases certain office facilities and equipment. Minimum
rental payments under non-cancelable operating leases with a remaining term of
more than one year as of December 31, 2001 are as follows:
(Dollars in thousands) Lease Commitments
- --------------------------------------------------------------------------------
Years ending December 31:
2002 $11,864
2003 9,859
2004 7,821
2005 2,050
2006 1,429
Thereafter 1,408
-------
Total $34,431
=======
The Company renewed its corporate headquarters lease for 5 years in 1999. In
December 2000, the Company executed a purchase agreement for a seven-story
commercial building to serve as the new executive offices. The total purchase
price was $74.0 million in cash, with an initial deposit of $4.5 million paid on
December 29, 2000 and the final progress payment due at closing, which is
expected to be in 2002. The Company has made payments of $16.5 million to date
and has incurred $3.7 million of other costs and fees relating to the
construction of the building, which were included in other assets.
Rent expense for all leases was $12.8 million for 2001, $11.3 million for 2000
and $9.6 million for 1999.
Legal Proceedings - On December 15, 2000, the Company announced that PMI entered
into an agreement with the plaintiffs to settle the putative class action
litigation captioned Baynham et al. v. PMI Mortgage Insurance Company. PMI
denied all facts and allegations in the lawsuit that alleged violations of
Section 8 of the Real Estate Settlement Procedures Act ("RESPA") and other
related claims.
To account for the settlement, PMI took an pre-tax charge against fourth quarter
2000 earnings of $5.7 million, which is the estimated settlement less
anticipated insurance recovery. In the third quarter of 2001, the Company
incurred an additional pre-tax charge of $1.5 million, due to the write off of a
portion of the insurance recovery as a result of the insolvency of one of the
Company's insurance carriers. The charges are based upon the estimate of the
cost of settlement less the estimate of insurance payments the Company will
receive from its insurance carriers as reimbursement for costs incurred in
connection with its defense and settlement of the action. The Company
participated in non-binding mediation with its insurance carriers with respect
to the amount of reimbursement without achieving settlement. There can be no
assurance that the Company's estimate of the amount of insurance proceeds will
be realized and such an event could have an adverse effect on the Company's
results of operations.
Various other legal actions and regulatory reviews are currently pending that
involve the Company and specific aspects of its conduct of business. In the
opinion of management, the ultimate liability in one or more of these actions is
not expected to have a material effect on the financial condition or results of
operations of the Company.
<PAGE>
NOTE 13. REINSURANCE
PMI uses reinsurance to reduce net risk in force, to optimize capital
allocation, and to comply with a statutory provision adopted by several states
that limits the maximum mortgage insurance coverage to 25% for any single risk.
The Company's reinsurance agreements typically provide for a recovery of a
proportionate level of claim expenses from reinsurers, and reinsurance
recoverable is recorded as assets. As with all reinsurance contracts, the
Company remains liable to its policyholders if the reinsurers are unable to
satisfy their obligations under the agreements. Reinsurance recoverable and
estimates are based on the Company's actuarial analysis of the applicable
business. Amounts the Company will ultimately recover could differ materially
from amounts recorded in reinsurance recoverable. Reinsurance transactions are
recorded in accordance with the provisions of the reinsurance agreements and the
accounting guidance provided in SFAB No. 113, Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts. Reinsurance
recoverable on paid losses was $6.1 million at December 31, 2001, $9.2 million
at December 31, 2000 and $11.4 million at December 31, 1999. Prepaid reinsurance
premiums were $1.6 million in 2001, $1.8 million in 2000 and $1.7 million in
1999.
The majority of the Company's existing reinsurance contracts are captive
reinsurance arrangements. Captive reinsurance is a reinsurance product in which
a portion of the risk insured by PMI is reinsured with the mortgage originator
or investor through an affiliated entity. Ceded premiums for U.S. captive
reinsurance accounted for 81% of total ceded premiums written in 2001 compared
to 77% in 2000 and 56% in 1999.
In December 1993, PMI ceased writing capital markets pool business ("Old Pool"),
except for honoring certain commitments in existence prior to the
discontinuation of this business. Concurrently, PMI entered into a reinsurance
agreement with Forestview Mortgage Insurance Co. ("Forestview"), a wholly owned
subsidiary of Allstate, to cede all future Old Pool premiums and net losses from
PMI to Forestview. In July of 1999, PMI and Forestview received regulatory
approval of a Recapture Agreement executed in March 1999 to commute the Old Pool
reinsurance agreement retroactive to January 1, 1999. The Recapture Agreement
also included the commutation of an insignificant second lien primary insurance
agreement between the parties.
During 1999, PMI entered into a reinsurance agreement with three reinsurers to
provide coverage for a ten-year period in the event of excessive losses on PMI's
pool business. PMI paid the reinsurers a one-time premium of $16.4 million. This
agreement does not transfer risk as prescribed in SFAS 113, and therefore, is
being reported in accordance with SOP 98-7, Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Risk. The expense
attributable to the expiration of coverage provided under the contract was $2.1
million in 2001, $2.2 million in 2000 and $1.9 million in 1999.
<PAGE>
The effects of reinsurance on premiums written, premiums earned and losses and
loss adjustment expenses of the Company's operations for the years ended
December 31 are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 2001 2000 1999
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Premiums written
Direct $ 821,968 $ 676,777 $ 597,551
Assumed 1,745 2,209 8,999
Ceded (65,874) (39,924) (35,296)
--------- --------- ---------
Net premiums written $ 757,839 $ 639,062 $ 571,254
========= ========= =========
Premiums earned
Direct $ 818,946 $ 671,602 $ 586,590
Assumed 3,954 1,800 6,445
Ceded (68,129) (39,040) (34,412)
--------- --------- ---------
Net premiums earned $ 754,771 $ 634,362 $ 558,623
========= ========= =========
Losses and loss adjustment expenses
Direct $ 119,134 $ 106,301 $ 115,180
Assumed 684 (643) 3,109
Ceded (1,770) (2,579) (5,607)
--------- --------- ---------
Net losses and loss adjustment expenses $ 118,048 $ 103,079 $ 112,682
========= ========= =========
</TABLE>
NOTE 14. DIVIDENDS AND SHAREHOLDERS' EQUITY
Dividends - Under Arizona State insurance law, PMI may pay out of any available
surplus account without prior approval of the Director of the Arizona Department
of Insurance dividends during any twelve-month period not to exceed the lesser
of 10% of policyholders' surplus as of the preceding year end, or the last
calendar year's investment income. Other state insurance laws restrict the
payment of dividends from the unassigned surplus account only. The laws of
Florida limit the payment of dividends by APTIC to TPG in any one year to 10% of
available and accumulated surplus derived from net operating profits and net
realized investment gains. In addition to the dividend restrictions by state
laws, the Company's credit agreements limit the payment of dividends by PMI,
insurance regulatory authorities have the ability, directly or indirectly, to
limit the payment of dividends to TPG by PMI or by APTIC. In 2001, APTIC
declared and paid a cash dividend of $2.5 million to TPG, substantially the full
amount of the dividend that can be paid in 2001 without prior permission from
the Florida Department of Insurance. In 2001, PMI paid a cash dividend of $50.0
million to TPG, which was approved by the Arizona Department of Insurance.
Preferred Stock - The Company's restated certificate of incorporation authorizes
the Board of Directors to issue up to 5,000,000 shares of preferred stock of TPG
in classes or series and to set the designations, preferences, qualifications,
limitations or restrictions of any class or series with respect to the rate and
nature of dividends, the price and terms and conditions on which shares may be
redeemed, the amount payable in the event of voluntary or involuntary
liquidation, the terms and conditions for conversion or exchange into any other
class or series of the stock, voting rights and other terms. The Company may
issue, without the approval of the holders of common stock, preferred stock that
has voting, dividend or liquidation rights superior to the common stock, which
may adversely affect the rights of holders of common stock.
Pursuant to the Runoff Support Agreement described in Note 18, the Company has
agreed that, in the event that Allstate makes a payment contemplated by the
Allstate Support Agreements or the Runoff Support Agreement, Allstate will have
the right to receive preferred stock of TPG or PMI with a
<PAGE>
liquidation preference equal to the amount of such payment. Such preferred stock
will rank senior in right of payment to the issuer's common stock and, so long
as such preferred stock is outstanding, the issuer thereof will be prohibited
from paying any dividends or making any other distributions on its common stock.
NOTE 15. BENEFIT PLANS
After one year of service, full-time and part-time employees of the Company
participate in The PMI Group, Inc. Retirement Plan ("Plan"), a noncontributory
defined benefit plan. The Plan has been funded by the Company to the fullest
extent permitted by federal income tax rules and regulations. In addition,
certain employees whose earnings exceed $170,000 per year participate in The PMI
Group, Inc. Supplemental Employee Retirement Plan, a noncontributory defined
benefit plan. Benefits under both plans are based upon the employees' length of
service, average annual compensation and estimated social security retirement
benefits.
The Company provides certain health care and life insurance benefits for retired
employees, referred to as the "OPEB Plan". Generally, qualified employees may
become eligible for these benefits if they retire in accordance with the
Company's established retirement policy and are continuously insured under the
Company's group plans or other approved plans for ten or more years prior to
retirement. The Company shares the cost of the retiree medical benefits with
retirees based on years of service, and the Company's share is subject to a 5%
limit on annual medical cost inflation after retirement. The Company has the
right to modify or terminate these plans.
The following table presents certain information with respect to the Company's
benefit plans as of December 31:
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
---------------------------------- -------------------------------
(Dollars in thousands, except percentages) 2001 2000 1999 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Change in benefit obligation
Benefit obligation at January 1 $ 34,624 $ 25,537 $ 18,376 $ 4,814 $ 3,952 $ 4,219
Service cost 6,130 5,955 5,443 529 574 578
Interest cost 3,098 2,725 1,710 373 410 320
Actuarial loss (gain) 935 1,614 1,046 (266) (92) (1,139)
Benefits paid (803) (1,207) (1,038) (55) (30) (26)
-------- -------- -------- ------- ------- -------
Benefit obligation at December 31 43,984 34,624 25,537 5,395 4,814 3,952
-------- -------- -------- ------- ------- -------
Change in plan assets
Fair value of plan assets at January 1 17,136 13,894 8,877 -- -- --
Actual return (loss) on plan assets (2,494) 1,296 2,397 -- -- --
Company contribution 5,864 3,155 3,658 55 30 26
Benefits paid (803) (1,209) (1,038) (55) (30) (26)
-------- -------- -------- ------- ------- -------
Fair value of plan assets at December 31 19,703 17,136 13,894 -- -- --
-------- -------- -------- ------- ------- -------
Funded status
Funded (under funded) status of plan
at December 31 (24,281) (17,488) (11,643) (5,396) (4,814) (3,952)
Unrecognized actuarial loss (gain) 9,129 4,357 2,891 (1,708) (1,532) (1,460)
Unrecognized prior service cost -- -- -- 205 225 245
-------- -------- -------- ------- ------- -------
Accrued and recognized benefit cost $(15,152) $(13,131) $ (8,752) $(6,899) $(6,121) $(5,167)
======== ======== ======== ======= ======= =======
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Components of net periodic benefit cost
Service cost $ 6,130 $ 5,955 $ 5,443 $ 529 $ 574 $578
Interest cost 3,098 2,725 1,710 373 411 320
Expected return on assets (1,495) (1,363) (893) -- -- --
Prior service cost amortization -- -- -- -- 20 20
Actuarial loss (gain) recognized 205 216 234 19 (20) --
Additional cost 305 -- -- (90) -- --
------- ------- ------- ----- ----- ----
Net periodic benefit cost $ 8,243 $ 7,533 $ 6,494 $ 831 $ 985 $918
======= ======= ======= ===== ===== ====
Weighted-average assumptions
Discount rate 7.50% 7.75% 8.00% 7.50% 7.75% 8.00%
Expected return on plan assets 8.50% 8.50% 8.50% N/A N/A N/A
Rate of compensation increase 5.50% 5.50% 5.50% N/A N/A N/A
Health care cost trend on covered charges N/A N/A N/A 6.00% 6.00% 6.00%
</TABLE>
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:
<TABLE>
<CAPTION>
One-Percentage- One-Percentage-
(In thousands) Point Increase Point Decrease
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Effect on total of service and interest cost components $ 200 $155
Effect on accumulated post-retirement benefit obligation 1,048 821
</TABLE>
Savings and Profit Sharing Plans. All full-time, part-time and certain temporary
employees of the Company are eligible to participate in The PMI Group, Inc.
Savings and Profit-Sharing Plan ("401(k) Plan"). Eligible employees who
participate in the 401(k) Plan receive, within certain limits, matching Company
contributions. Costs relating to the 401(k) Plan were $2.7 million for 2001,
$2.4 million for 2000 and $2.2 million for 1999. Contract underwriters are
covered under The PMI Group, Inc. Alternate 401(k) Plan, under which there are
no matching Company contributions.
NOTE 16. INCENTIVE PLANS
Equity Incentive Plan - In 2001, the shareholders approved the amendment of The
PMI Group, Inc. Equity Incentive Plan ("Equity Incentive Plan") and The PMI
Group, Inc. Stock Plan for Non-Employee Directors ("Directors Plan"), to reflect
the merger of the Directors Plan into the Equity Incentive Plan. Pursuant to the
merger, the director awards are now made under the Equity Incentive Plan on
substantially the same terms and conditions as were in effect under the Director
Plan before the plan merger date. The Equity Incentive Plan provides for awards
of both non-qualified stock options and incentive stock options, stock
appreciation rights, restricted stock subject to forfeiture and restrictions on
transfer, and performance awards entitling the recipient to receive cash or
common stock in the future following the attainment of performance goals
determined by the Board of Directors. Generally, options are granted with an
exercise price equal to the market value on the date of grant, expire ten years
from the grant date and have a three-year vesting period. The directors' award
program provides that each director who is not an employee of the Company
receives an annual grant of up to 450 shares of common stock and receives 3,750
shares of stock options annually, after an initial option of up to 6,000 shares.
The shares are granted on June 1 of each year or as soon as administratively
practicable after each anniversary of the director's commencement of service.
<PAGE>
The following is a summary of the stock option activity in the Equity Incentive
Plan during 2001, 2000 and 1999:
<TABLE>
<CAPTION>
2001 2000 1999
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Option Exercise Price Under Option Exercise Price Under Option Exercise Price
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 2,078,103 $36.31 1,756,041 $34.41 1,318,388 $36.13
Granted 751,745 60.52 646,667 39.12 587,256 29.54
Exercised (159,039) 33.54 (243,021) 30.63 (102,776) 25.19
Forfeited (42,559) 51.96 (81,584) 34.65 (46,827) 42.18
--------- --------- ---------
Outstanding at end of year 2,628,250 43.15 2,078,103 36.31 1,756,041 34.41
========= ========= =========
Exercisable at year-end 1,141,123 $34.94 827,541 $33.20 746,398 $31.00
Weighted-average fair
market value of options
granted during the year -- $60.52 -- $39.12 -- $29.54
Reserved for future grants 4,498,810 -- 1,738,350 -- 2,353,469 --
</TABLE>
Note: As of December 31, 2001, exercise price for options outstanding ranged
from $19.66 to $70.88. The weighted-average remaining contractual life of three
options was 7.3 years.
The fair value of stock-based compensation to employees is calculated using the
option pricing models that are developed to estimate the fair value of freely
tradable and fully transferable options without vesting restrictions, which
differ from the Company's stock option program. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect calculated value. The fair value of each
stock option grant is estimated on the date of the grant using the Black-Scholes
option pricing model with the following weighted-average assumptions:
2001 2000 1999
- --------------------------------------------------------------------------------
Dividend yield 0.28% 0.30% 0.35%
Expected volatility 36.92% 35.08% 29.66%
Risk-free interest rate 4.50% 6.14% 5.53%
SFAS 123 requires the pro-forma disclosure of net income and earnings per share
using the fair value method. If the computed fair values of the 2001, 2000 and
1999 awards had been amortized to expense over the vesting period of the awards,
the Company's net income, basic net income per share and diluted net income per
share would have been reduced to the pro-forma amounts indicated below:
(Dollars in thousands, except per share amounts) 2001 2000 1999
- --------------------------------------------------------------------------------
Net income:
As reported $307,212 $260,212 $204,466
Pro-forma 298,444 255,811 201,503
Basic earnings per share:
As reported $ 6.91 $ 5.88 $ 4.55
Pro-forma 6.72 5.78 4.49
Diluted earnings per share:
As reported $ 6.78 $ 5.78 $ 4.52
Pro-forma 6.58 5.68 4.45
Equity Stock Purchase Plan - In 1999, the Company adopted The PMI Group, Inc.
Employee Stock Purchase Plan ("ESPP"). The ESPP allows eligible employees to
purchase shares of the Company's stock
<PAGE>
at 15% discount of fair market value of the stock at the beginning or ending of
each six-month enrollment period, whichever is lower. Under the ESPP, the
Company sold approximately 26,693 shares in 2001, 23,638 shares in 2000 and
13,578 shares in 1999. The Company applies APB 25 in accounting for the ESPP.
The pro-forma effect on the Company's net income and earnings per share had
compensation cost been determined under SFAS 123 was deemed immaterial in 2001.
NOTE 17. STATUTORY ACCOUNTING
The Company's domestic insurance subsidiaries prepare statutory financial
statements in accordance with the accounting practices prescribed or permitted
by their respective state's Department of Insurance, which is a comprehensive
basis of accounting other than GAAP.
The National Association of Insurance Commissioners ("NAIC") revised the NAIC
Accounting Practices and Procedures Manual in a process referred to as
Codification. The revised manual was adopted by the respective states effective
January 1, 2001. The Company prepares its statutory financial statements in
conformity with accounting practices prescribed or permitted by the State of
Arizona. Effective January 1, 2001, the State of Arizona required that insurance
companies domiciled in the State of Arizona prepare their statutory basis
financial statements in accordance with the NAIC Accounting Practices and
Procedures Manual - Version effective January 1, 2001 subject to any deviations
prescribed or permitted by the State of Arizona insurance commissioner.
Accounting changes adopted to conform to the provisions of the NAIC Accounting
Practices and Procedures Manual are reported as changes in accounting
principles. The cumulative effect of changes in accounting principles is
reported as an adjustment to unassigned funds, or surplus, at the end of the
period in which the change in accounting principle occurs. The cumulative effect
is the difference between the amount of capital and surplus at the beginning of
the period and the amount of capital and surplus that would have been reported
at that date if the new accounting principles had been applied retroactively for
all prior periods. As a result of these changes, the Company reported an
increase in statutory unassigned funds of $6.2 million as of January 1, 2001.
The statutory net income, statutory surplus and contingency reserve liability of
PMI as of and for the years ended December 31 are as follows:
(Dollars in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Statutory net income $ 318,989 $ 276,946 $ 270,301
Statutory surplus 190,813 159,528 134,133
Contingency reserve liability 1,709,896 1,457,991 1,238,140
Under the insurance laws of the State of Arizona and several other states,
mortgage insurers are required to establish a special contingency reserve from
unassigned funds, with annual additions equal to 50% of premiums earned for that
year. This reserve is required to be maintained for a period of 120 months to
protect against the effects of adverse economic cycles. After 120 months, the
reserve is released to unassigned funds. In the event an insurer's loss ratio in
any calendar year exceeds 35%, however, the insurer may withdraw from its
contingency reserve an amount equal to the excess portion of such losses. The
Company has not withdrawn from the contingency reserve since the year ended
1997.
The differences between the statutory net income and equity presented above and
the consolidated net income and equity presented on a GAAP basis primarily
reflect the differences between GAAP and statutory accounting practices as well
as the results of operations and equity of other subsidiaries of the Company.
<PAGE>
NOTE 18. CAPITAL SUPPORT AGREEMENTS
PMI's claims-paying ratings from certain national rating agencies have been
based on various capital support commitments from Allstate ("Allstate Support
Agreements"). On October 27, 1994, the Allstate Support Agreements were
terminated with respect to policies issued after October 27, 1994, but continue
in modified form (as so modified, the "Runoff Support Agreement") for policies
written prior to such termination. Under the terms of the Runoff Support
Agreement, Allstate may, at its option, either directly pay or cause to be paid,
claims relating to policies written during the terms of the respective Allstate
Support Agreements if PMI fails to pay such claims or, in lieu thereof, make
contributions directly to PMI or TPG. In the event any amounts are paid or
contributed, which possibility management believes is remote; Allstate would
receive subordinated debt or preferred stock of PMI or TPG in return. No payment
obligations have arisen under the Runoff Support Agreement. The Runoff Support
Agreement provides PMI with additional capital support for rating agency
purposes.
The Runoff Support Agreement contains certain covenants, including covenants
that (i) PMI will write no new business after its risk-to-capital ratio equals
or exceeds 23 to 1; (ii) PMI will pay no dividends if, after the payment of any
such dividend, PMI's risk-to-capital ratio would equal or exceed 23 to 1; and
(iii) on the date that any of the following events occur: (a) PMI's
risk-to-capital ratio exceeds 24.5 to 1, (b) Allstate shall have paid any claims
relating to PMI policies directly to a policyholder or by paying an amount equal
to such claims to PMI, or to TPG for contribution to PMI, pursuant to the Runoff
Support Agreement, or (c) any regulatory order is issued restricting or
prohibiting PMI from making full or timely payments under policies, PMI will
transfer substantially all of its assets in excess of $50.0 million to a trust
account established for the payment of claims.
In 1997, PMI entered into a capital support commitment to Duff & Phelps Credit
Rating Co. ("Fitch"), under which it agreed to contribute to APTIC amounts
necessary to maintain APTIC's capital and surplus at a level no less than 100%
of Fitch's risk adjusted capital requirements to attain a Fitch claims paying
ability rating of not less than "AA-" at the end of each year. PMI also entered
a cancellation agreement with APTIC that provides that, in the event PMI
provides notice of its intent to cancel the capital support commitment, APTIC
will immediately submit a request to Fitch to be rated on a stand-alone basis
and sign an agreement canceling APTIC's rights under the capital support
commitment.
In 2001, PMI executed a capital support agreement whereby it agreed to
contribute funds, under specified conditions, to maintain CMG's risk-to-capital
at or below 18.0 to 1. PMI's obligation under the agreement is limited to an
aggregate amount of $37.7 million, exclusive of capital contributions made prior
to April 10, 2001. A 1999 CMG capital support agreement was superceded by
execution of the new agreement. On December 31, 2001, CMG's risk-to capital
ratio was 14.8 to 1.
PMI has entered into capital support agreements with its European and Australian
subsidiaries that could require PMI to make additional capital contributions to
those subsidiaries in order to maintain their credit ratings. With respect to
the European and Australian subsidiaries, the Company guarantees the performance
of PMI's capital support agreements.
As of December 31, 2001, the Company was in compliance with all covenants
included in its capital support agreements.
<PAGE>
NOTE 19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
A summary of selected quarterly results follows:
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter
------------------- ------------------- ------------------- -------------------
2001 2000 2001 2000 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $204,573 $179,418 $216,621 $187,893 $236,817 $195,046 $278,952 $200,211
Net income $ 71,531 $ 59,990 $ 75,197 $ 64,979 $ 78,344 $ 69,256 $ 82,140 $ 65,983
Basic EPS $ 1.61 $ 1.36 $ 1.69 $ 1.47 $ 1.76 $ 1.57 $ 1.84 $ 1.49
Diluted EPS $ 1.59 $ 1.34 $ 1.66 $ 1.45 $ 1.72 $ 1.53 $ 1.81 $ 1.46
</TABLE>
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.
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
The PMI Group, Inc.
We have audited the accompanying consolidated balance sheets of The PMI Group,
Inc. and subsidiaries (the Company) as of December 31, 2001 and 2000, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the two years then ended. Our audits also included the financial
statement schedules as of and for each of the two years ended December 31, 2001
listed in the index at item 14(a). These financial statements and schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedules based on our audits. The
financial statements of the Company for the year ended December 31, 1999 were
audited by other auditors whose report dated January 20, 2000, expressed an
unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The PMI Group,
Inc. and subsidiaries at December 31, 2001 and 2000, and the consolidated
results of their operations and their cash flows for each of the years then
ended, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedules as of
and for each of the two years ended December 31, 2001, when considered in
relation to the basic financial statements taken as a whole, present fairly in
all material respects the information set forth therein.
/s/ Ernst & Young LLP
Los Angeles, California
January 21, 2002
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of The PMI Group, Inc.:
We have audited the accompanying consolidated statements of operations, cash
flows, and shareholders' equity of The PMI Group, Inc. and subsidiaries for the
year ended December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of the operations, cash flows and shareholders'
equity of The PMI Group, Inc. and subsidiaries for the year ended December 31,
1999, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Deloitte & Touche LLP
San Francisco, California
January 20, 2000
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-21.1
<SEQUENCE>6
<FILENAME>dex211.txt
<DESCRIPTION>SUBSIDIARIES OF THE REGISTRANT
<TEXT>
<PAGE>
EXHIBIT 21.1
------------
THE PMI GROUP, INC. -- SUBSIDIARIES
Name Under Which
Subsidiary Does Jurisdiction of
Subsidiary Name Business (if different) Incorporation
- --------------------------------------------------------------------------------
PMI Mortgage Insurance Co. Arizona
American Pioneer Title Insurance Co. Chelsea Title Company Florida
Residential Guaranty Co. Arizona
PMI Mortgage Guaranty Co. Arizona
Residential Insurance Co. Arizona
TPG Insurance Co. Vermont
CLM Technologies, Ltd. California
TPG Segregated Portfolio Company Cayman
PMI Mortgage Insurance Australia
(Holdings) Pty Limited Australia
PMI Mortgage Insurance Ltd Australia
PMI Indemnity Limited Australia
TPG Reinsurance Company Limited Ireland
PMI Mortgage Insurance Company Limited Ireland
PMI Insurance Services Limited United Kingdom
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23.1
<SEQUENCE>7
<FILENAME>dex231.txt
<DESCRIPTION>CONSENT OF INDEPENDENT AUDITORS
<TEXT>
<PAGE>
EXHIBIT 23.1
------------
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of The PMI Group, Inc. of our report dated January 21, 2002, included in the
2001 Annual Report to Shareholders of The PMI Group, Inc.
Our audits also included the financial statement schedules of The PMI Group,
Inc. as of and for each of the two years in the period ended December 31, 2001
listed in Item 14(a). These schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements take as a whole,
present fairly in all material respects the information set forth therein.
We also consent to the incorporation by reference in:
-------------------------------------------
Registration Statement On
Number Form
-------------------------------------------
333-92636 S-8
-------------------------------------------
333-47473 S-8
-------------------------------------------
333-66829 S-8
-------------------------------------------
333-81679 S-8
-------------------------------------------
333-32190 S-8
-------------------------------------------
333-76742 S-8
-------------------------------------------
333-63122 S-8
-------------------------------------------
033-99378 S-8
-------------------------------------------
333-48035 S-3
-------------------------------------------
333-67125 S-3
-------------------------------------------
333-70306 S-3
-------------------------------------------
333-29777 S-4
-------------------------------------------
of our report dated January 21, 2002, with respect to the consolidated financial
statements incorporated herein by reference, and our report included in the
preceding paragraph with respect to the financial statement schedules as of and
for each of the two years in the period ended December 31, 2001 included in this
Annual Report (Form 10-K) of The PMI Group, Inc.
/s/ Ernst & Young LLP
Los Angeles, California
March 26, 2002
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23.2
<SEQUENCE>8
<FILENAME>dex232.txt
<DESCRIPTION>INDEPENDENT AUDITOR'S REPORT
<TEXT>
<PAGE>
EXHIBIT 23.2
------------
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
333-92636, No. 333-99378, No. 333-47473, No. 333-66829, No. 333-81679, No.
333-32190, No. 333-76742, No. 333-63122, and No. 033-99378 of The PMI Group,
Inc. (the "Company") on Form S-8 and Registration Statements No. 333-48035, No.
333-67125, and No. 333-70306 of the Company on Form S-3 and Registration
Statement No. 333-29777 of the Company on Form S-4 of our reports dated January
20, 2000 appearing in and incorporated by reference in this Annual Report on
Form 10-K of the Company for the year ended December 31, 2001.
/s/ Deloitte & Touche LLP
San Francisco, California
March 26, 2002
</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
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