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SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

For the fiscal year ended December 31, 2002

OR

Commission file number 1-13664

THE PMI GROUP, INC.

(Exact name of registrant as specified in its charter)

(925) 658-7878

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

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.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  x  No  ¨

The market value of the voting stock (common stock) held by non-affiliates of the registrant as of the close of business on June 28, 2002 was $3,430,198,758 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 registrant’s common stock, as of close of business on February 28, 2003: 88,821,747

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for registrant’s Annual Meeting of Stockholders to be held on May 22, 2003 are incorporated by reference into Items 10 through 13 of Part III.

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Cautionary Statement Regarding Forward-Looking Statements

Statements we make or incorporate by reference in this and other documents filed with the Securities and Exchange Commission that are not historical facts, that 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 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 our 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.

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PART I

Item 1.    Business

A.     Overview of Operations—The PMI Group, Inc.

The PMI Group, Inc. is an international provider of credit enhancement products and lender services that promote homeownership and facilitate mortgage transactions in the capital markets. Through our wholly-owned subsidiaries and unconsolidated strategic investments, we offer residential mortgage insurance and credit enhancement products domestically and internationally, residential lender services and financial guaranty reinsurance. In January 2003, we announced the formation of a wholly-owned subsidiary, PMI Capital Corporation, to manage our international mortgage operations and unconsolidated strategic investments.

Our primary operating subsidiary, PMI Mortgage Insurance Co., or PMI, is a leading U.S. residential mortgage insurer, licensed in all 50 states, the District of Columbia and Puerto Rico. Residential mortgage insurance protects lenders and investors against potential losses in the event of borrower default.

PMI’s 50% owned joint venture, CMG Mortgage Insurance Company, or CMG, offers mortgage insurance for loans originated by credit unions.

In the United States, we offer title insurance through our wholly-owned subsidiary, American Pioneer Title Insurance Company, or APTIC, and we participate in the mortgage loan servicing market through our unconsolidated strategic investment, Fairbanks Capital Holding Corp., or Fairbanks. We are also an investor in Truman Capital Founders, LLC, or Truman, which is the general partner and majority-owner of Truman Capital Investment Fund, L.P., or Truman Fund, an investment vehicle that focuses on the residential whole loan purchase market.

We have a number of international operations that offer mortgage insurance and other credit enhancement products.

Our consolidated net income was $346.2 million for the year ended December 31, 2002. As of December 31, 2002, our total assets were $3.5 billion, including our investment portfolio which had a market value of $2.5 billion as of that date. Our shareholders’ equity was $2.2 billion as of December 31, 2002. See Part II, Item 8, Financial Statements and Supplementary Data, Note 18, Business Segments, for financial information regarding our business segments.

We are incorporated in Delaware and our principal executive offices are located at 3003 Oak Road, Walnut Creek, California 94597. Our telephone number is (925) 658-7878.

Our website address is http://www.pmigroup.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports are available free of charge on

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our website via a hyperlink as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

B.    U.S. Mortgage Insurance Operations

Private mortgage insurance facilitates the sale of low down payment mortgages in the capital mortgage market and expands homeownership opportunities by enabling borrowers to buy homes with down payments of less than 20%. PMI’s mortgage insurance covers default risk on first mortgage loans secured by one to four unit residential properties. PMI’s insurance is purchased by lenders and investors seeking protection against default risk, capital relief or credit enhancement for portfolio or secondary mortgage market transactions. PMI is incorporated in Arizona and headquartered in Walnut Creek, California.

1.    Products

Primary Mortgage Insurance

Primary mortgage insurance, or primary insurance, provides mortgage default protection to lenders and 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 policies, and take title to the mortgaged property. 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, 2002 was $47.8 billion. PMI’s primary NIW includes insurance that PMI underwrites on a loan-by-loan basis (flow channel) and insurance acquired in bulk (bulk channel), primarily in the capital mortgage market. PMI generally offers coverage percentages on its flow primary insurance ranging from 6% to 42% of the claim amount. PMI’s coverage percentages for its bulk primary insurance generally range from 1% to 50% of the claim amount. PMI does not include primary insurance placed upon loans more than 12 months after their origination when calculating and reporting NIW. PMI’s primary insurance in force and primary risk in force at December 31, 2002 were $107.6 billion and $25.2 billion, respectively. Primary insurance in force refers to the current principal balance of all outstanding mortgage loans with primary insurance coverage as of a given date. Primary risk in force is the aggregate dollar amount equal to the product of each individual insured mortgage loan’s current principal balance multiplied by the loan’s specified primary insurance coverage percentage. (These definitions are discussed further below under Primary and Pool Mortgage Insurance as Reported to MICA.)

Primary 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 95% of NIW in 2002 and 97% of NIW in 2001. As of December 31, 2002, monthly plans represented 92% 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 to be made at loan closing or financed into the loan amount. Single premium plan payments may be

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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 5% and 3% of NIW in 2002 and 2001, respectively. Single premium and annual premium plans combined represented 8% of PMI’s primary risk in force as of December 31, 2002.

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.

PMI may not cancel mortgage insurance coverage except for events of nonpayment of premiums or certain material violations of PMI’s master policies. With respect to PMI’s flow channel, 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 NIW. Accordingly, a decline in insurance in force as a result of policy cancellations of older books of business could harm our financial condition and results of operations. During a period of falling interest rates, an increasing number of borrowers refinance their mortgage loans, and as a result of policy cancellations of older books of business with higher interest rates, PMI generally experiences a decrease in existing insurance in force. New insurance written during periods of low interest rates may ultimately prove to be inadequate to offset the loss of insurance in force resulting from policy cancellations. Additionally, an increasing amount of PMI’s NIW is subject to captive reinsurance agreements (see Products—Captive Reinsurance below), and this trend could negatively impact net premiums written and the yield PMI obtains on net premiums earned.

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 by maintaining lender recourse or lender participation. Lenders that purchase private mortgage insurance in connection with the sale of loans to the GSEs must comply with the GSEs’ mortgage insurance coverage percentage requirements. The GSEs have some discretion to increase or decrease the amount of mortgage insurance coverage they require on loans, provided that minimum requirements are met. For example, in 1995, the GSEs increased their mortgage insurance 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 LTVs of 85.01% to 90%, or 90s. LTV is the ratio of the original loan amount to the value of the property. Accordingly, PMI’s percentage of risk in force with these higher coverage requirements increased. As PMI charges higher premium rates for higher coverage levels, the increased mortgage insurance coverage requirements imposed by the GSEs in 1995 resulted in increased earned premiums for loans of similar type.

In cooperation with participating lenders, PMI has entered into agreements with the GSEs to restructure primary insurance coverage on high LTV loans sold to the GSEs over a specified period of time. The coverage restructuring involves reducing the level of primary insurance coverage in exchange for PMI providing a second layer of modified pool insurance coverage (see Pool Mortgage Insurance below). These transactions may provide for payments to the GSEs for the reduced coverage and/or the services provided by the GSEs. Restructuring primary insurance negatively impacts our net premium written and PMI’s yield on net premiums earned.

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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 insurance coverage, up to a stated aggregate loss limit, or stop loss, for all of the loans in a pool. Because the insurance exposure is not limited to a set coverage percentage on specific loans as with primary insurance, the rating agencies’ capital requirements for traditional pool insurance are greater than for primary insurance. Prior to 2002, PMI offered traditional pool insurance primarily to two different customer segments: lenders and the GSEs (GSE Pool), and capital market participants (Old Pool). PMI is not currently offering traditional pool insurance to its customers.

PMI offered GSE Pool, a traditional pool insurance product for mortgage loans sold by PMI’s customers to the GSEs, from 1997 to 2001. PMI did not write any new risk for GSE Pool in 2002, compared to $19.5 million written for the year ended December 31, 2001. The average stop loss limit for GSE Pool as of December 31, 2002 was 1.1%. GSE Pool risk in force at December 31, 2002 was $794.1 million.

In 1999, pursuant to a recapture agreement between PMI and Forestview Mortgage Insurance Company, or Forestview, PMI assumed mortgage pool insurance loss reserves presently estimated to be $0.7 million, net of expense allocations, previously insured by Forestview. These Old Pool policies, which were written prior to 1994, are past their peak claim periods. Risk in force for the Old Pool portfolio was $0.9 billion at December 31, 2002.

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, 2002 was $310.1 million.

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 currently offers modified pool insurance products that, in addition to having a stated aggregate loss limit and other risk reduction features, have exposure limits on each individual loan in the pool. Modified pool insurance may be attractive to investors and lenders seeking capital relief, a reduction of default risk beyond the protection provided by existing primary insurance, or coverage for loans that do not require primary insurance. To date, PMI has issued modified pool insurance principally to the GSEs as supplemental coverage.

PMI wrote $807.9 million of modified pool risk in 2002, compared to $398.8 million in 2001. Total modified pool risk in force as of December 31, 2002 and 2001 was $1,159.6 million and $414.5 million, respectively. The majority of PMI’s modified pool business in 2002 came through its participation in a market outreach program offered by Fannie Mae. This program allows lenders to take a more comprehensive view of a borrower’s creditworthiness and expand the benefit of conventional financing to homeowners. PMI’s modified pool product enhances the primary insurance coverage on these loans.

Primary and Pool Mortgage Insurance as Reported to MICA

Prior to July 2001, PMI did not include modified pool insurance in its NIW, primary insurance in force or primary risk in force calculations and reporting. In July 2001, in accordance with standards set by the industry’s trade association, Mortgage Insurance Companies of America, or MICA, PMI revised several definitions of insurance. Under the revised MICA definitions, PMI included modified pool insurance towards NIW, primary insurance in force and risk in force when the modified pool insurance was placed on a loan that did not also have primary insurance coverage and the investor’s exposure after the application of PMI’s insurance coverage was more than 50% of the value of the loan. Under the revised definitions, PMI also excluded from its NIW calculation primary insurance on loans where the coverage exceeded 50% of the loan value and included these amounts in pool insurance totals.

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Beginning in the fourth quarter of 2002, PMI returned to its pre-July 2001 definitions of primary insurance and pool insurance, which reflect more appropriately the manner in which PMI’s management measures and analyzes its portfolio. Accordingly, in this report unless otherwise noted:

However, PMI’s insurance portfolio statistics as reported in other documents between the third quarter of 2001 and the third quarter of 2002 may not be comparable to PMI’s pre-July 2001 or post December 2002 portfolio statistics because the portfolio statistics between the third quarter of 2001 and the third quarter of 2002 were reported based on the revised MICA definitions.

Negotiated Transactions

PMI engages in negotiated, capital market “bulk” transactions. While their terms vary, negotiated transactions generally involve bidding upon and, if successful, insuring a large group of loans or committing to insure a large group of loan originations on agreed terms. Insurance issued in negotiated transactions may include primary insurance or modified pool insurance, or a combination of both. 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 down to a percentage of the loan balance selected by the insured.

To obtain this business, PMI competes with other mortgage insurers and other providers 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. However, 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. Persistency is the percentage of insurance policies at the beginning of a 12-month period that remains in force at the end of the period. PMI issued approximately $3.2 billion of primary insurance through negotiated transactions in 2002, which accounted for approximately 7% of PMI’s NIW for 2002. In 2001, approximately 14% of PMI’s NIW was acquired through negotiated transactions. PMI issued virtually all of its modified pool insurance through negotiated transactions in 2002 and 2001. PMI enters into negotiated transactions primarily with capital mortgage market participants, including mortgage investors, such as the GSEs, and underwriters of mortgage-backed securities. We believe that negotiated transactions will make up a significant portion of the mortgage insurance industry’s and PMI’s NIW and modified pool risk written in 2003.

Captive Reinsurance

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, or captive reinsurers, affiliated with such lenders. In return, a proportionate amount of PMI’s gross premiums written is ceded to the captive reinsurers.

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These increases in the percentages of primary NIW, primary insurance in force and total risk in force subject to captive reinsurance agreements were driven by heavy refinance activity in which borrowers obtain lower interest rate mortgage loans with lenders with captive insurance programs and a higher percentage of NIW generated by lenders with captive reinsurance programs. We anticipate that higher levels of captive reinsurance cessions will continue to reduce PMI’s premium yield, and that the percentage of PMI’s primary risk in force subject to captive reinsurance agreements will continue to increase as a percentage of total risk in force.

PMI’s captive reinsurance agreements primarily provide for excess-of-loss reinsurance, under which 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 is also a party to three 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.

Freddie Mac’s “Eligibility Criteria for Private Mortgage Insurers” establishes financial requirements for captive reinsurance agreements. Among other things, the requirements: (i) mandate that captive reinsurance agreements include risk transfer in accordance with Financial Accounting Standards Board 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. In addition, under the terms of the Baynham settlement (see Item 3. Legal Proceedings below), PMI must obtain a written opinion of an independent actuary that the net ceded premiums under each captive reinsurance agreement are “commensurate or reasonably related to the risk transferred.”

To ensure the performance of its captive reinsurers, PMI requires each captive reinsurer to establish a trust account with a United States-domiciled bank approved by the National Association of Insurance Commissioners 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 given written consent for such withdrawal.

Other Risk-Sharing Products

In addition to captive reinsurance, PMI offers other risk-sharing products, including:

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Joint Venture—CMG Mortgage Insurance Company

CMG Mortgage Insurance Company, or 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. Both PMI and CMIC provide services to CMG. At December 31, 2002, CMG had $10.9 billion of primary insurance in force. CMG’s financial results are reported in PMI’s financial statements under the equity method of accounting in accordance with generally accepted accounting principles in the United States, or GAAP. CMG’s operating results are not included in PMI’s results shown in Part I of this Form 10-K, unless noted. CMIC manages CMG’s investment portfolio.

Under the terms of the joint venture agreement executed on September 8, 1994, CMIC has the right on September 8, 2009, or earlier under certain limited conditions, 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 of PMI’s interest. For this purpose, fair market value will be determined by agreement between PMI and CMIC, or if the parties are unable to reach an agreement, through appraisal by nationally recognized investment banking firms. PMI and CMIC have also entered into a capital support agreement for the benefit of CMG in order to maintain CMG’s claims-paying ability rating at “AA-” by S&P and “AA” by Fitch.

CMG is a party to one captive reinsurance agreement and may enter into additional captive reinsurance agreements in the future.

2.    Competition

U.S. Private Mortgage Insurance Industry

The U.S. private mortgage insurance industry consists of eight active mortgage insurers: PMI; CMG; 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.

The Mortgage Bankers Association of America estimates that, for the year ended December 31, 2002, total mortgage originations were $2.5 trillion compared to $2.1 trillion for the year ended December 31, 2001.

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 Federal Housing Association, or 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.

Source: FHA, VA and MICA.

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Effective January 1, 2003, the U.S. Housing and Urban Development Department, or HUD, in accordance with its index, increased the maximum single-family loan amount that the FHA can insure from $261,609 to $280,749 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 premium it charges on loans from 2.25% to 1.5% of the original loan amounts. The FHA has also 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 that 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 for eligible loans credit enhancement that is not limited to mortgage insurance. Purchases of secondary mortgage loans by the Mortgage Partnership Finance Program increased in 2002. 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 thus, the lender’s cost of doing business may be adversely affected. Consequently, lenders prefer to originate loans that can be sold in the secondary market utilizing mortgage insurance from insurers deemed eligible by the GSEs. PMI and CMG are GSE-authorized mortgage insurers.

Private mortgage insurers must satisfy requirements set by the GSEs to be eligible to insure loans sold to the GSEs. For example, 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 mortgage 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.

In 2002, the maximum single-family principal balance loan limit eligible for purchase by the GSEs was increased in accordance with the applicable index to $300,700, and effective January 1, 2003, that limit was raised to $322,700. 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.

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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, which became effective 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 underserved 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 LTVs between 95.01% and 97%, or 97s, and between 97.01% and 100%, or 100s.

On February 20, 2002, the Office of Federal Housing Enterprise Oversight, or OFHEO, 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 private 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. Under the rule, which became effective in the third quarter of 2002, OFHEO tests the GSEs’ capital position every quarter. PMI has an “AA+” rating. It is not apparent at this point that the finalized rule will result in the GSEs increasing their use of either “AAA”-rated mortgage insurers instead of “AA”-rated entities or credit protection counterparties other than mortgage insurers. Changes in the preferences of the GSEs for private mortgage insurance to other forms of credit enhancement as a result of the new OFHEO risk-based capital rule, or a tiering of mortgage insurers based on their credit rating, could adversely affect 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 insurance coverage and the addition of pool insurance 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 LTV mortgages. In October 2000, Fannie Mae announced its intention 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, during the next three years.

In 2001 and 2002, 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. As the GSEs are not required by regulation or charter to purchase this coverage, PMI believes that the GSEs purchased this coverage to assist in their 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^™, 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 also able to obtain approval for mortgage insurance. PMI works with the GSEs 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 mortgage insurance coverage and high LTV programs. Generally, PMI’s underwriting guidelines allow PMI to place mortgage insurance coverage on any mortgage loan accepted by the GSEs’ automated underwriting systems for purchase. A significant portion of PMI’s NIW in 2002 consisted of loans accepted by the GSEs’ automated underwriting systems, and the portion of PMI’s NIW in 2002 consisting of loans accepted by the GSEs’ automated underwriting systems increased compared to 2001. Accordingly, 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. A broadening by the GSEs of their underwriting standards, if adopted by PMI with respect to its mortgage insurance underwriting, could cause PMI to insure riskier mortgage loans, which could increase PMI’s claims and losses.

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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 mortgages that have a first mortgage lien with an LTV of 80%, a 10% second mortgage lien, and 10% of the purchase price from the borrower’s funds, or an 80/10/10. This 80/10/10 product and other similar products have reduced the available market for primary insurance. These products also compete with mortgage insurance as an alternative for lenders selling loans in the capital mortgage market. PMI believes that the use of 80/10/10 loans increased significantly in 2002 and may continue to increase in the future.

In addition to captive reinsurance agreements with affiliates of lenders, mortgage insurers share a portion of their coverage with their customers through risk retention agreements. 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

The Gramm-Leach-Bliley Act of 1999 allows, among other things, bank holding companies to engage in a substantially broader range of activities, including insurance underwriting, than they were allowed to engage in historically. 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 payment 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 its provisions, we are unable to ascertain the full impact of the Gramm-Leach-Bliley Act on PMI.

3.    Customers

Traditionally, PMI’s primary customers have been mortgage bankers, with the balance of PMI’s customers consisting of savings institutions, commercial banks and other mortgage lenders. As the beneficiary under PMI’s master policies 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 a substantial majority of our mortgage insurance coverage.

In 2002, PMI’s top ten customers generated approximately 44% of PMI’s premiums earned compared to approximately 40% in 2001.

In 2002, the mortgage lending industry continued its consolidation trend. 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 ordering mortgage insurance and selecting particular mortgage insurance providers. PMI anticipates that large lenders will generally continue to allow their correspondents to control these decisions in 2003. 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 2001 and 2002, PMI offered a variety of mortgage insurance products to capital market participants such as underwriters of mortgage-backed securities and the GSEs. These entities entered into negotiated transactions

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with PMI pursuant to which PMI insured large groups of loans or committed to insure a large group of loan originations on agreed terms. Mortgage insurance issued through negotiated transactions may include primary or modified pool insurance or a combination of both.

4.    Business Composition

A significant percentage of PMI’s premiums earned is generated from existing insurance in force and not from NIW. With respect to our flow channel, the insured, the policy owner or servicer of a loan may cancel insurance coverage at any time.

PMI’s primary risk in force was $25.2 billion as of December 31, 2002 and $25.0 billion as of December 31, 2001. The composition of PMI’s primary and pool risk in force is summarized in the table below. The table is based upon information available on the date of mortgage origination.

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The following table shows PMI’s primary insurance in force by FICO score as of December 31, 2002:

Management expects higher default rates and claim payment rates for high LTV loans, ARMs, less-than-A quality loans and non-traditional loans, and incorporates these assumptions into its pricing. However, there can be no assurance that the premiums earned 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, which is the ratio of the claim paid to the original risk in force relating to the loan, depends in part upon the specified coverage percentage for that loan. A higher coverage percentage on a loan increases the potential severity of a claim on that loan. Accordingly, PMI generally charges higher premium rates for higher coverage. PMI’s average coverage percentage was 24% for NIW in both 2002 and 2001. PMI’s percentage of NIW comprised of 95s with 30% coverage increased from 23% for the year ended December 31, 2001 to 24% for the year ended December 31, 2002. The percentage of NIW made up of 90s with 25% coverage was 31% at December 31, 2002 and 32% at December 31, 2001.

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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 and 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 PMI’s large lender customers, also known as “national accounts.” As a result of PMI’s growing negotiated transactions business, PMI has also dedicated 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 an application and supporting documentation to PMI. 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, advances in technology have enabled PMI to offer its customers the option of electronic submission of applications and electronic receipt of insurance commitments and certificates. In 2002, 69% of PMI’s primary insurance commitments (excluding negotiated transactions) were issued electronically, compared to 52% in 2001. Management expects this trend 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 human effort per transaction than PMI’s traditional paper acquisition channels. Examples of PMI’s electronic acquisition channels include:

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6.     Underwriting Practices

Risk Management Approach

PMI analyzes its primary insurance business based upon the historical performance of risk factors of individual loan profiles. 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 its national guidelines over time, taking into account its loss experience and the GSEs’ underwriting guidelines. PMI’s underwriting guidelines generally allow PMI to place mortgage insurance coverage on any mortgage loan accepted by the GSEs’ automated underwriting systems for purchase by the GSEs.

PMI’s underwriting guidelines consider five categories of risk:

PMI’s underwriting guidelines are based, in part, on several statistical models that PMI employs to predict default and to measure performance as well as capital requirements. One of these models is the pmiAURA^SM System, a proprietary system developed by PMI that contains performance data on more than 3.5 million loans. The pmiAURA System includes economic and demographic information and assigns a risk score corresponding to the predicted likelihood of mortgage default.

PMI’s extensive database also provides detailed performance reports of underwriting quality trends by geographic region, product type, customer characteristics and other key risk factors. These reports allow PMI’s underwriting management to monitor risk quality and to formulate responses to developing risk quality trends. Ultimately, such responses can lead to regional variations from, or permanent changes to, PMI’s underwriting guidelines.

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 1,239 lenders approve applications under the PDQ Program. PMI’s delegated business accounted for approximately 62% and 56% of PMI’s NIW in 2002 and 2001, 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. PMI audits a representative sample of loans insured by lenders participating in the PDQ Program on a regular basis to determine compliance with

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program requirements and employs the pmiAURA System to monitor the quality of the delegated business. If a lender participating in the program commits PMI to insure a loan that 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, such as a failure to meet maximum LTV criteria. Loans that are not eligible for the PDQ Program may be submitted to PMI for mortgage 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 PDQ Program; (ii) only loans meeting average or above average underwriting eligibility criteria are eligible for the PDQ 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 Program 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.

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 has discretionary authority to insure loans that are substantially in conformance with PMI’s published underwriting guidelines. Significant deviations from such guidelines require higher level underwriting approval. PMI shares its knowledge of risk management principles and real estate economic conditions with customers to improve the quality of submitted applications 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:

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

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or part of their mortgage loan underwriting. MSC provides contract underwriting services for mortgage loans for which PMI provides mortgage insurance and for mortgage 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) issuance of additional mortgage insurance coverage; (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. MSC paid $6.5 million in contract underwriting remedies in 2002, compared to $3.3 million in 2001. MSC also agreed to indemnify certain customers in 2002 and 2001, as described above. Worsening economic conditions or other factors that could lead to increases in PMI’s primary insurance default rate could also cause the number and severity of the remedies that must be offered by MSC to further increase. Such an increase could have a material effect on our financial condition and results of operations.

Contract underwriting services are important to mortgage lenders as they continue to seek to reduce costs. New policies processed by MSC contract underwriters represented 30% of PMI’s NIW in 2002, compared to 27% in 2001. 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 systems, Loan Prospector^SM and Desktop Underwriter^SM, 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 homeownership 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 for mortgage loans under traditional underwriting practices. These underwriting standards do not accommodate borrowers who have historically failed to manage 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, 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 stability traditionally associated with having a single employer due to the nature of their employment.

To further promote affordable housing, PMI has entered into risk-sharing agreements 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 lending goals and by Native American tribes and housing authorities to provide homeownership opportunities to traditionally underserved populations. Under such agreements, the mortgage insurance is structured so that financial responsibility is shared between (i) the lender, Native American tribe or housing authority and (ii) PMI. Typically, PMI is responsible for the first loss layer, as well as a third catastrophic layer, with the lender, Native American tribe or housing authority retaining a predetermined second loss layer.

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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, the American Homeownership and Counseling Institute, the National Association of La Raza and the National Association of Real Estate Professionals. In addition, PMI has developed partnerships with local organizations in an effort to expand homeownership 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, Habitat for Humanity 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.

Although programs offered under PMI’s affordable housing initiatives receive the same credit and actuarial analysis as all other standard programs, some programs utilize affordable underwriting guidelines established by lenders that differ from PMI’s criteria. PMI believes that some of its insured affordable housing loans may carry higher risks than its other insured loans. 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 by the insured to PMI of a default on an insured loan. “Default” is defined in PMI’s master policies 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 policies require 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 a reduction of income, unemployment, divorce, illness, inability to manage credit and interest rate levels. 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.

The following table shows the number of loans insured, the number of loans in default and the default rate for PMI’s primary insurance portfolio.

At December 31, 2002, PMI’s bulk primary insurance default rate was 10.40% compared to 5.55% at December 31, 2001. PMI’s default rate for its pool insurance portfolio (excluding Old Pool and including modified pool insurance) was approximately 2.28% at December 31, 2002, compared to approximately 1.38% at December 31, 2001.

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We believe that the higher default rate for bulk primary insurance is due to the greater concentration of less-than-A quality and non-traditional loans. We believe that loans in PMI’s less-than–A quality and non-traditional primary book 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 2003 due to the weak economy and the continuing maturation of the portfolio.

We believe that the higher default rate for pool insurance is due to the maturation of PMI’s GSE pool insurance business and the growth in modified pool insurance written. We also believe that delinquencies for PMI’s pool insurance will increase due to the growth and aging of the relatively new book of modified pool insurance as well as the higher proportion of less-than-A quality loans under modified pool insurance policies.

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 the years ended December 31, 2002, 2001 and 2000, respectively. Default rates are shown by region based on location of the underlying property.

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Claim activity is not spread evenly throughout the coverage period of a primary insurance book of business. Based on PMI’s experience, the majority of claims on traditional primary insurance 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 20% of PMI’s primary insurance in force at December 31, 2002. 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 less-than-A quality and non-traditional primary book will have earlier incidences of default than loans in PMI’s traditional book. Less-than-A quality loans represented 11% of PMI’s primary insurance in force at December 31, 2002 and at December 31, 2001. Non-traditional loans represented 12% of PMI’s primary insurance in force at December 31, 2002 and at December 31, 2001.

The following table sets forth the dispersion of PMI’s primary insurance in force and risk in force as of December 31, 2002, by year of policy origination and average annual mortgage interest rate since PMI began operations in 1972.

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Claims and Policy Servicing

Primary insurance claims paid by PMI in 2002 increased to $98.5 million from $76.9 million in 2001. Pool insurance claims paid by PMI in 2002 (excluding Old Pool) increased to approximately $10.0 million from approximately $3.9 million in 2001. Old Pool claims paid by PMI in 2002 decreased to $0.6 million from $2.4 million in 2001.

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 likelihood of a defaulted loan being reinstated is minimal, PMI works with the servicer of the loan for a 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 PMI’s master policies.

Under the terms of PMI’s master policies, 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 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 the filing of a claim on an uncured default. PMI’s master policies exclude 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 it is determined that the insured, its agents or the borrower misrepresented 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:

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While PMI attempts to choose the claim settlement option which best mitigates the amount of its claim payment, PMI generally settles by paying the coverage percentage multiplied by the claim amount. In 2002 and 2001, PMI settled 22% and 21%, respectively, of the primary insurance claims processed for payment on the basis of a prearranged sale. In 2002 and 2001, PMI exercised the option to acquire the property on approximately 7% and 12%, respectively, of the primary claims processed for payment. At December 31, 2002, PMI owned $33.2 million, and at December 31, 2001, PMI owned $31.1 million, of REO valued at the lower of cost or estimated realizable value.

The ratio of the claim paid to the original risk in force relating to such loan is referred to as “claim severity.” 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 foreclosure expenses. These amounts depend in part on the time required to complete foreclosure, which varies depending on state laws. Pre-foreclosure sales, acquisitions and other early workout efforts help to reduce overall claim severity. The average primary claim severity level has decreased from 100% in 1994 to 77% in 2002. PMI’s primary claim severity level in 2001 was 76%.

Technology Used 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 claim submissions, claim payments 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 ClaimEase^SM, 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.

In 2002, PMI implemented a new claims processing program called MI Direct^TM, which it developed in conjunction with Fannie Mae to streamline mortgage-servicing procedures. Under the new program, Fannie Mae works directly with PMI by filing claims on loans it owns, thereby eliminating loan servicers’ responsibility to file claims on Fannie Mae’s behalf.

Policy Servicing.    PMI has developed several technology tools with respect to policy servicing and claims. Introduced in 2001, e-PMI Servicing^SM 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. Similar inquiries and exchanges of information between customers and PMI are also 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, referred to as a “policy year,” expressed as a percentage of the cumulative premiums written on such policies.

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Percentage of Cumulative Primary Insurance Losses Paid (Gross)  

To Cumulative Primary Insurance Premiums Written