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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

For the fiscal year ended December 31, 2004

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.  ¨

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 30, 2004 was approximately $3,564 million based on the closing sale price of the common stock on the New York Stock Exchange consolidated tape on that date. All executive officers and directors of the registrant have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the registrant.

Number of shares outstanding of registrant’s common stock, as of close of business on February 28, 2005: 94,074,358

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for registrant’s Annual Meeting of Stockholders to be held on May 19, 2005 are incorporated by reference into Items 10 through 14 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 Risk Factors addressed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” 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

We are an international provider of credit enhancement as well as other products and services that promote homeownership and facilitate mortgage transactions in the capital markets.

We offer mortgage insurance products in the U.S. that enable borrowers to buy homes with low down-payment mortgages. Our U.S. Mortgage Insurance Operations generated 72.6% of our consolidated revenues in 2004. Our primary operating subsidiary, PMI Mortgage Insurance Co., including its affiliated U.S. mortgage insurance and reinsurance companies, collectively referred to as PMI, is a leading U.S. residential mortgage insurer. PMI’s insurer financial strength is currently rated “AA” (“Very Strong”) with a stable outlook by Standard & Poor’s, or S&P, “AA+” (“Very Strong”) with a stable outlook by Fitch Ratings, or Fitch, and “Aa2” (“Excellent”) with a stable outlook by Moody’s Investors Service, or Moody’s.

Our International Operations offer mortgage insurance and other credit enhancement products. Through our Australian subsidiaries, we are one of the leading providers of mortgage insurance in Australia and New Zealand. Our European subsidiary, headquartered in Dublin, Ireland, offers mortgage insurance and mortgage credit enhancement products throughout Europe. PMI also reinsures residential mortgage insurance in Hong Kong.

We are the lead investor in FGIC Corporation, whose subsidiary, Financial Guaranty Insurance Company, or FGIC, provides primary financial guaranty insurance for public finance and structured finance obligations. We also have a significant interest in RAM Reinsurance Company, Ltd., or RAM Re, a financial guaranty reinsurance company based in Bermuda.

We own 64.9% of SPS Holding Corp., or SPS, whose subsidiary, Select Portfolio Servicing, Inc. (“Select Portfolio Servicing”), services single-family residential mortgages in the United States. In January 2005, we entered into a Summary of Terms with Credit Suisse First Boston (USA), Inc., or CSFB, that provides CSFB with the option, exercisable on or before July 31, 2005, to acquire 100% of our investment in SPS. In March 2004, we completed the sale of our title insurance subsidiary, American Pioneer Title Insurance Company.

Our consolidated net income was $399.3 million for the year ended December 31, 2004. As of December 31, 2004, our consolidated total assets were $5.1 billion, including our investment portfolio of $3.3 billion as of that date. Our consolidated shareholders’ equity was $3.1 billion as of December 31, 2004. See Item 8. Financial Statements and Supplementary Data—Note 20. Business Segments, for financial information regarding our business segments. S&P and Fitch have assigned our holding company, The PMI Group, Inc., an “A” and “A+” counterparty credit and senior unsecured debt ratings (stable outlook), respectively, and Moody’s has assigned an “A1” senior unsecured debt rating (stable outlook).

Our website address is http://www.pmigroup.com. Information on our website does not constitute part of this report. 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 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.

Our principal executive offices are located at 3003 Oak Road, Walnut Creek, California 94597-2098, and our telephone number is (925) 658-7878.

Residential mortgage insurance facilitates the sale of low down-payment mortgages in the mortgage capital markets and expands homeownership opportunities by enabling borrowers to buy homes with down-payments of

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less than 20%. PMI provides primary mortgage insurance, or primary insurance, and pool mortgage insurance, or pool insurance, against losses in the event of borrower default. PMI’s mortgage insurance products are purchased by lenders and investors, including Fannie Mae and Freddie Mac, or the GSEs, and the Federal Home Loan Banks, seeking protection against default risk, capital relief or credit enhancement for mortgage transactions in the capital markets. PMI is licensed in all 50 states, the District of Columbia, Puerto Rico, Guam and the Virgin Islands. PMI is incorporated in Arizona and headquartered in Walnut Creek, California.

Primary Insurance

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 coverage percentage selected by the insured by the loss amount on the defaulted loan, which includes any unpaid loan balance, delinquent interest and certain expenses associated with the loan’s default and property foreclosure. In lieu of paying the coverage percentage of the loss amount on a defaulted loan, PMI may pay the loss amount and take title to the mortgaged property.

PMI’s primary new insurance written, or NIW, for the year ended December 31, 2004 was $41.2 billion. NIW refers to the original principal balance of all loans which receive primary mortgage insurance coverage during a given period. PMI’s primary insurance in force and primary risk in force at December 31, 2004 were $105.3 billion and $25.7 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 of each primary insured mortgage loan’s current principal balance multiplied by the insurance coverage percentage specified in the policy.

PMI acquires primary insurance on a loan-by-loan basis (flow channel) and in bulk transactions (bulk channel). While their terms vary, bulk transactions generally involve bidding upon and, if successful, insuring a large group of loans on agreed terms. Some bulk transactions contain a risk-sharing component under which the insured shares in losses. Bulk transactions may involve loans that 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 property value selected by the insured. This coverage generally involves capital market transactions with respect to mortgage-backed securities. PMI issued $5.0 billion of bulk primary insurance in 2004, which accounted for 12.0% of PMI’s NIW for 2004. In 2003, 12.3% of PMI’s NIW was bulk primary insurance. Coverage levels for loans insured through PMI’s flow channel are determined by the coverage percentages selected by the lenders. Lenders that require mortgage insurance in connection with the origination or sale of loans generally require a coverage percentage that effectively reduces the ratio of the original loan amount to the value of the property, or LTV, to not more than 80%. Higher LTV loans, therefore, generally have higher coverage percentages, resulting in higher premiums, but also greater potential losses in the event of a claim. Generally, refinanced mortgage loans insured by PMI have lower LTVs, and therefore lower coverage percentages, than purchase money mortgages due to the benefits of home price appreciation often associated with refinanced loans. Purchase money mortgages, which generally have higher LTVs, tend to have higher coverage percentages, or “deeper” coverage. Accordingly, the relative sizes of the purchase money and refinance mortgage origination markets influence both the average LTV and average coverage of PMI’s NIW and insurance in force.

Premium payments may be paid to PMI on a monthly, annual or single premium basis. Monthly payment plans represented 97.7% of NIW in 2004 and 91.4% of NIW in 2003. As of December 31, 2004, monthly plans represented 93.7% of PMI’s primary risk in force compared to 92.1% at December 31, 2003. Single premium plan payments may be refundable if coverage is canceled by the insured, which generally occurs when the loan is repaid, the loan amortizes to a sufficiently low amount, or the value of the property has increased significantly.

Depending upon the loan, the premium payments relating to primary mortgage insurance coverage may ultimately be borne by the insured (Lender Paid MI) or by the insured’s customer, the individual mortgage

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borrower (Borrower Paid MI). In the case of Borrower Paid MI, the cost of coverage is generally paid via an extra charge included in the monthly remittance to the mortgage lender. Traditionally, the significant majority of NIW has been comprised of Borrower Paid MI. However, Lender Paid MI increased to 21.1% in 2004 from 17.2% in 2003 and 10.3% in 2002. With respect to lender paid mortgage insurance acquired through our flow channel, the cost of the mortgage insurance coverage is embedded in the total financing cost of the mortgage loan. As a result, the cost of mortgage insurance coverage in these instances may be tax deductible by the borrower.

Regardless of whether coverage is Lender Paid MI or Borrower Paid MI, 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. Similarly, PMI may not cancel mortgage insurance coverage except in the event of nonpayment of premiums or certain material violations of PMI’s master policies. With respect to PMI’s flow channel, the insured or the loan’s mortgage servicer may generally cancel mortgage insurance coverage at any time. In addition, the GSEs’ guidelines 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 conditions set forth in the statute.

The GSEs are the predominant purchasers of conventional mortgage loans in the United States, providing a direct link between mortgage origination and the capital markets. The GSEs may purchase conventional mortgages with high LTVs 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. 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, thereby increasing the lender’s cost of doing business. Consequently, lenders tend to originate loans that can be sold in the secondary market utilizing mortgage insurance from insurers deemed eligible by the GSEs. 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 charter requirements are met. PMI is a GSE-authorized mortgage insurer.

Pool Insurance

Traditional Pool Insurance.    Prior to 2002, PMI offered certain pool insurance products, referred to as “traditional” pool insurance, to lenders, the GSEs and the capital markets. These products insure all losses on individual loans held within a pool of insured loans up to a stated aggregate loss limit, or stop loss limit, for the entire pool.

Modified Pool Insurance.    PMI currently offers modified pool insurance products that may be attractive to investors and lenders seeking a reduction of default risk beyond the protection provided by existing primary insurance or with respect to loans that do not require primary insurance, or for capital relief purposes. In addition to having stop loss limits and other risk reduction features (which may include deductibles), PMI’s modified pool insurance products may have exposure limits on each individual loan in the pool. To date, PMI has issued modified pool insurance principally to the GSEs as supplemental coverage and to other mortgage capital markets participants. PMI issues all of its modified pool insurance through bulk-type transactions, which are comprised predominantly of Alt-A loans (see 4. Business Composition, below).

Unless otherwise noted, primary insurance statistics in this report do not include pool insurance.

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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 affiliated with such lenders. In return, a proportionate amount of PMI’s gross premiums written is ceded to the captive reinsurance companies less a ceding commission paid to PMI for underwriting and administering the business. PMI’s captive reinsurance agreements primarily provide for excess-of-loss reinsurance, in which PMI retains a first loss position on a defined set of mortgage insurance risk, reinsures a second loss layer of this risk with the captive reinsurance company and retains the remaining risk above the second loss layer up to the maximum coverage level. PMI is also a party to one quota share captive reinsurance agreement under which the captive reinsurance company assumes a pro rata share of all losses in return for a pro rata share of the premiums collected. PMI is also a party to two other quota share captive reinsurance agreements that are currently in run-off. We believe that captive reinsurance agreements serve to better align credit decisions with respect to loans which require mortgage insurance and provide lenders with an ongoing stake in the outcome of the lending decision. This risk transfer approach also decreases the possibility of PMI incurring unacceptably high levels of losses in times of economic stress. Captive reinsurance agreements also partially offset the impact upon PMI’s portfolio of the ongoing consolidation in the mortgage lending industry. Finally, the trust balances of the captive reinsurers are explicitly recognized in the capital computations of certain rating agency models applied to PMI, and thus improves PMI’s capital position within those models.

In 2004, the percentages of primary NIW, primary insurance in force and total primary risk in force subject to captive reinsurance agreements increased. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations, U.S. Mortgage Insurance Operations, Premiums written and earned. These increases were driven by refinance activity that resulted in a high volume of cancellations of mortgage insurance policies not subject to captive reinsurance, as well as a higher percentage of NIW generated by lenders with captive reinsurance programs. We anticipate that captive reinsurance cessions will continue to reduce PMI’s premiums earned, and that the percentage of PMI’s flow primary risk in force subject to captive reinsurance agreements will continue to increase as a percentage of total risk in force in 2005.

Other Risk-Sharing Products

In addition to captive reinsurance, PMI offers other risk-sharing products, including layered co-insurance, a primary insurance program under which the insured retains liability for losses between certain levels of aggregate losses. PMI also offers various products designed for, and in cooperation with, the GSEs and lenders that involve some aspect of risk-sharing.

Joint Venture—CMG Mortgage Insurance Company

CMG Mortgage Insurance Company and its affiliates, or CMG, offer 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, 2004, CMG had $14.0 billion of primary insurance in force and $3.2 billion of primary risk in force compared to $12.6 billion of primary insurance in force and $2.8 billion of primary risk in force at December 31, 2003. 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 Report on Form 10-K, unless otherwise noted.

Under the terms of the restated joint venture agreement effective as of June 1, 2003, CMIC has the right on September 8, 2015, 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. 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 GSE-authorized mortgage insurer.

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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; Genworth Financial, Inc., an affiliate of General Electric 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. Assured Guaranty Mortgage Insurance Company, a subsidiary of Assured Guaranty Ltd., is also licensed to offer mortgage insurance in the U.S. We believe other companies may also be considering offering mortgage insurance.

U.S. and State Government Agencies

PMI and other private mortgage insurers compete with federal and state government agencies that sponsor their own mortgage insurance programs. The private mortgage insurers’ principal government competitor is the Federal Housing Administration, 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.

Effective January 1, 2005, 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 to $312,895 in “high-cost” areas. Private mortgage insurers have no limit as to maximum individual loan amounts that they can insure. Increases in the amount that these agencies can insure could cause future demand for private mortgage insurance to decrease.

PMI and other private mortgage insurers also face competition from state-supported mortgage insurance funds in several states, including California and New York. From time to time, other state legislatures and agencies may consider expansions of the authority of their state governments to insure residential mortgages.

Federal Home Loan Banks.    The Federal Home Loan Banks, or FHLBs, purchase single-family conforming mortgage loans originated by participating financial institutions. Purchases of secondary mortgage loans by participating FHLBs have increased since the program began in 1997. Typically, mortgage insurance coverage is placed on these loans when the LTV exceeds 80%. Any expansion of the FHLBs’ ability to use, or the increased use of, alternatives to mortgage insurance could reduce the demand for private mortgage insurance and harm our financial condition and consolidated results of operations.

Fannie Mae and Freddie Mac—The GSEs

Mortgage insurers, including PMI, compete with the GSEs when the GSEs seek to assume mortgage default risk that could be covered by mortgage insurance. The GSEs have introduced programs that allow lenders to

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purchase reduced mortgage insurance coverage, as well as programs that provide for the restructuring of existing mortgage insurance with reduced amounts of primary insurance coverage and the addition of pool insurance coverage. If the GSEs were to reduce mortgage insurance coverage requirements for loans they purchase, PMI’s premium revenues would decline.

Financial Institutions and Mortgage Lenders

PMI and other private mortgage insurers compete with financial institutions, primarily commercial banks and thrifts, which retain risk on all or a portion of their high LTV mortgage portfolio rather than obtain insurance for this risk. The use of captive reinsurance by certain of the lenders with whom we do business (see Captive Reinsurance, above) also negatively impacts PMI’s risk in force and premiums earned.

In addition, the private mortgage insurance industry faces competition from the home equity lending operations of these financial institutions and other mortgage lenders who structure their high LTV residential loans in such a way that mortgage insurance is not required. Certain lenders originate mortgages that have a first mortgage lien with an LTV of 80%, and a second mortgage lien ranging from 10% to 20% LTV. These loans are commonly referred to as “piggyback,” 80/10/10 or 80/20 loans. Since the first mortgage is only an 80% LTV, the GSEs do not require mortgage insurance with respect to either mortgage, even though the combined LTV exceeds 80%. These products have grown in popularity in 2003 and 2004 due to a number of factors, including sustained low interest rates leading to narrower differentials in banks’ interest rates between second and first mortgage liens, high home appreciation rates and aggressive home equity line of credit lending. The increasing popularity and use of these and other similar products have reduced the available market for primary mortgage insurance.

Other Credit Enhancement Providers

Bulk transactions often involve bidding upon and, if successful, insuring a pool of loans that will be securitized in a capital market transaction. When bidding upon these transactions, PMI may be competing against other mortgage insurers as well as credit enhancement providers that offer credit enhancement products other than mortgage insurance. The selection of credit enhancement other than mortgage insurance with respect to these capital market transactions negatively affects the private mortgage insurance market and PMI’s insurance in force and NIW.

PMI’s customers are primarily mortgage lenders, savings institutions, commercial banks, and investors, including the GSEs, the FHLBs, and other capital market participants. 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 PMI’s mortgage insurance coverage. In 2004, PMI’s top ten customers generated 42.0% of PMI’s premiums earned compared to 42.1% in 2003.

Persistency; Policy Cancellations.    Historically, a significant percentage of PMI’s premiums earned has been generated from insurance policies written in previous years. Consequently, the length of time that insurance remains in force is a key determinant of PMI’s consolidated revenues and net income. Lower interest rates beginning in 2001 have resulted in heavy mortgage refinance activity, causing PMI’s policy cancellations to increase and thereby negatively impacting earned premiums. For example, calendar years 2003 and 2004 exhibited the lowest average interest rates in the period 1994 to 2004. One way in which PMI measures the rate of policy cancellations is PMI’s persistency rate, which is based upon the percentage of primary insurance in

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force at the beginning of a 12-month period that remains in force at the end of that period. The following table shows average annual mortgage interest rates and PMI’s primary portfolio persistency rates from 1994 to 2004.

The declining interest rate environment has been a major factor in shortening the length of time our primary insurance in force has remained in effect. In 2004, PMI’s persistency improved compared to 2003 while the average annual mortgage interest rate did not change. We believe that PMI’s higher persistency rate in 2004 was due in large part to the overall decline in mortgage refinance activity in 2004 compared to 2003.

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PMI’s Risk in Force.    PMI’s primary risk in force was $25.7 billion as of December 31, 2004 and $24.7 billion as of December 31, 2003. 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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PMI insured a greater number of high LTV loans (Above 97s), ARMs and Alt-A loans in 2004 than in 2003. As a result, as shown in the chart above, the percentages of PMI’s risk in force containing Above 97s, ARMs and Alt-A loans increased in 2004. We believe that these increases were driven by, and reflect, higher concentrations of high LTV loans, ARMs and Alt-A loans as percentages of both the 2004 mortgage origination market and the 2004 private mortgage insurance market. We believe that this trend will continue in 2005.

We expect higher default rates and claim payment rates for high LTV loans, ARMs, less-than-A quality loans and Alt-A loans and incorporate these assumptions into our pricing. In 2004, PMI’s average premium rate increased primarily as a result of PMI’s primary portfolio containing higher percentages of high LTV loans, ARMs and Alt-A loans. 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. PMI offers pre- and post-purchase borrower counseling to borrowers with high LTV loans in an effort to reduce the risk of default on those loans. PMI also believes that the risk reduction features, which may include deductibles, of its modified pool products mitigate the risk of loss to PMI from the Alt-A loans insured.

The following table shows PMI’s primary risk in force by FICO score:

PMI employs a sales force located throughout the country to directly sell its products and provide services to lenders located throughout the United States. PMI does not employ insurance brokers. PMI’s sales force is comprised entirely of PMI employees who receive compensation consisting of a base salary and incentive compensation tied to performance objectives. PMI’s product development department has primary responsibility for advertising, sales materials and the creation of new products and services.

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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 are based, in part, on several statistical models that PMI employs to predict default and to measure performance as well as capital requirements. The pmiAURA^SM System, a proprietary system developed by PMI, includes economic and demographic information and assigns a risk score corresponding to the predicted likelihood of an insurance policy going to claim.

Underwriting Process

To obtain mortgage insurance on a specific mortgage loan, a customer submits an application to PMI. If the loan is approved for mortgage insurance, PMI issues a certificate of insurance to the customer. During the last several years, advances in technology have enabled PMI to offer its customers the option of electronic submission of applications and any supporting documentation and electronic receipt of insurance commitments and certificates. Customer use of PMI’s electronic delivery options accounted for approximately 85% of PMI’s insurance commitments issued in its primary flow channel in 2004, compared to approximately 81% in 2003 and 74% in 2002.

Delegated Underwriting.    Approximately 76% of PMI’s 2004 primary flow NIW is underwritten pursuant to a delegated underwriting program that allows approved lenders, subject to routine audit by PMI, to determine whether loans meet program guidelines and are thus eligible for mortgage insurance. 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, such as a failure to meet maximum LTV criteria and fraud. Delegated underwriting enables PMI to meet mortgage lenders’ demands for immediate insurance coverage of certain loans. Delegated underwriting has become standard industry practice. 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.

Non-Delegated Underwriting.    Customers that are not approved to participate in the delegated program generally must submit to PMI an application for each loan, supported by various documents. The significant majority of such customers’ loans are underwritten in connection with our provision of contract underwriting services (see below). Verification of the borrower’s employment, income and funds needed for the loan closing are required in addition to other documents 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.

Bulk Primary and Modified Pool Transactions.    Bulk primary insurance and modified pool insurance transactions generally involve PMI bidding for a customer’s delivery to PMI of a portfolio of loans that have been previously underwritten and closed under one or more loan programs. Regardless of the fact that the customer or lender has previously underwritten the loans, PMI evaluates each transaction on a loan-by-loan basis and as a portfolio. In the loan-by-loan review, PMI analyzes the characteristics of each loan and compares them to forecasts of performance generated by proprietary performance and pricing models. In the portfolio review,

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PMI analyzes the diversity and the aggregate risk characteristics of the portfolio as a whole. PMI also reviews the risks and potential mitigating factors inherent in the proposed coverage structure, which may include, among other things, coverage limits, stop loss limits, and/or deductibles.

In some cases, PMI provides commitments for the future delivery of bulk primary or modified pool transactions. The same processes described above are used to review an indicative portfolio of loans. PMI’s commitments are contingent upon a loan-by-loan review of the actual loans delivered and allow for pricing and other structural adjustments if the characteristics of the actual delivery vary from those of the indicative portfolio.

Contract Underwriting

Contract underwriting services are provided by PMI’s wholly-owned subsidiary, PMI Mortgage Services Co., or MSC. MSC provides contract underwriting services for mortgage loans for which PMI provides mortgage insurance and for mortgage loans for which PMI does not provide insurance. MSC also performs the contract underwriting activities of CMG.

As a part of its contract underwriting services, MSC provides to its customers monetary and other remedies, including loan indemnifications under certain circumstances, in the event that MSC fails to properly underwrite a mortgage loan. These remedies are separate from the insurance coverage provided by PMI. MSC paid or accrued $10.0 million in contract underwriting remedies in 2004, compared to $13.1 million in 2003. Worsening economic conditions or other factors that could lead to increases in PMI’s primary insurance default rate could also cause the number and magnitude of the remedies that must be offered by MSC to increase. Such an increase could have a material adverse effect on our consolidated financial condition and results of operations.

Due to a decline in contract underwriting activity in 2004, new policies processed by MSC contract underwriters in 2004 declined to 20.3% of PMI’s NIW from 24.0% in 2003. 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 some mortgage lenders for processing loan applications. The number of contract underwriters deployed by MSC is related to the volume of mortgage originations.

Expanding homeownership opportunities for low- and moderate-income individuals and communities is an important priority of PMI. 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 products and services do not accommodate borrowers who have failed to manage their affairs responsibly; rather, they seek to identify those home buyers who have met or will meet their obligations in a timely and conscientious manner. The beneficiaries of these programs have included recent immigrants who have not established traditional credit histories, borrowers not accustomed to using traditional savings institutions, borrowers with less than five percent for a down-payment, 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 to provide homeownership opportunities to traditionally underserved populations. Under such agreements, the mortgage insurance is structured so that financial responsibility is shared between the lender, Native American tribe or housing authority, and PMI.

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

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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 Council of La Raza, the Congressional Hispanic Caucus Institute and the National Association of Hispanic Real Estate Professionals. In addition, PMI has developed partnerships with local organizations in an effort to expand homeownership opportunities and promote community revitalization.

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, risk-sharing and risk based pricing seeking to mitigate the additional risks that may be associated with some affordable housing loan programs.

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. For reporting and internal tracking purposes, we do not consider a loan to be in default for the purposes of reporting defaults and default rates until a loan has been delinquent for two consecutive monthly payments. Depending upon its scheduled payment date, a loan delinquent for two consecutive payments could be reported to PMI between the 31^st and 60^th day after the first missed payment. 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.

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. Default rates are shown by region based on location of the underlying property.

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Claims and Policy Servicing

Primary insurance claims paid by PMI in 2004 increased to $193.2 million from $176.9 million in 2003. Pool insurance claims paid by PMI in 2004 increased to $19.4 million from $18.0 million in 2003. In 2004, pool claims paid represented approximately 9% of PMI’s total claims paid.

The frequency of defaults is not directly proportional 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 conditions. Whether an uncured default leads to a claim principally depends on the borrower’s equity in the underlying property 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 loss reduction to PMI compared to the percentage coverage amount payable under PMI’s master policies.

Within 60 days after a primary insurance 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 that best mitigates the amount of its claim payment, PMI generally settles by paying the coverage percentage multiplied by the loss amount. In 2004 and 2003, PMI settled 28.4% and 23.2%, respectively, of the primary insurance claims processed for payment on the basis of a prearranged sale. In 2004 and 2003, PMI exercised the option to acquire the property on 4.6% and 7.8%, respectively, of the primary claims processed for payment. At December 31, 2004, PMI’s carrying value, which approximates fair value, of REO properties was $22.7 million compared to $37.0 million at December 31, 2003.

Claims and the Aging of PMI’s Insurance Portfolio.    Claim activity is not spread evenly throughout the coverage period of a primary insurance book of business. We expect the significant majority of claims on insured loans in PMI’s current portfolio to occur in the second through fourth years after loan origination. Primary insurance written from the period of January 1, 2001 through December 31, 2003 represented 56.2% of PMI’s primary insurance in force at December 31, 2004. This portion of PMI’s book of business is in its expected peak claim period with respect to primary loans.

The following table sets forth the dispersion of PMI’s primary insurance in force and risk in force as of December 31, 2004, by year of policy origination and average annual mortgage interest rate since PMI began operations in 1972.

Claim Severity.    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 generally decreases the potential severity of a claim on that loan, even though the claim amount may increase. PMI generally charges higher premium rates for higher coverage. PMI’s average primary coverage percentage for NIW was 25.9% in 2004 and 23.6% in 2003.

The main determinants of the severity of a claim are the value of the underlying property, accrued interest on the loan, expenses advanced by the insured and foreclosure expenses, and the amount of mortgage insurance coverage placed on the loan. 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 81.8% in 2004. PMI’s primary claim severity level in 2003 was 80.9%.

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Pool Claims.    Pool claims are generally filed after the underlying property is sold. PMI settles a pool claim in accordance with the agreed upon terms of the applicable pool insurance policy, which includes a stop loss limit and, in some cases, a specified deductible. Subject to such stop loss limit and any deductible, PMI generally covers 100% of the loss minus net proceeds from the sale of the property and any primary claim proceeds. Other pool insurance policies may include a maximum coverage percentage or a defined benefit. Claims relating to policies with a maximum coverage percentage are settled at the lesser of the actual loss or the maximum coverage set forth in the applicable policy. Claims relating to policies with defined benefits are settled at the maximum coverage percentage set forth in the applicable policy. PMI settles pool claims immediately upon receipt of all supporting documentation.

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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.

Percentage of Cumulative Primary Insurance Losses Paid (Gross)

To Cumulative Primary Insurance Premiums Written

The above table shows that, measured by gross cumulative losses paid relative to cumulative premiums written, or the cumulative loss payment ratios, the performance of policies originally issued in the years 1983 and 1984 was adverse, with cumulative loss payment ratios for those years of 189.5% and 140.7%, respectively at the

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end of 2004. Such adverse experience was significantly impacted by deteriorating economic and real estate market conditions in the “Oil Patch” states in the 1980s. In 1985, PMI adopted substantially more conservative underwriting standards which we believe, along with increased premium rates and generally improving economic conditions, contributed to the lower cumulative loss payment ratios in that and subsequent years.

The table also shows the general improvement in PMI’s cumulative loss payment ratios since policy year 1985, relative to 1983 and 1984. This reflects both improved claims experience and higher premium rates charged by PMI for policy years 1985 and later. All policy years through 1995 have cumulative loss payment ratios at the end of 2004 that differ by no more than 0.1% from the end of 2003, an indication that these ratios have stabilized and reached their ultimate development for each of these policy years. Policy years 1996 through 1999 also have seen only slight claims development since the end of 2003.

A major factor affecting the development of these loss ratios was the relatively low level of interest rates throughout 2003 and 2004. These low rates led to record numbers of mortgage refinances in 2003 and 2004, materially decreasing the amount of business remaining in book years before 2003. This had the effect of decreasing the remaining premium flow from these book years and putting upward pressure on the cumulative loss payment ratios.

Policy years 1986 through 1988 have developed to cumulative loss payment ratios between 28.6% and 35.2%. Policy years 1989 through 1992 have developed to somewhat higher ratios between 41.0% and 61.4%, reflecting both higher levels of claims on California loans insured in those years, as well as higher prepayment speeds when market rates dropped to relatively low levels from late 1992 through early 1994. Loss payment ratios continued to decline year-to-year after 1993 (21.9% at the end of seven years), bottoming out at 8.3% at the end of seven years for the 1998 policy year, a record low. The declines were due to an improvement in California’s economy and a strong national economy with no material regional weaknesses. The 1999 policy year is developing at a level slightly higher than 1998, but still at very low levels. Given the small amount of business left in the 1996 through 1999 books, further development is expected to be small.

The 2000 and 2001 book years have developed to ratios now slightly less than the 1985 book year at similar policy ages of five and four years, respectively, but for different reasons. The 1985 book year, which reached a ratio of 47.4% at the end of five years, was driven primarily by loss development. The 2000 and 2001 book years, on the other hand, reaching ratios of 43.0% and 34.1% at the end of five and four years, respectively, are being driven by the dual factors of significantly higher prepayments and higher claims payments than the previous years. The higher levels of claims combined with the lower levels of accumulated premiums have led to this increase in ratios.

The higher levels of claims in the 2000 and 2001 policy years were a result of an expansion into less-than-A quality and Alt-A loan product offerings primarily through the introduction of PMI’s bulk channel. These loan types generally have shorter lives and earlier incidence of default than A quality loans, leading to earlier emergence of claims and shorter streams of premium income. The large volume of refinances in A quality business written in 2000 and 2001 experienced in 2003 decreased the accumulated premium received from those policy years, affecting the loss payment ratio development by increasing the ratio of claims paid to premiums received.

The 2002 book year is developing favorably compared to 2000 and 2001 due to a lower level of claims. 2003 is performing favorably compared to 2002 due to lower levels of claims and higher persistency in 2004. 2003 has developed to levels reached by the 1995, 1996 and 1999 books at the comparable two year period although future loss development may not be similar to those years.

Loss Reserves

A 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

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payment of the claim related to such default. To recognize the liability for unpaid losses related to the loans in default, PMI, in accordance with industry practice, establishes loss reserves in respect of loans in default based upon the estimated claim rate and estimated average claim amount of loans in default. 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 for estimated potential defaults that have not occurred but that may occur in the future. For a full discussion of our loss reserving policy and process, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates, Reserves for Losses and LAE. For a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses on a consolidated basis, see Item 8. Financial Statements and Supplementary Data—Note 10. Reserve for Losses and Loss Adjustment Expenses.

Reinsurance is used as a capital and risk management tool by the mortgage insurance industry. Reinsurance does not discharge PMI, as the primary insurer, from liability to a policyholder. The reinsurance company simply agrees to indemnify PMI for the reinsurance company’s share of losses incurred under a reinsurance agreement, unlike an assumption agreement, where the assuming reinsurance company’s liability to the policyholder is substituted for that of PMI.

PMI has a 5% quota share reinsurance agreement in place with a participating reinsurance company relating to primary insurance business written by PMI from 1994 through 1997. Under the terms of this agreement, the reinsurance company indemnifies PMI for 5% of all losses paid under the reinsured primary insurance business and PMI cedes 5% of the related premiums, less a ceding commission paid to PMI for underwriting and administering the business. Effective January 1, 2001, PMI commenced reinsuring its wholly-owned Australian subsidiary, PMI Mortgage Insurance Ltd, on an excess-of-loss basis. Under the terms of the agreement, for each of the calendar years from 2001 through 2006, 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 such year, but not for losses that exceed 220% of such net earned premiums. The agreement provides for automatic one-year extensions, unless terminated upon prior notice by either party. Upon such notice of termination, the agreement would continue in effect in the year of such notice and for the next four calendar years.

Certain states limit the amount of risk a mortgage insurer may retain on a single loan to 25% of the indebtedness to the insured, and as a result, the deep coverage portion of such insurance in excess of 25% must be reinsured. To minimize reliance on third party reinsurance companies and to permit PMI 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, and PMI Mortgage Guaranty Co., or PMG, to provide reinsurance of such deep coverage to PMI. PMI uses reinsurance provided by its reinsurance affiliates solely for purposes of compliance with statutory coverage limits. CMG also uses reinsurance provided by its reinsurance affiliate, CMG Reinsurance Company, to comply with statutory limits.

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. PMI also offers reinsurance products in Asia through its Hong Kong branch. (See Item 1, Section C.1, International Operations—Hong Kong, below.)

State Regulation

General.    Our mortgage insurance subsidiaries are subject to comprehensive, detailed regulation by the insurance departments of the various states in which they are licensed to transact business. The purpose of this

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regulation is to safeguard their solvency for the protection of policyholders. 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 most significant aspects of the insurance business.

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 kinds 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 Regulations.    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.

The PMI Group is treated as an insurance holding company under the laws of the State of Arizona. The Arizona insurance laws govern, among other things, certain transactions in our common stock and certain transactions between or among The PMI Group and its domestic and international subsidiaries. For example, no person may, directly or indirectly, offer to acquire or acquire voting securities of The PMI Group or any one of the Arizona subsidiaries, if after consummation thereof, such person would be in control, directly or indirectly, of such entity, unless such person obtains the Arizona Director of Insurance’s prior approval. For purposes of the foregoing, “control” is rebuttably presumed to exist if such person, following the acquisition, would, directly or indirectly, own, control or hold with the power to vote or hold proxies representing 10% or more of the entity’s voting securities. In addition, all material transactions involving PMI, PMG, RGC and/or RIC and any of their affiliates, such as PMI Australia and PMI Europe, are subject to prior approval of the Arizona Director of Insurance, and will be disapproved if they are found not to be “fair and reasonable.” PMI, on behalf of itself and its affiliates, is required to file an annual insurance holding company system registration statement with the Arizona and Wisconsin Departments of Insurance (and any other states that so request) disclosing all interaffiliate relationships, transactions and arrangements that occurred or were in effect during the prior calendar year, and providing information on The PMI Group, the holding company’s “ultimate controlling person.” PMI must also submit and update biographical information of the executive officers and directors of the holding company’s insurance subsidiaries, as well as executive officers and directors of The PMI Group.

The insurance holding company laws and regulations are substantially similar in Wisconsin (where CMG, Commercial Loan Insurance Corporation, or CLIC, and WMAC Credit Insurance Corporation, or 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 states of domicile. FGIC Corporation and FGIC are subject to regulation under insurance holding company statutes of New York, where FGIC is domiciled, as well as other jurisdictions where FGIC is licensed to do insurance business. Transactions between FGIC Corporation or FGIC and The PMI Group and its subsidiaries are subject to prior approval of the New York Department of Insurance.

Reserves.    Our mortgage insurance subsidiaries are required under the insurance laws of their state of domicile 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. Contingency reserves are required to be held for ten years (and then released into surplus), although earlier releases may be authorized by state insurance regulators in certain cases. The first year in which contingency reserves were released into surplus was 2003. At December 31, 2004, PMI and its mortgage insurance subsidiaries had statutory policyholders’ surplus of $750.9 million and statutory contingency reserves of $2.4 billion.

Dividends.    PMI’s ability to pay dividends (including returns of capital) to The PMI Group as its sole shareholder is limited, among other things, by the insurance laws of Arizona and other states. PMI’s other

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Arizona subsidiaries (PMG, RGC and RIC) 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 Director of Insurance, 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. PMI is permitted to pay ordinary dividends (as such are termed under the Arizona statute) to The PMI Group of $64.5 million in 2005 without prior approval of the Arizona Director of Insurance, provided that any such dividends are paid after the first anniversary of PMI’s 2004 dividends, which were made in July 2004. Any 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 of Insurance. In 2004, PMI paid an extraordinary stockholder dividend of $150 million to The PMI Group. This dividend will be added to any proposed dividends to be paid within the subsequent twelve months to determine if such future dividends are “extraordinary”, and accordingly, would require the Arizona Director of Insurance’s prior approval. The Arizona Director of Insurance may approve 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.

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. In 2004, PMI Plaza LLC, a Delaware limited liability company and wholly-owned subsidiary of PMI, paid a $600,000 cash dividend to PMI. As of December 31, 2004, PMI’s liabilities (excluding contingency reserves) were $592.2 million, meaning shareholder dividends in 2005 may not reduce PMI’s statutory surplus below $59.2 million. CMG is subject to shareholder dividend/distribution restrictions similar to those imposed on PMI.

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 jurisdiction in which each is licensed to transact business. In most U.S. jurisdictions, policy forms must be filed prior to their use. In some U.S. jurisdictions, forms must also be approved prior to use.

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 reinsurance companies. Under such laws, if a reinsurance company is not admitted or accredited in such states, the domestic company (e.g., PMI) ceding business to the reinsurance company cannot take credit in its statutory financial statements for the risk ceded to such reinsurance company absent compliance with certain reinsurance security requirements. In addition, Arizona prohibits reinsurance unless the reinsurance agreements meet certain requirements even if no statutory financial statement credit is to be taken.

Examinations.    Our licensed insurance and reinsurance subsidiaries 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. PMI was examined by the Arizona Director of Insurance in 2003 for the five year period ending December 31, 2002. In lieu of examining a foreign insurer, the Arizona Insurance Commissioner may accept an examination report by a state that has been accredited by the National Association of Insurance Commissioners.

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CMG, CLIC and WMAC Credit were examined by the Wisconsin Department of Insurance in 2003 for the three year period ending December 31, 2002. The final examination reports are public records and can be obtained from the applicable state’s department of insurance.

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 12 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.

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; purchasers of mortgage loans such as Freddie Mac and Fannie Mae; and 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 material adverse effect on PMI. Legislation that increases the number of persons eligible for FHA or VA mortgages could have a material adverse effect on our ability to compete with the FHA or VA.

The Homeowners Protection Act, or HPA, provides for the automatic termination, or cancellation upon a borrower’s request, of private mortgage insurance upon satisfaction of certain conditions. HPA applies to owner-occupied residential mortgage loans regardless of lien priority and to borrower-paid mortgage insurance closed on or after July 29, 1999. FHA loans are not covered by HPA. Under HPA, automatic termination of mortgage insurance would generally occur once the LTV reaches 78%. A borrower who has a “good payment history”, as defined by HPA, 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.

The Real Estate Settlement and Procedures Act of 1974, or RESPA, applies to most residential mortgages insured by PMI. Mortgage insurance has been considered in some cases to be 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. RESPA is enforced by HUD and also provides for private rights of action.

In July 2002, HUD proposed a rule under RESPA that, if implemented as proposed, would have, among other things, given lenders and other packagers the option of offering a Guaranteed Mortgage Package, or GMP, or providing a good faith estimate of settlement costs subject to a 10% tolerance level. The proposed rule provided that qualifying packages were entitled to a “safe harbor” from litigation under RESPA’s anti-kickback rules. Mortgage insurance would have been included in the package to the extent an upfront premium is charged. Inclusion in the package could have caused mortgage insurers to experience reductions in the prices of their services or products. HUD withdrew that proposed rule in March 2004. In late 2004, HUD announced that it will submit a new proposed rule under RESPA to the Office of Management and Budget for review. We do not know what form, if any, the rule will take and whether it will be approved.

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. 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 on the basis of certain classifications. Mortgage insurers have, through the

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Mortgage Insurance Companies of America entered voluntarily into an agreement with the Federal Financial Institutions Examinations Council to report the same data on loans submitted for insurance as is required for most mortgage lenders under HMDA.

Privacy and Information Security.    The Gramm-Leach-Bliley Act of 1999, or GLB, imposes 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. With respect to PMI, GLB is enforced by state insurance regulators. Many of the states have enacted legislation implementing GLB and establishing information security regulation. Some states have enacted privacy laws which impose compliance obligations beyond GLB.

The U.S.A. Patriot Act of 2001, or the Patriot Act, contains anti-money laundering provisions and financial transparency laws and mandates the implementation of various new regulations applicable to financial services companies including insurance companies. The Patriot Act seeks to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Anti-money laundering laws outside the U.S. contain similar provisions. In September 2002, the U.S. Treasury Department proposed anti-money laundering rules under the Patriot Act, which exempt property and casualty insurers, including our mortgage insurance subsidiaries.

Fair Credit Reporting Act.    The Fair and Accurate Credit Transactions Act of 2003, or FACTA, amends and reauthorizes certain provisions of the Fair Credit Reporting Act, or FCRA, including provisions which direct the Federal Trade Commission, or FTC, and the Federal Reserve Board, or FRB, to promulgate regulations requiring notice to any consumer receiving an extension or grant of credit based on a counter offer by the creditor on material terms, including interest rate, that are materially less favorable than the terms generally available from the creditor to consumers, based in whole or in part on a consumer report. No regulations have yet been proposed, and the FTC and FRB have stated that those provisions of FACTA that require regulation will not be effective until the date specified in the final regulations. The risk-based pricing notice provision is among the affected provisions. It is not clear at this point what that regulation will provide or what its impact, if any, will be on our mortgage insurance operations.

11.    Financial Strength Ratings

PMI has been assigned the following insurer financial strength ratings: “AA” by S&P with a stable outlook; “AA+” by Fitch with a stable outlook; and “Aa2” by Moody’s with a stable outlook.

PMI’s financial strength ratings have been based in part on the third party reinsurance agreements discussed above and on a capital support commitment 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 agreements 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, Allstate will be entitled to receive, at its option, subordinated debt or preferred stock of PMI or The PMI Group, as applicable, in return. However, we believe that the possibility of Allstate making such a payment is remote because we have several courses of action available to us to maintain PMI’s risk-to-capital ratio at the requisite level.

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 at least two of the following three ratings: “AA-” by S&P or Fitch, or “Aa3” by Moody’s.

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Our wholly-owned subsidiary, PMI Capital Corporation, manages our international operations and strategic investments, including our Financial Guaranty segment. Our International Operations and Financial Guaranty segments generated 25.0% of our consolidated revenues in 2004 compared to 16.0% in 2003. Revenues for the year ended December 31, 2004 from our consolidated subsidiary, PMI Australia, were $109.6 million or 10.6% of our consolidated revenues in 2004 and $85.6 million and 9.6% in 2003, respectively. Revenues for the year ended December 31, 2004 from our consolidated subsidiary, PMI Europe, were $27.7 million or 2.7% of our consolidated revenues in 2004 and $13.2 million and 1.5% in 2003, respectively. Revenues for the year ended December 31, 2004 from our branch office in Hong Kong were $6.4 million or 0.6% of our consolidated revenues in 2004. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—International Operations, and Item 8. Financial Statements and Supplementary Data—Note 20. Business Segments, for additional information about geographic areas.

Our international mortgage insurance and credit enhancement operations include our operations in Australia and New Zealand, the European Union and Hong Kong.

Australia and New Zealand

We offer mortgage insurance in Australia and New Zealand through our wholly-owned subsidiaries, PMI Mortgage Insurance Ltd, or PMI Ltd, and PMI Indemnity Limited, or PMI Indemnity. The combined operations of PMI Ltd and PMI Indemnity are referred to as PMI Australia. PMI Australia is headquartered in Sydney, Australia, and has offices throughout Australia and New Zealand. PMI Ltd’s financial strength is rated “AA” by S&P and Fitch, and “Aa2” by Moody’s. At December 31, 2004, the total assets of PMI Australia were $871.4 million compared to $703.8 million at December 31, 2003.

Australian mortgage insurance, known as “lenders mortgage insurance,” or LMI, is characterized by single premiums and coverage of 100% of the loan amount. Lenders usually collect the single premium from a prospective borrower and remit the amount to PMI Australia as the mortgage insurer. PMI Australia recognizes earnings from single premiums in its financial statements over time in accordance with an actuarially determined multi-year schedule. Premiums are partly refundable if the policy is canceled within the first year.

LMI covers the unpaid loan balance, plus selling costs and expenses, following the sale of the security property. Historically, loss severities have normally ranged from 20% to 30% of the original loan amount. In New Zealand, insurance coverage is predominantly “top cover”, where the total loss (including expenses) is paid up to a prescribed percentage of the original loan amount. Typical top cover in New Zealand ranges between 20% and 30% of the original loan amount.

The majority of the loans insured by PMI Australia are variable interest rate principal and interest loans with terms up to 30 years. Interest rate changes impact the frequency of defaults and claims with respect to these loans. Since mortgage interest is not tax deductible in Australia or New Zealand on owner-occupied properties, borrowers have a strong incentive to accelerate reduction of their principal balance by amortizing or prepaying their mortgages. As savings interest is taxable, most mortgage loans allow advance repayment.

PMI Australia’s primary NIW includes flow channel insurance and insurance on loans underlying residential mortgage-backed securities, or RMBS. In Australia, an active securitization market exists due in part to the relative absence of government sponsorship of the mortgage market. RMBS transactions include insurance on seasoned portfolios comprised of prime credit quality loans that have LTVs often below 80%. 42.9% of PMI Australia’s NIW in 2004 was RMBS insurance written, compared to 23.8% in 2003. The significant increase in RMBS insurance written in 2004 reflects increased securitization activity in the Australian market and the fact that there are limited market participants providing mortgage insurance for RMBS in the Australian market. Levels of activity in the Australian RMBS market vary from quarter to quarter.

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The five largest Australian banks collectively provide 75% or more of Australia’s residential housing financing. These banks represented approximately 39% of PMI Australia’s gross premiums written in 2004. Other market participants in Australian and New Zealand mortgage lending include regional banks, building societies, credit unions and non-bank mortgage originators. PMI Australia’s five largest customers provided 65.2% of PMI Australia’s 2004 gross premiums written.

A significant portion of PMI Australia’s business is acquired through quota share reinsurance agreements with its lending customers’ captive LMI companies. These quota share reinsurance agreements typically contain a contractual period under which the lender commits to send PMI Australia a prescribed proportion of business. PMI Australia wrote approximately 58% of its new business premiums under these agreements in 2004, compared to approximately 46% in 2003. PMI Indemnity, being in run-off, is not a party to any such agreements.

PMI Australia’s principal competitor is Genworth Financial. While PMI Australia and Genworth Financial are the only two independent lenders mortgage insurers in Australia that are rated by the rating agencies S&P, Fitch and Moody’s, several large banks have captive LMI companies in Australia.

The following table sets forth the dispersion of PMI Australia’s risk in force as of December 31, 2004, by year of policy origination and average original LTV since PMI commenced operations in Australia and New Zealand in 1999.

In 2004, PMI Australia introduced pmiAURA, a statistical model used to analyze PMI Australia’s claims frequency risk, as part of its underwriting and risk analysis program. This methodology is the same as that applied by U.S. Mortgage Insurance Operations, but was developed for PMI Australia using Australian claims, economic and demographic information. The pmiAURA model assigns a predictive claim risk score to individual policies. PMI Australia also commenced the electronic submission of applications and delivery of underwriting decisions in 2004.

As in the United States, mortgage insurance underwriting decisions have been delegated by PMI Australia to certain of its customers. Delegated underwriting allows approved customers, subject to agreed policy limitations, to commit PMI Australia to offering LMI with respect to a mortgage loan. The pmiAURA system is also used to analyze these arrangements which are subject to regular compliance audit by PMI Australia. PMI Australia may be committed to insure a loan that fails to meet all the agreed delegated guidelines. Long term performance of delegated insured loans is not expected to vary materially from all other insured loans.

In May 2004, S&P designated PMI Ltd as a core business and affirmed its “AA” rating and stable outlook. In 2004, Fitch also affirmed PMI Ltd’s insurer financial strength rating of “AA” with a stable outlook. In May 2004, Moody’s upgraded PMI Ltd’s rating to “Aa2” with a stable outlook from “Aa3.” PMI Indemnity maintained its S&P rating of “AA-,” Fitch rating of “AA,” and Moody’s rating of “Aa3.” PMI Australia is a party to capital support agreements in which PMI agrees to provide funds to ensure that both PMI Ltd. and PMI Indemnity are able to maintain prudent levels of capital to maintain their credit ratings.

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For discussion on PMI Australia’s loss reserves, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Policies and Estimates, Reserves for Losses and LAE—International Operations.