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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-13664
THE PMI GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 601 Montgomery Street 94-3199675
(State of Incorporation) San Francisco, California 94111 (I.R.S. Employer
(Address of principal executive offices) Identification No.)
(415) 788-7878
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
---------------------------- -----------------------------------------
Common Stock, $.01 par value New York Stock Exchange
Pacific Exchange
Preferred Stock Purchase Rights New York Stock Exchange
Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
--
The market value of the voting stock (common stock) held by non-affiliates of
the registrant as of the close of business on February 28, 2002 was
$3,170,313,685 based on the closing sale price of the common stock on the New
York Stock Exchange consolidated tape on that date.
Number of shares outstanding of the Registrant's common stock, as of the close
of business on February 28, 2002: 44,746,841.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the fiscal year ended December
31, 2001 are incorporated by reference into Items 6 through 8 of Part II.
Portions of the Proxy Statement for registrant's 2002 Annual Meeting of
Stockholders to be held on May 16, 2002 are incorporated by reference into Items
10 through 13 of Part III. The Exhibit Index is located on page 59.
TABLE OF CONTENTS
Cautionary Statement
PART I
Item 1. Business ........................................................................ 4
A. Overview of Operations............................................................ 4
B. U.S. Mortgage Insurance Operations................................................ 5
1. Products................................................................ 5
2. Competition............................................................. 11
3. Customers............................................................... 14
4. Business Composition.................................................... 15
5. Sales; Mortgage Insurance Acquisition Channels.......................... 17
6. Underwriting Practices.................................................. 18
7. Affordable Housing...................................................... 21
8. Defaults and Claims..................................................... 22
9. Reinsurance............................................................. 29
10. Regulation.............................................................. 30
11. Financial Strength; Ratings............................................. 34
C. International Operations and Other Residential Lender Services.................... 35
1. International Mortgage Insurance........................................ 35
Australia and New Zealand
Europe
Hong Kong
2. Title Insurance......................................................... 39
3. Financial Guaranty Reinsurance.......................................... 40
4. Mortgage Loan Servicing................................................. 40
D. Investment Portfolio.............................................................. 40
E. Employees......................................................................... 41
Item 2. Properties............................................................................ 41
Item 3. Legal Proceedings..................................................................... 41
Item 4. Submission of Matters to a Vote of Security Holders................................... 42
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............. 44
Item 6. Selected Financial Data............................................................... 46
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................. 46
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................ 46
Item 8. Financial Statements and Supplementary Data........................................... 46
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................................ 46
2
PART III
Item 10. Directors and Executive Officers of the Registrant.................................... 46
Item 11. Executive Compensation................................................................ 46
Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 47
Item 13. Certain Relationships and Related Transactions........................................ 47
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 48
INDEX TO EXHIBITS....................................................................................... 59
3
Cautionary Statement Regarding Forward-Looking Statements
Certain written and oral statements we make in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, or are preceded by, followed by or
include the words "believes," "expects," "anticipates," "estimates" or similar
expressions, or that relate to future plans, events or performance are
forward-looking statements within the meaning of the federal securities laws.
When a forward-looking statement includes an underlying assumption, we caution
that, while we believe the assumption to be reasonable and make it in good
faith, assumed facts almost always vary from actual results, and the difference
between assumed facts and actual results can be material. Where, in any
forward-looking statement, we express an expectation or belief as to future
results, there can be no assurance that the expectation or belief will result.
Our actual results may differ materially from those expressed in our
forward-looking statements. Forward-looking statements involve a number of risks
or uncertainties including, but not limited to, the Investment Considerations
addressed in the "Management's Discussion and Analysis" section of the
Company's 2001 Annual Report to Stockholders (Exhibit 13.1), which is
incorporated by reference in Item 7. Other risks are referred to from time to
time in our periodic filings with the Securities and Exchange Commission. All of
our forward-looking statements are qualified by and should be read in
conjunction with such risk disclosures. Except as may be required by applicable
law, we undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
PART I
Item 1. Business
A. Overview of Operations - The PMI Group
The PMI Group, Inc. is an international provider of credit enhancement products
and lender services that promote home ownership and facilitate mortgage
transactions in the capital markets. Through our wholly and partially owned
subsidiaries, we offer residential mortgage insurance and credit enhancement
products domestically and internationally, title insurance, financial guaranty
reinsurance, mortgage servicing and other residential lender services.
Our primary operating subsidiary, PMI Mortgage Insurance Co., or PMI, is a
leading U.S. residential mortgage insurer, licensed in all 50 states and the
District of Columbia. Residential mortgage insurance protects lenders and
investors against potential losses in the event of borrower default.
. PMI generated 67% of our consolidated revenues in 2001.
. PMI's claims-paying ability is currently rated "AA+" (excellent) by
Standard & Poor's, "Aa2" (excellent) by Moody's and "AA+" (very
strong) by Fitch.
PMI's 50% owned subsidiary, CMG Mortgage Insurance Company, offers mortgage
insurance for loans originated by credit unions.
We also offer title insurance through our wholly owned subsidiary, American
Pioneer Title Insurance Company, and mortgage loan servicing to lenders through
our partially owned subsidiary, Fairbanks Capital Holding Corporation.
We have a number of international operations that offer mortgage insurance and
other credit enhancement products.
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. Our Australian subsidiaries, PMI Mortgage Insurance Ltd and PMI
Indemnity Limited, are leading providers of mortgage insurance in
Australia and New Zealand.
. Our Irish subsidiary, PMI Mortgage Insurance Company Limited,
headquartered in Dublin, Ireland, offers mortgage insurance and
mortgage credit enhancement products in the European Union.
. PMI reinsures residential mortgage insurance in Hong Kong.
. We own 50% interest in RAM Holdings Ltd. and RAM Holdings II
Ltd., financial guaranty reinsurance companies based in Bermuda.
Our consolidated net income was $307.2 million including extraordinary losses
for the year ended December 31, 2001, and $260.2 million for the year ended
December 31, 2000. As of December 31, 2001, our total assets were $3.0 billion,
including our investment portfolio which had a market value of $2.6 billion as
of that date. Our shareholders' equity was $1.8 billion as of December 31, 2001.
Our principal executive offices are located at 601 Montgomery Street, San
Francisco, California 94111. Our telephone number is (415) 788-7878. We are
scheduled to move our principal executive offices in 2002 to 3003 Oak Road,
Walnut Creek, California 94596.
B. U.S. Mortgage Insurance Operations
PMI provides private mortgage insurance in the United States to residential
mortgage lenders and investors. PMI is incorporated in Arizona and currently
headquartered in San Francisco, California.
Private mortgage insurance insures lenders and investors against potential
losses in the event of borrower default. Specifically, PMI covers default risk
on first mortgage loans on one to four unit residential properties. Mortgage
insurance facilitates the sale of low down payment mortgages in the secondary
mortgage market and expands home ownership opportunities by enabling people to
buy a home with a down payment of less than 20%. Mortgage insurance is also
purchased by investors and lenders desiring additional protection against
mortgage default or capital relief.
1. Products
Primary Mortgage Insurance
Primary mortgage insurance provides mortgage default protection to lenders or
investors on individual loans at specified coverage percentages. PMI's
obligation to an insured with respect to a claim is generally determined by
multiplying the specified "coverage percentage" by the "claim amount," which
includes any unpaid loan balance, delinquent interest and certain expenses
associated with the loan's default and foreclosure. In lieu of paying the
coverage percentage of the claim amount on a defaulted loan, PMI may pay the
claim amount, as defined in PMI's Master Policy, and take title to the mortgaged
property. PMI generally offers coverage percentages on primary insurance ranging
from approximately 6% to 42% of the claim amount. The insured selects the
coverage percentage, often to comply with investor requirements to reduce the
loss exposure on loans purchased by the investor.
PMI's primary new insurance written, or NIW, for the year ended December 31,
2001 was $48.1 billion. NIW does not include primary mortgage insurance placed
upon loans more than 12 months after their
5
origination or loans where the insurance coverage exceeds 50%. PMI's primary
insurance in force and primary risk in force at December 31, 2001 were $109.2
billion and $25.8 billion, respectively. Primary insurance in force refers to
the current principal balance of all mortgage loans with primary insurance as of
a given date. Primary risk in force is the dollar amount equal to the product of
each individual insured mortgage loan's current principal balance multiplied by
the loan's specified primary coverage percentage.
Primary mortgage insurance premiums are usually charged to the borrower by the
mortgage lender or loan servicer, who in turn remits the premiums to PMI. In
certain instances, the lender pays the premiums to PMI without directly charging
the borrower. In those cases, the lender may adjust the interest rate on the
loan to reflect, in part, the mortgage insurance premium. Premium payments may
be paid to PMI on a monthly, annual or single premium basis.
Under PMI's monthly premium plans, premiums are paid at the mortgage loan
closing and monthly thereafter. PMI also offers a monthly plan under which the
first monthly premium is payable at the time the first monthly mortgage payment
is due. Monthly plans represented 97% of NIW in 2001 and 92% of NIW in 2000. As
of December 31, 2001, monthly plans represented 90% of PMI's primary risk in
force.
Annual premium plans require payment of the first-year premium at the time of
loan closing and annual renewal premium payments in advance each year
thereafter. Single premium plans require lump-sum premium payments at loan
closing or financed into the loan amount, which may be refundable if coverage is
canceled by the insured, which generally occurs when the loan is repaid or the
value of the property has increased significantly. Single premium and annual
premium plans represented 3% and 8% of NIW in 2001 and 2000, respectively.
Single and annual premium plans combined represented 10% of PMI's primary risk
in force as of December 31, 2001.
Generally, mortgage insurance is renewable at the option of the insured at the
premium rate fixed when the insurance on the loan was initially issued. As a
result, the impact of increased claims and incurred losses from policies
originated in a particular year cannot be offset by renewal premium increases on
policies in force or mitigated by PMI's nonrenewal of insurance coverage.
PMI may not cancel mortgage insurance, except for nonpayment of premiums or
certain material violations of PMI's Master Policy. The insured, the holder of
the loan or the loan's mortgage servicer may cancel mortgage insurance coverage
at any time. Fannie Mae and Freddie Mac's current guidelines regarding
cancellation of mortgage insurance generally provide that a borrower's written
request to cancel mortgage insurance should be honored if the borrower has a
satisfactory payment record and the principal balance is not greater than 80% of
the original value of the property or, in some instances, the current value of
the property. The Homeowners Protection Act of 1998 also provides for the
automatic termination, or cancellation upon a borrower's request, of private
mortgage insurance upon satisfaction of certain conditions.
A significant percentage of PMI's premiums earned is generated from existing
primary insurance in force and not from new insurance written. Accordingly, a
decline in insurance in force as a result of policy cancellations of older books
of business could harm our financial condition. During a period of falling
interest rates, an increasing number of borrowers refinance their mortgage loans
and PMI generally experiences a decrease in existing insurance in force,
resulting from policy cancellations of older books of business with higher rates
of interest. New insurance written during periods of low interest rates may
ultimately prove to be inadequate to offset the loss of insurance in force
arising from policy cancellations.
Fannie Mae and Freddie Mac, or the GSEs, are the predominant purchasers of
conventional mortgage loans in the United States. In order to sell low down
payment loans to the GSEs, lenders must comply with the GSEs' requirements by
purchasing private mortgage insurance, or maintaining lender recourse or lender
6
participation. Lenders that purchase private mortgage insurance in connection
with the sale of loans to the GSEs must comply with the GSEs' coverage
percentage requirements. The GSEs have some discretion to increase or decrease
the amount of mortgage insurance coverage they require on loans provided minimum
requirements are met. For example, in 1995, the GSEs increased their coverage
requirements from 25% to 30% on mortgages with loan-to-value ratios, or LTV, of
90.01% to 95%, or 95s, and increased their coverage requirements from 17% to 25%
for mortgages with LTV's of 85.01% to 90%, or 90s. PMI's percentage of risk in
force with the "deeper" coverage requirements increased as a result of the
changed coverage requirements. As PMI charges higher premium rates for higher
coverage, the deeper coverage requirements imposed by the GSEs in 1995 resulted
in higher earned premiums for loans of similar type.
During 1999, the GSEs offered reduced coverage requirements for certain loans
approved for purchase by their automated loan underwriting systems. Coverage
requirements on these "approved" loans are similar to those required by the GSEs
prior to 1995. PMI has seen some movement by lenders toward these "reduced
coverage" programs. The GSEs will further reduce the coverage requirements for
loans approved for purchase by their automated underwriting systems if the
lender pays an up-front delivery fee. PMI believes that lenders generally have
declined to pay the delivery fee required to obtain this further reduction in
coverage. The GSEs also offer several high LTV programs that require coverage
similar to those levels established in 1995.
In cooperation with participating lenders, PMI has entered into agreements with
the GSEs to restructure primary mortgage insurance coverage on high LTV loans
sold to the GSEs over a specified period of time. The coverage restructuring
involves reduced amounts of primary coverage and a second layer of coverage,
usually in the form of pool insurance (see Pool Mortgage Insurance, below).
These restructuring transactions may provide for the provision of services by
the GSEs to the mortgage insurer and payment of fees by the mortgage insurer to
the GSEs for the reduced coverage and/or the services provided. This
restructured coverage represented a greater percentage of PMI's NIW and total
pool risk written in 2001 than in 2000. Should it continue, this trend could
negatively impact net premiums written and our yield on net premiums earned.
Pool Mortgage Insurance
Traditional Pool Insurance. "Traditional" pool insurance covers the entire loss
on a defaulted mortgage loan that exceeds the claim payment under any primary
coverage, up to a stated aggregate loss limit, or stop loss, for all of the
loans in the pool. Because the insurance exposure is not limited to a set
coverage percentage on specific loans as with primary insurance, the rating
agency capital requirements for traditional pool insurance are greater than for
primary insurance.
In 1997, PMI began offering GSE Pool, a traditional pool insurance product for
mortgage loans sold by PMI's customers to the GSEs. New risk written for GSE
Pool was $19.5 million and $106.0 million for the years ended December 31, 2001
and 2000, respectively. The average stop loss limit for GSE Pool as of December
31, 2001 was 1.1%. GSE Pool risk in force at December 31, 2001 was $801.5
million.
In 1999, pursuant to a Recapture Agreement between PMI and Forestview Mortgage
Insurance Company, PMI assumed mortgage pool insurance loss reserves presently
estimated to be $6.3 million, net of expense allocations, previously insured by
Forestview. These "old pools" are traditional pool policies written prior to
1994 and are past their peak claim periods. Risk in force for the Forestview
recaptured Old Pool portfolio was $1.1 billion at December 31, 2001.
In addition to GSE Pool and Old Pool, PMI has offered traditional pool products
to certain state housing authorities and investors. Other traditional pool risk
in force as of December 31, 2001 was $6.2 million.
7
PMI is not actively offering new traditional pool insurance to its customers.
Traditional pool insurance is not counted by the mortgage insurance industry
towards NIW, primary insurance in force or primary risk in force. Accordingly,
references to such figures in this document do not include traditional pool
insurance, unless otherwise indicated.
Modified Pool Insurance. PMI offers modified pool insurance products that, in
addition to having a stated aggregate loss limit, have exposure limits on each
individual loan in the pool. PMI issues modified pool insurance coverage in
negotiated transactions (see Negotiated Transactions, below) and to the GSEs in
connection with the restructuring of primary mortgage insurance. Modified pool
insurance may be attractive to lenders and investors seeking capital relief or
the reduction of default risk beyond the protection provided by existing primary
mortgage insurance. Modified pool insurance may be used as a substitute for
primary insurance, used to cover loans that do not require primary mortgage
insurance because they have LTVs of less than 80%, or used as an additional
credit enhancement for secondary market mortgage transactions.
Prior to July 2001, PMI generally did not include modified pool insurance
towards NIW, primary insurance in force or primary risk in force. Effective July
2001, PMI revised several categories of insurance. Under the revised categories,
PMI includes modified pool insurance towards NIW, primary insurance in force and
risk in force when:
. the modified pool insurance is placed on a loan that does not also
have primary mortgage insurance coverage, and
. the difference between the loan's LTV and the modified pool coverage
percentage is greater than 50%. The difference between the LTV and the
modified pool coverage percentage is sometimes referred to as the
"down-to" percentage.
We believe that this definitional change does not materially affect PMI's
previously reported NIW, primary insurance in force and risk in force results or
its current year-end results as compared to comparable periods in 2000.
Total modified pool risk written in 2001 (excluding modified pool that PMI
included in NIW) was $414.7 million. Total modified pool risk in force as of
December 31, 2001 and 2000 was $554.1 million and $163.5 million, respectively
(excluding modified pool that PMI included in primary risk in force).
Negotiated Transactions
PMI engages in negotiated, secondary market "bulk" transactions. While the terms
vary from deal to deal, negotiated transactions generally involve bidding upon
and, if successful, insuring a large group of loans or committing to insure new
loan originations on agreed terms. Insurance issued in negotiated transactions
may include primary or modified pool, or a combination thereof. Some negotiated
transactions contain a risk-sharing component under which the insured shares in
losses in some manner. Negotiated transactions may involve loans that are or
will be securitized and in these instances PMI may be asked to provide "down to"
insurance coverage sufficient to reduce the insured's exposure on each loan to a
percentage of the loan balance selected by the insured.
PMI issued approximately $9 billion of primary mortgage insurance through
negotiated transactions in 2001, which accounted for approximately 19% of PMI's
NIW for 2001. In 2000, approximately 21% of PMI's NIW was acquired through
negotiated transactions. Negotiated transactions have come primarily from
secondary mortgage market participants, including underwriters of
mortgage-backed securities and mortgage investors such as the
8
GSEs. We believe that negotiated transactions will make up a material portion of
the mortgage insurance industry's and PMI's NIW and pool risk written in 2002.
Negotiated transactions have impacted us in a number of ways and we believe this
business will continue to impact us in the future. In 2000, PMI's sales force,
which traditionally focused on mortgage originators, was reorganized, in part,
to allocate additional resources to pursue negotiated transactions with
secondary mortgage market participants. PMI maintains a "negotiated
transactions" team dedicated to acquiring and executing secondary market
transactions.
To obtain this business, PMI competes with other mortgage insurers and other
providers of credit enhancement who may offer alternative forms of credit
enhancement. Accordingly, PMI's ability to quickly and efficiently analyze large
loan portfolios and develop and adequately price complex insurance products is
critical. Generally, PMI prices and bids upon a loan portfolio by aggregating
the price of mortgage insurance to be charged for each particular loan in the
portfolio. PMI prices loans in negotiated transactions based upon a number of
risk factors, including borrower and credit characteristics, loan and property
characteristics including LTV, the level of insurance coverage requested,
housing market considerations and persistency estimations.
Negotiated transactions often include "non-traditional" loans, including
Alternative A and Alternative A- loans and less than A quality mortgages.
Alternative A loans have approximately the same credit profile as traditional
loans insured by PMI but have been underwritten with reduced income, deposit
and/or employment documentation. Alternative A- loans have slightly weaker
credit profiles than traditional loans insured by PMI and have been underwritten
with reduced income, deposit and/or employment documentation. Loans of less than
A quality have been underwritten to non-traditional and generally lower credit
requirements than credit guidelines for traditional loans.
Captive Reinsurance
Certain mortgage insurers, including PMI, reinsure portions of their risk
written on loans originated by certain lenders with captive reinsurance
companies affiliated with such lenders. PMI's captive reinsurance programs allow
the lender-affiliated reinsurance company to assume a portion of the mortgage
insurance default risk in exchange for a portion of the insurance premiums for
loans originated by the lender and insured by PMI.
. In 2001, approximately 43% of PMI's NIW was subject to captive
reinsurance arrangements, compared to approximately 34% of PMI's NIW
in 2000.
. As of December 31, 2001, approximately 29% of PMI's primary insurance
in force was subject to captive reinsurance arrangements, compared to
approximately 23% of PMI's primary insurance in force as of December
31, 2000.
. As of December 31, 2001, approximately 31% of PMI's total risk in
force was subject to captive reinsurance arrangement, compared to
approximately 24% of PMI's total risk in force in 2000.
These increases in the percentages of primary insurance in force and NIW subject
to captive reinsurance arrangements were the result of the heavy volume of
refinance activity during 2001 as well as additional reinsurance agreements
entered into during 2000 and 2001. PMI expects these percentages to continue to
increase in 2002 as refinance activity continues and an increasing amount of NIW
is subject to reinsurance agreements. This trend could negatively impact net
premiums written and the yield we obtain on net premiums earned.
9
. In 2001, PMI ceded approximately 29% of the total premiums subject to
captive reinsurance arrangements for a commensurate level of risk,
compared to approximately 25% in 2000. This increase was primarily the
result of additional captive reinsurance arrangements and the heavy
refinance activity experienced during 2001.
. As of December 31, 2001, PMI had ceded approximately $692.2 million of
risk in force to captive reinsurers, and such ceded risk was supported
by restricted trust account balances of approximately $122.9 million.
PMI's captive reinsurance agreements primarily consist of what are known in the
industry as excess-of-loss reinsurance. In excess-of-loss reinsurance, PMI
retains a first loss position on a defined set of mortgage insurance risk,
reinsures a second loss layer of this risk with a captive reinsurer and retains
the remaining risk above the second loss layer up to the maximum coverage level.
PMI also has entered into four quota-share captive reinsurance agreements under
which the captive reinsurer assumes a pro rata share of all (i.e., first dollar)
losses in return for a pro rata share of the premiums collected.
In 2000, Freddie Mac issued revised Eligibility Criteria for Private Mortgage
Insurers that established certain financial requirements for captive reinsurance
transactions. These revised requirements contained new, detailed requirements
with respect to captive reinsurance transactions. Among other things, the new
requirements: (i) mandate that captive reinsurance agreements include risk
transfer in accordance with Financial Accounting Standards Board ("FASB") No.
113, Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts; and (ii) impose capital or rating requirements on
captive reinsurers that reinsure more than 25% of the ceded risk or premium
under a quota-share or excess-of-loss agreement. Freddie Mac also has the
authority to waive these requirements on a case by case basis. In addition,
under the terms of the Baynham settlement (see Item 3. Legal Proceedings), PMI
must obtain a written opinion of an independent actuary that the net ceded
premiums under each captive agreement is "commensurate or reasonably related to
the risk transferred" and that there is a real transfer of risk.
To ensure the performance of its captive reinsurers, PMI requires each captive
reinsurer to establish a trust account with a National Association of Insurance
Commissioner's approved United States domiciled bank and to maintain funds
therein in an amount not less than the greater of (i) loss, unearned premium and
contingency reserves required to be held under Arizona law, or (ii) 10% of the
risk reinsured for excess of loss reinsurance or 5% of the risk reinsured for
quota share reinsurance. These estimated liabilities and risk-to-capital ratios
are recalculated by PMI on a quarterly basis. All reinsurance premiums payable
by PMI are deposited directly into the trust accounts and the captive reinsurers
are permitted to make withdrawals from the trust account only if, and to the
extent that, the trust balances exceed certain predetermined reserve and
risk-to-capital levels and PMI as the sole beneficiary of the trust has
expressed written consent for such withdrawal.
Other Risk-Sharing Products
In addition to captive reinsurance, PMI offers other risk-sharing products,
including:
. layered co-insurance, a primary mortgage insurance program under which
the insured retains liability for losses between certain levels of
aggregate losses; and
. various products designed for, and in cooperation with, the GSEs
and/or lenders that involve some aspect of risk-sharing. Some of these
products are executed through negotiated transactions.
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Joint Venture - CMG Mortgage Insurance Company
CMG offers mortgage insurance for loans originated by credit unions. CMG is a
joint venture, equally owned by PMI and CUNA Mutual Investment Corporation, or
CMIC. CMIC is part of the CUNA Mutual Group which provides insurance and
financial services to credit unions and their members in the United States and
other countries. PMI and CMIC both provide services to CMG. At December 31,
2001, CMG had $8.9 billion of primary insurance in force. CMG's financial
results are reported in PMI's financial statements under the equity method of
accounting. CMG's operating results are not included in PMI's results shown in
Part I of this Form 10-K, unless noted. PMI and CMIC also jointly own CMG
Mortgage Assurance Company, or CMGA, which offers mortgage insurance for credit
union loans secured by junior liens, and CMG Mortgage Reinsurance Company, which
provides reinsurance to CMG and CMGA.
Under the terms of the joint venture arrangement, at the end of fifteen years,
or earlier under certain limited conditions, CMIC has the right to require PMI
to sell, and PMI has the right to require CMIC to purchase, PMI's interest in
CMG for an amount equal to the then current fair market value. For this purpose,
fair market value will be determined by agreement between PMI and CMIC or,
failing such agreement, through appraisal by nationally recognized
investment-banking firms. PMI and CMIC have entered into a capital support
agreement for the benefit of CMG in order to maintain CMG's claims-paying
ability rating at AA- by Standard & Poor's and AA by Fitch.
CMG has one captive reinsurance agreement and may enter into additional
arrangements in the future.
2. Competition
U.S. Private Mortgage Insurance Industry
The U.S. private mortgage insurance industry (excluding CMG) consists of seven
active mortgage insurers: PMI; Mortgage Guaranty Insurance Corporation; GE
Capital Mortgage Insurance Corporation, an affiliate of GE Capital Corporation;
United Guaranty Residential Insurance Company, an affiliate of American
International Group, Inc; Radian Guaranty Inc; Republic Mortgage Insurance Co.,
an affiliate of Old Republic International; and Triad Guaranty Insurance Corp.
According to the Mortgage Bankers Association of America, for the year ended
December 31, 2001, total mortgage originations were $2.1 trillion compared to
$1.1 trillion for the year ended December 31, 2000.
U.S. and State Government Agencies
PMI and other private mortgage insurers compete with federal and state
government and quasi-governmental agencies that sponsor their own mortgage
insurance programs. The private mortgage insurers' principal government
competitor is the FHA and, to a lesser degree, the Veterans Administration, or
VA. The following table shows the relative mortgage insurance market share of
FHA/VA and private mortgage insurers over the past five years.
Federal Government and Private Mortgage Insurance
Market Share (Based on NIW)
---------------------------
Year Ended December 31,
-----------------------
2001 2000 1999 1998 1997
----- ----- ----- ----- -----
FHA/VA ....................... 37.3% 41.4% 47.6% 43.7% 45.6%
Private Mortgage Insurance ... 62.7 58.6 52.4 56.3 54.4
----- ----- ----- ----- -----
Total ................... 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
- ----------
Source: Inside Mortgage Finance
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Effective January 1, 2002, the Department of Housing and Urban Development, or
HUD, in accordance with its index, increased the maximum single-family loan
amount that the FHA can insure from $239,250 to $261,609 in high-cost areas.
While there is no maximum VA loan amount, lenders will generally limit VA loans
to $240,000. Private mortgage insurers have no limit as to maximum individual
loan amounts that they can insure. In January 2001, the FHA reduced the up-front
mortgage insurance premiums it charges on loans from 2.25% to 1.5% of the
original loan amounts. The FHA also has streamlined its down-payment formula
making FHA insurance more competitive with private mortgage insurance in areas
with higher home prices. These and other legislative and regulatory changes
could cause future demand for private mortgage insurance to decrease.
Federal Home Loan Bank Mortgage Partnership Finance Program. In October 1999,
the Federal Housing Finance Board, or FHF Board, adopted resolutions which
authorize each Federal Home Loan Bank, or FHLB, to offer programs to purchase
single-family conforming mortgage loans originated by participating member
institutions under the single-family member mortgage assets program. In July
2000, the FHF Board gave permanent authority to each FHLB to purchase such loans
from member institutions without any volume cap. Under the FHF Board's rules,
member institutions are also authorized to provide credit enhancement for
eligible loans that is not limited to mortgage insurance. Any expansion of the
FHLBs' ability to use alternatives to mortgage insurance could reduce the demand
for private mortgage insurance and harm our financial condition and results of
operations.
PMI and other private mortgage insurers also face limited competition from
several state housing insurance funds which are either independent agencies or
affiliated with state housing agencies.
Fannie Mae and Freddie Mac - The GSEs
As the predominant purchasers of conventional mortgage loans in the United
States, the GSEs provide a direct link between the mortgage origination and
capital markets. The GSEs may purchase conventional high LTV mortgages only if
the lender (i) secures private mortgage insurance from an eligible insurer on
those loans; (ii) retains a participation of not less than 10% in the mortgage;
or (iii) agrees to repurchase or replace the mortgage in the event of a default
under specified conditions. However, if the lender retains a participation in
the mortgage or agrees to repurchase or replace the mortgage, applicable federal
bank and savings institution regulations may increase the level of capital
required to be held by the lender and the lender's cost of doing business may be
adversely affected. Consequently, lenders prefer to make loans that can be sold
in the secondary market utilizing mortgage insurance from insurers deemed
eligible by the GSEs. PMI is a GSE authorized mortgage insurer.
Private mortgage insurers must satisfy requirements set by the GSEs to be
eligible to insure loans sold to the GSEs. One of the GSEs requires mortgage
insurers to maintain at least two of the three ratings equal to or higher than
AA- by Fitch, AA- by S&P or Aa3 by Moody's. Any change in PMI's eligibility
status with either GSE could have a material, adverse effect on our financial
condition and results of operations.
The GSEs have the ability to implement new eligibility requirements for mortgage
insurers. They also have the authority to change the pricing arrangements for
purchasing retained participation mortgages as compared to insured mortgages,
increase or reduce required insurance coverage percentages, and alter or
liberalize underwriting standards on low down payment mortgages they purchase.
Private mortgage insurers, including PMI, are affected by such changes. One of
the GSEs has indicated that it is considering adopting and implementing new
approval requirements for mortgage insurers. The extent to which these new
requirements may alter the guidelines for PMI's business operations, capital
requirements and products is not currently known.
12
In 2001, the maximum single-family principal balance loan limit eligible for
purchase by the GSEs was increased in accordance with the applicable index to
$275,000 and in January 2002 that limit was raised to $300,700. PMI believes
that any increase in this loan limit may positively affect the number of loans
eligible for mortgage insurance, thereby increasing the size of the mortgage
insurance market.
The GSEs are subject to oversight by HUD. In October 2000, HUD announced new GSE
mortgage purchase requirements, known as affordable housing goals. Under these
goals that began in 2001, at least 50% of all loans purchased by the GSEs must
support low- and moderate-income homebuyers and 31% of such units must be in
under-served areas. PMI believes that the GSEs' goals to expand purchases of
affordable housing loans have increased the size of the mortgage insurance
market. The GSEs also have expanded programs to include commitments to purchase
certain volumes of loans with LTV's between 95% and 97%, or 97s, and between 97%
and 100%, or 100s.
The Office of Federal Housing Enterprise Oversight, or OFHEO, is required to
develop risk-based capital regulations for the GSEs and in July 2001 OFHEO
published a risk-based capital rule that specified a risk-based capital stress
test that, when applied to the GSEs, determines the amount of capital that a GSE
must hold to maintain positive capital throughout a 10-year period of severe
economic conditions. The published rule treated credit enhancements issued by
private mortgage insurance companies with claims-paying ability ratings of "AAA"
more favorably than those issued by mortgage insurance companies with "AA"
ratings, such as PMI. The rule also provided capital guidelines for the GSEs in
connection with their use of other types of credit protection counter parties in
addition to mortgage insurers. In December 2001, OFHEO proposed a revised rule
and OFHEO finalized the revised rule in February 2002. The finalized rule
reduced, but did not eliminate, the differential between the "AAA" and "AA"
rated mortgage insurance companies. It is not clear whether the finalized rule
will result in the GSEs increasing their use of either AAA-rated mortgage
insurers instead of AA-rated entities or credit counter parties other than
mortgage insurers due to the more favorable capital treatment afforded to such
entities. Changes in the preferences of the GSEs for private mortgage insurance
to other forms of credit enhancement, or a tiering of mortgage insurers based on
their credit rating, could harm our financial condition and results of
operations.
Mortgage insurers, including PMI, compete with the GSEs when the GSEs seek to
assume mortgage default risk that could be covered by mortgage insurance. As
discussed above, the GSEs have introduced programs that allow lenders to
purchase reduced mortgage insurance coverage or provide for the restructuring of
existing mortgage insurance with reduced amounts of primary coverage and the
addition of pool coverage. In the past, Freddie Mac stated that it would pursue
a permanent charter amendment allowing it to utilize alternative forms of
default risk protection or otherwise forego the use of private mortgage
insurance on higher loan-to-value mortgages. In October 2000, Fannie Mae
announced its intention during the next three years to increase its share of
revenue associated with the management of mortgage credit risk by retaining
mortgage risk previously borne by its "risk-sharing partners," including
mortgage insurers.
In 2000 and 2001, the GSEs purchased primary and modified pool insurance
coverage on GSE-held loans with down payments exceeding 20%. The GSEs often
acquired this mortgage insurance, some of which was written by PMI, through a
bidding process. The GSEs are not required by regulation or charter to purchase
this coverage and PMI believes that the GSEs purchased this coverage to assist
in their risk-to-capital management programs. If the GSEs continue to purchase
mortgage insurance on loans with down payments exceeding 20%, it would represent
an additional market for private mortgage insurance in the United States.
Freddie Mac's and Fannie Mae's automated underwriting systems, Loan
Prospector(SM) and Desktop Underwriter(TM), respectively, can be used by
mortgage originators to determine whether Freddie Mac or Fannie Mae will
purchase a loan prior to closing. Through these systems, lenders are able to
obtain
13
approval for mortgage insurance with any participating mortgage insurer. PMI
works with both agencies in offering insurance services through their systems,
while utilizing its proprietary risk management systems to monitor the risk
quality of loans insured through such systems. These automated underwriting
systems are used by the GSEs in connection with, among other things, their
reduced coverage and high-LTV programs. Generally, PMI's underwriting guidelines
allow PMI to place mortgage insurance coverage on any mortgage loans accepted by
the GSEs' automated underwriting systems for purchase. A significant portion of
PMI's NIW in 2001 consisted of loans accepted by the GSEs' automated
underwriting systems.
Mortgage Lenders
PMI and other private mortgage insurers compete indirectly with mortgage lenders
that elect to retain the risk of loss from defaults on all or a portion of their
high LTV mortgage loans rather than obtain insurance for such risk. Certain
lenders originate a first mortgage lien with an 80% LTV ratio, a 10% second
mortgage lien, and 10% of the purchase price from borrower's funds, or an
80/10/10. This 80/10/10 product and other similar products compete with mortgage
insurance as an alternative for lenders selling loans in the secondary mortgage
market.
In addition to captive reinsurance arrangements with affiliates of lenders,
mortgage insurers share a portion of their coverage with their customers through
risk retention arrangements. PMI also offers various premium rates based on the
risk characteristics, loss performance or class of business of the loans to be
insured or on the costs associated with doing such business. While many factors
are considered in determining rates, there can be no assurance that the premiums
charged will be adequate to compensate us for the risks associated with the
coverage provided to our customers.
Gramm-Leach-Bliley Act
Effective March 2000, the Gramm-Leach-Bliley Act allows, among other things,
bank holding companies to engage in a substantially broader range of activities,
including insurance underwriting. The Gramm-Leach-Bliley Act allows a bank
holding company to form an insurance subsidiary, licensed under state insurance
law, to issue insurance products, including mortgage insurance. Any such
mortgage insurance subsidiary would be subject to state insurance regulations
including capital, reserve and risk diversification requirements and
restrictions on the payments of dividends. Further, before any loans insured by
the subsidiary are eligible for purchase by the GSEs, the insurance subsidiary
must meet the GSEs' eligibility standards that currently require a claims-paying
ability rating of at least AA- and the establishment of comprehensive operating
policies and procedures. Because aspects of the Gramm-Leach-Bliley Act still
require clarification and promulgation and because few bank holding companies
have sought to utilize the Gramm-Leach-Bliley Act, we are unable to ascertain
the full impact of the Act on PMI.
The Office of the Comptroller of the Currency has granted permission to certain
national banks to form a reinsurance company as a wholly owned operating
subsidiary for the purpose of reinsuring mortgage insurance written on loans
originated or purchased by such bank. The Federal Reserve Board adopted a final
rule, effective as of February 2, 2001, that permits similar activities for bank
holding companies. The Office of Thrift Supervision has granted permission for
subsidiaries of thrift institutions to reinsure private mortgage insurance
coverage on loans originated or purchased by affiliates of such thrift's parent
organization. The reinsurance subsidiaries of national banks, savings
institutions or bank holding companies could become significant competitors of
us in the future.
3. Customers
PMI insures mortgage loans funded by mortgage originators. Mortgage originators
include mortgage bankers, savings institutions, commercial banks and other
mortgage lenders. Traditionally, PMI's primary
14
customers have been mortgage bankers with the balance of PMI's customers being
savings institutions, commercial banks and other mortgage lenders. As the
beneficiary under PMI's master policy is the owner of the insured loan, the
purchaser of that loan is entitled to the policy benefits. The GSEs, as the
predominant purchasers of conventional mortgage loans in the U.S., are the
beneficiaries of the majority of our mortgage insurance coverage.
In 2001, PMI's top ten customers generated approximately 38% of its NIW,
compared to approximately 40% in 2000.
In 2001, the mortgage lending industry continued its consolidation trend. A
greater percentage of that industry's business in 2001 was originated by large
lenders. At least several large lenders, however, rely in part upon mortgage
brokers and smaller loan originators, or correspondents, to source and originate
loans on their behalf. To date, large lenders generally have allowed their
correspondents to control decisions relating to the ordering of mortgage
insurance and the selection of particular mortgage insurance providers. PMI
anticipates that large lenders in 2002 generally will continue to allow their
correspondents to control these decisions. The centralization of these decisions
by large lenders, however, could magnify the impact that mortgage lending
consolidation has on mortgage insurers. Accordingly, the loss of a large lender
as PMI's customer, or a large lender's decision to significantly reduce its
business with PMI could, if permanent, have an adverse effect on PMI.
In 2000 and 2001, PMI offered a variety of mortgage insurance products to
secondary market participants such as underwriters of mortgage-backed securities
and the GSEs. These entities entered into negotiated transactions with PMI
pursuant to which PMI insured pools of loans or committed to insure new loan
originations on agreed terms. Insurance issued in negotiated transactions may
include primary or modified pool insurance or a combination thereof.
4. Business Composition
A significant percentage of PMI's premiums earned is generated from existing
insurance in force and not from NIW. For each of PMI's last four policy years,
more than half of the NIW for the year remains in force. The insured, the policy
owner or servicer of a loan may cancel insurance coverage at any time.
The composition of PMI's risk in force is summarized in the table below. The
table is based upon information available on the date of mortgage origination.
15
Risk in Force
As of December 31,
2001 2000 1999 1998 1997
-------- -------- -------- ------- -------
Primary Risk in Force (in millions) $ 25,772 $ 23,559 $ 21,159 $19,324 $18,092
LTV:
97s and above ................... 6.3% 5.7% 4.9% 3.3% 1.8%
95s ............................. 43.3 45.7 46.7 46.3 46.2
90s and below ................... 50.4 48.6 48.4 50.4 52.0
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Loan Type:
Fixed ........................... 90.5% 90.5% 91.4% 89.7% 83.3%
ARM ............................. 9.4 9.4 7.9 9.2 15.2
ARM (scheduled/potential negative
Amortization) ................... 0.1 0.1 0.7 1.1 1.5
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Mortgage Term:
Over 15 years ................... 99.0% 98.8% 95.6% 94.7% 93.7%
15 years and under .............. 1.0 1.2 4.4 5.3 6.3
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Property Type:
Single-family detached .......... 87.5% 87.3% 87.5% 87.1% 86.3%
Condominium ..................... 5.4 6.0 6.1 6.4 6.8
Other ........................... 7.1 6.7 6.4 6.5 6.9
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Occupancy Status:
Primary residence ............... 96.2% 97.2% 98.0% 98.6% 99.0%
Second home ..................... 1.6 1.5 1.2 1.0 0.8
Non-owner occupied .............. 2.2 1.3 0.8 0.4 0.2
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Loan Amount:
$100,000 or less ................ 22.8% 23.2% 24.0% 26.4% 27.3%
Over $100,000 and up to $250,000 67.2 68.2 68.6 66.1 65.6
Over $250,000 ................... 10.0 8.6 7.4 7.5 7.1
-------- -------- -------- ------- -------
Total ......................... 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======= =======
Traditional ........................ 84.5% 91.4% 93.2% N/A N/A
Non-traditional (Alt A/Less than A) 15.5 8.6 6.8 N/A N/A
-------- -------- --------
Total ......................... 100.0% 100.0% 100.0%
======== ======== ========
Pool Risk in Force (in millions):
GSE Pool ........................ $ 801.5 $ 785.6 $ 681.2 $ 450.3 N/A
Old Pool ........................ 1,114.1 1,391.5 1,407.8 N/A N/A
Modified Pool ................... 554.1 163.5 100.4 42.4 N/A
Other traditional pool .......... 6.2 5.9 3.9 N/A N/A
16
. Fixed v. Adjustable Rate Mortgages. Relatively low interest rates between 1996
and 2001 resulted in an increasing percentage of mortgages insured by PMI at
fixed rates of interest. Based on PMI's experience, fixed rate loans represent
less risk than adjustable rate mortgages, or ARMs, because claim frequency on
ARMs is generally higher than on fixed rate loans.
. High LTV Loans. The composition of PMI's NIW and risk in force includes 95s,
which in PMI's experience have claims frequency approximately one and a half
times that of 90s. PMI also offers coverage for mortgages with LTV's in excess
of 95% and PMI believes that these loans have higher risk characteristics than
95s.
. Non-Traditional Loans. PMI's NIW and risk in force also includes
non-traditional loans, chiefly Alternative A and Alternative A- loans and less
than A quality mortgages. Loan characteristics, credit quality, loss
development, pricing structures and persistency on non-traditional loans can be
significantly different and riskier than PMI's traditional prime business, and
non-traditional loans generally do not meet the standard underwriting guidelines
of the GSEs. Non-traditional loans represented approximately 19% of PMI's 2001
NIW and 20% of PMI's NIW in 2000.
Management expects higher default rates and claim payment rates for ARMs, high
LTV loans and non-traditional loans and incorporates these assumptions into its
pricing. However, there can be no assurance that the premiums earned on ARMs,
high LTV loans, non-traditional loans and the associated investment income will
prove adequate to compensate for future losses from these loans.
Changes in Coverage Percentages. The severity of a claim on an insured loan
depends in part upon the specified coverage percentage for that loan. Deeper
coverage on a loan increases the potential severity of a claim on that loan.
Accordingly, PMI generally charges higher premium rates for deeper coverage
(higher coverage percentages).
. PMI's average coverage percentage was 23% for NIW in 2001 and 24% for
NIW in 2000.
. PMI's percentage of NIW comprised of 95s with 30% coverage (deep
coverage) decreased from 25% for the year ended December 31, 2000 to
23% for the year ended December 31, 2001. This decrease was due in
part to PMI's execution in 2001 of certain negotiated transactions
that included mortgage loans with lower coverage percentages, and to
the large refinance mortgage market in 2001 that resulted in PMI
insuring a greater percentage of 90s than 95s.
. The percentage of NIW made up of 90s with 25% coverage (deep coverage)
was 32% at December 31, 2001 and 27% at December 31, 2000.
5. Sales; Mortgage Insurance Acquisition Channels
Sales. PMI employs a sales force located throughout the country to sell its
products and provide services to lenders located throughout the United States.
PMI's sales force receives compensation comprised of a base salary with
incentive compensation tied to performance objectives. PMI's Product Development
and Pricing Department has primary responsibility for advertising, sales
materials, pricing and the creation of new products and services.
In light of continuing mortgage lender consolidation and the increasing
dominance of the largest mortgage originators, PMI's sales force is organized
tactically, focusing on customer relationships with an emphasis on "national
accounts," PMI's large lender customers. As a result of PMI's increasing
negotiated
17
transactions business, PMI has dedicated additional resources to focus on PMI's
negotiated transactions customers.
Mortgage Insurance Acquisition Channels. To obtain mortgage insurance on a
specific mortgage loan a customer typically submits to PMI an application and
supporting documentation. If the loan is approved for mortgage insurance, PMI
issues a certificate of insurance to the customer. Historically, the customer's
application and PMI's response have been paper transactions executed via mail,
courier or facsimile. During the last several years, however, advances in
technology have enabled PMI to offer its customers the option of electronic
submission of applications and receipt of insurance commitments and
certificates. In 2001, 52% of PMI's primary insurance commitments (excluding
negotiated transactions) were issued electronically, compared to 23% in 2000.
A growing number of PMI's customers require that PMI provide its products and
services electronically. Many of these customers also require that PMI customize
its electronic delivery methods to their particular technology platforms. An
increasing portion of PMI's NIW is delivered electronically. Management expects
these trends to continue and, accordingly, believes that it is essential for PMI
to continue to invest substantial resources to maintain electronic connectivity
with its customers. In some instances, connectivity has become a primary factor
used by mortgage originators to choose a mortgage insurer.
While development and customization costs are substantial, electronic
acquisition and delivery of mortgage insurance benefits PMI. E-commerce reduces
paperwork for both PMI and its customers, streamlines the mortgage insurance
application process, reduces errors associated with re-entering information and
increases the speed with which PMI is able to respond to applications, all of
which can enhance PMI's relationship with lenders while reducing acquisition
costs. PMI's electronic acquisition channels, once developed, require
significantly less per transaction human effort than PMI's traditional paper
acquisition channels. Examples of PMI's electronic acquisition channels include:
. e-PMI(R). PMI introduced its electronic delivery channel for mortgage
insurance, "e-PMI," in 1999. PMI's customers can order mortgage
insurance directly from the e-PMI web-site or, in the case of certain
lenders, by using an embedded link that "frames" e-PMI within the
customer's own site. e-PMI offers users real-time access to, among
other things, mortgage insurance origination services, mortgage
insurance rates, and premium payment and refund information.
. EDI. PMI accepts applications for insurance electronically through
electronic data interchange, or EDI, links with lenders. EDI links
typically run over value-added networks and use industry-standard data
sets to exchange information.
. Connectivity to Third Party Internet Sites. PMI also electronically
connects to its customers directly through lender-specific web-sites
and, indirectly, through lender-neutral web-sites or "portals" and
loan origination and servicing systems.
. Tape-to-Tape Negotiated Transactions. PMI's negotiated transactions,
which often involve large loan portfolios, are conducted largely
electronically. Prior to insuring these groups of loans, PMI receives
from the insured details of the loan portfolios in electronic "tape"
format.
6. Underwriting Practices
Risk Management Approach
PMI underwrites its primary business based upon the historical performance of
risk factors of individual loan profiles and utilizes an automated underwriting
system in the risk selection process to assist the underwriter with decision
making. PMI's underwriting process evaluates five categories of risk:
18
. Borrower. An evaluation of the borrower's credit history is an
integral part of PMI's risk selection process. In addition to the
borrower's credit history, PMI analyzes several factors, including the
borrower's employment history, income, funds needed for closing and
the details of the home purchase.
. Loan Characteristics. PMI analyzes four general characteristics of the
loan product to quantify risk: (1) LTV; (2) type of loan instrument;
(3) type of property; and (4) purpose of the loan. Certain categories
of loans are generally not insured by PMI because such loans are
deemed to have an unacceptable level of risk, such as loans with
scheduled negative amortization.
. Property Profile. PMI reviews appraisals used to determine the
property value.
. Housing Market Profile. PMI places significant emphasis on the
condition of regional housing markets in determining its underwriting
guidelines. PMI analyzes the factors that impact housing values in
each of its major markets and closely monitors regional market
activity on a quarterly basis.
. Mortgage Lender. PMI tracks the historical risk performance of all
customers that hold a master policy. This information is factored into
the determination of the loan programs that PMI will approve for
various lenders.
PMI uses national and territorial underwriting guidelines to evaluate the
potential risk of default on mortgage loans submitted for insurance coverage.
PMI has developed and refined the national guidelines over time, taking into
account its loss experience and the underwriting guidelines of the GSEs. PMI's
underwriting guidelines generally allow PMI to place mortgage insurance coverage
on any mortgage loans accepted by the GSEs' automated underwriting systems for
purchase by the GSEs.
PMI expects its underwriters to utilize their knowledge of local markets, risk
management principles and business judgment in evaluating loans on their own
merits in conjunction with PMI's underwriting guidelines. Accordingly, PMI's
underwriting staff is trained to consider combined risk characteristics and
their impact in different real estate markets and have discretionary authority
to insure loans which are substantially in conformance with PMI's published
underwriting guidelines. Significant deviations from such guidelines require
higher level underwriting approval. PMI also offers pre-loan and post-loan
credit counseling to borrowers with high-LTV loans.
PMI's underwriting guidelines are based, in part, upon analysis performed by its
automated underwriting system, the pmiAURA(SM) System. The pmiAURA System
employs claim and risk statistical models to predict the relative likelihood of
default by a mortgage borrower and it assigns risk scores predicting the
likelihood of default. The pmiAURA System's database contains performance data
on more than 3.5 million loans, and includes economic and demographic
information to enhance its predictive power.
The pmiAURA System can generate several types of scores, including: a loan risk
score that assesses the risk solely due to the borrower and loan and property
characteristics that are independent of market risk; a market score which is a
measure of the default risk due solely to the economic conditions of a specific
metropolitan area and a total risk score that combines the information in the
loan risk and market scores. As an added benefit, pmiAURA's extensive database
provides detailed performance reports of underwriting quality trends by
geographic region, product type, customer characteristics and other key factors.
These reports allow PMI's underwriting management to monitor risk quality on a
daily basis and to formulate long-term responses to developing risk quality
trends. Ultimately, such responses can lead to regional variations from, or
permanent changes to, PMI's underwriting guidelines. pmiAURA is approved by the
Wall Street rating agencies as an effective tool for establishing levels of
credit support needed on securities backed by non-conforming, conventional
loans. Underwriting Process
19
Underwriting Process
Delegated Underwriting. The majority of PMI's NIW is underwritten pursuant to
PMI's Partner Delivered Quality Program, or PDQ Program. The PDQ Program is a
delegated underwriting program that allows approved lenders to determine whether
loans meet program guidelines and requirements and are thus eligible for
mortgage insurance. At present, more than 1,260 lenders approve applications
under the PDQ Program. PMI's delegated business accounted for approximately 55%
and 50% of PMI's NIW in 2001 and 2000, respectively. Delegated underwriting
enables PMI to meet mortgage lenders' demands for immediate insurance coverage
of certain loans. Delegated underwriting has become standard industry practice.
Under the PDQ Program, customers use their own PMI-approved underwriting
guidelines and eligibility requirements in determining whether PMI is committed
to insuring a loan. Upon receipt of delegated loans, PMI uses pmiAURA to
evaluate their key loan risk characteristics and to monitor the quality of
delegated business on an ongoing basis. Additionally, PMI audits a
representative sample of loans insured by lenders participating in the PDQ
Program on a regular basis to determine compliance with program requirements. If
a lender participating in the program commits PMI to insure a loan which fails
to meet all of the applicable underwriting guidelines, PMI is obligated to
insure such a loan except under certain narrowly-drawn exceptions to coverage,
for example, maximum loan-to-value criteria. Loans that are not eligible for the
PDQ Program may be submitted to PMI for insurance coverage through the standard
application process.
PMI believes that the performance of its delegated insured loans will not vary
materially over the long-term from the performance of all other insured loans
because: (i) only qualified lenders who demonstrate average or above-average
underwriting proficiency are eligible for the program; (ii) only loans meeting
average or above average underwriting eligibility criteria are eligible for the
program; and (iii) PMI has the ability to monitor the quality of loans approved
for insurance under the PDQ Program with proprietary risk management tools and
an on-site audit of each PDQ lender.
Non-delegated Underwriting. Customers that are not approved to participate in
the PDQ Program generally must submit to PMI an application for each loan,
supported by various documents. Applications submitted to PMI by mortgage
lenders generally include a copy of the borrower's loan application, an
appraisal report or other statistical evaluation on the property by either the
lender's staff appraiser or an independent appraiser, and a written credit
report on the borrower. Verifications of the borrower's employment, income and
funds needed for the loan closing are also required, unless the loan is
submitted by a lender that has been approved to participate in PMI's Quick
Application Program. This program allows selected lenders to submit insurance
applications that do not include all standard documents. The lender is required
to maintain written verification of employment and source of funds needed for
closing and other supporting documentation in its origination file. PMI may
schedule on-site audits of lenders' files on loans submitted under this program.
Once the loan package is received by PMI's home or field underwriting offices,
key borrower, property and loan product information are extracted from the file
and analyzed by the underwriter and/or the pmiAURA System. PMI generally
responds within one business day after it receives an application and supporting
documentation. PMI shares its knowledge of risk management principles and real
estate economic conditions with customers to improve the quality of submitted
business and reduce the rejection rate.
Negotiated Transactions. Negotiated transactions frequently involve a customer's
delivery of a portfolio of loans to PMI. Negotiated transactions require both
loan-by-loan analysis and evaluation of the loan portfolio as a whole. While the
underwriting process for negotiated transactions varies, underwriting steps
generally include:
20
. Obtaining complete data files from customer including all PMI required
elements;
. Preparation and review of stratification summaries of the loans by
various loan risk factors, such as borrower credit characteristics,
LTV, loan type and property type;
. Review of loan group by PMI's Credit Policy department including
identification and exclusion of uninsurable loans;
. Due diligence underwriting of sample loan files and review of loan
originator and loan servicer; and
. Analysis of loans by PMI's proprietary claims modeling system
specifically tailored to negotiated transactions.
Contract Underwriting
Contract underwriting services are provided by PMI's wholly owned subsidiary,
PMI Mortgage Services Co., or MSC. MSC enables customers to improve the
efficiency and quality of their operations by outsourcing all or part of their
mortgage loan underwriting. MSC provides contract underwriting services for
mortgage loans for which PMI provides mortgage insurance and for loans for which
PMI does not. MSC also performs the contract underwriting activities of CMG.
As a part of its contract underwriting services, MSC provides monetary and other
remedies to its customers in the event that MSC fails to properly underwrite a
mortgage loan. Such remedies may include: (1) the purchase of additional or
"deeper" mortgage insurance; (2) assumption of some or all of the costs of
repurchasing insured and uninsured loans from the GSEs and other investors; or
(3) issuance of indemnifications to customers in the event that the loans
default for varying reasons including, but not limited to, underwriting errors
by MSC. Generally, the scope of these remedies is in addition to those contained
in PMI's master primary insurance policies. Worsening economic conditions or
other factors that could lead to increases in PMI's default rate could also
cause the number and severity of the remedies that must be offered by MSC to
increase. Such an increase could have a material effect on our financial
condition.
Contract underwriting services are important to mortgage lenders as they
continue to seek to reduce costs. New policies processed by contract
underwriters represented 26% of PMI's NIW in 2001 compared with 23% in 2000. PMI
anticipates that loans underwritten by MSC will continue to make up a
significant percentage of PMI's NIW and that contract underwriting will remain
the preferred method among many mortgage lenders for processing loan
applications. The number of contract underwriters deployed by us is directly
related to the volume of mortgage originations and/or refinancing.
PMI, through its contract underwriting systems, provides its customers with
access to Freddie Mac's and Fannie Mae's automated underwriting services, Loan
ProspectorSM and Desktop UnderwriterSM, respectively, which are used as tools by
mortgage originators to determine whether Freddie Mac or Fannie Mae will
purchase a loan prior to closing.
7. Affordable Housing
In recent years, expanding home ownership opportunities for low and
moderate-income individuals and communities has been an increasing priority for
PMI, lenders and the GSEs. PMI's approach to affordable lending is to develop
products and services that assist responsible borrowers who may not qualify
using traditional underwriting practices. These underwriting standards do not
accommodate borrowers who have historically not managed their affairs in a
responsible manner; rather they seek to identify those home buyers who have met
or will meet their obligations in a timely and conscientious manner.
Additionally,
21
affordable housing programs assist homebuyers who have demonstrated good credit
quality and who have the ability and the willingness to meet their mortgage
obligations but who may not have accumulated sufficient cash for a traditional
down payment. The beneficiaries of these programs have included recent
immigrants who have not established traditional credit histories, borrowers not
accustomed to using traditional savings institutions and home buyers who,
although consistently employed, lack the traditional stability with a single
employer due to the nature of their employment.
To further promote affordable housing, PMI has entered into risk-sharing
arrangements or "layered co-insurance" with certain institutional lenders,
Native American tribes and housing authorities. Layered co-insurance is utilized
primarily by financial institutions to meet Community Reinvestment Act ("CRA")
lending goals and by Native American tribes and housing authorities to provide
homeownership opportunities to traditionally under-served populations. Under
such arrangements, the mortgage insurance is structured so that financial
responsibility is shared between the lender or Native American tribe/housing
authority and PMI. Typically PMI is responsible for the first loss layer, as
well as a third catastrophic layer, with the lender or Native American
Tribe/Housing Authority retaining a predetermined second loss layer.
PMI has also established partnerships with numerous national organizations to
mitigate affordable housing risks and expand the understanding of
responsibilities of home ownership. These community partners include Consumer
Credit Counseling Services, Neighborhood Reinvestment Corp. and the affiliated
Neighborhood Housing Services of America, the National Black Caucus, Social
Compact, the National American Indian Housing Conference, the AFLCIO Housing
Advancement Trust and the American Homeownership and Counseling Institute. In
addition, PMI has developed partnerships with local organizations in an effort
to expand home ownership opportunities and promote community revitalization.
Included among these organizations are the Oakland, California based Unity
Council, the San Francisco Chinatown Community Development Corporation, the
Orange County Affordable Home Ownership Alliance, the East Los Angeles Community
Corporation and several Native American nations. Finally, PMI has partnered with
the Los Angeles chapter of Consumer Credit Counseling Services to sponsor and
present seminars which provide consumers with the tools they need to identify
and avoid being victimized by predatory lending practices.
Programs offered under PMI's affordable housing initiatives receive the same
credit and actuarial analysis as all other standard programs although some
programs utilize affordable underwriting guidelines established by lenders that
differ from PMI's criteria. PMI believes that some affordable housing loans may
have higher risks than its other insured business. As a result, PMI has
instituted various programs including pre- and post-purchase borrower counseling
and risk sharing approaches, seeking to mitigate the additional risks that may
be associated with some affordable housing loan programs.
8. Defaults and Claims
Defaults
PMI's claim process begins with notification of a default from the insured on an
insured loan. "Default" is defined in PMI's master policy as the borrower's
failure to pay when due an amount equal to the scheduled monthly mortgage
payment under the terms of the mortgage. Generally, the master policy requires
an insured to notify PMI of a default no later than the last business day of the
month following the month in which the borrower becomes three monthly payments
in default. In most cases, defaults are reported earlier. PMI's insureds
typically report defaults within approximately 60 days of the initial default.
Borrowers default for a variety of reasons, including the reduction of income,
unemployment, divorce, illness, the inability to manage credit, and the level of
interest rates. Borrowers may cure defaults by making all of the delinquent loan
payments or by selling the property in full satisfaction of all amounts due
under the mortgage. Defaults that are not cured result in most cases in a claim
to PMI.
22
The following tables show the number of loans insured, the number of loans in
default and the default rate for PMI's primary insurance portfolio.
At December 31,
---------------
2001 2000 1999 1998 1997
------- ------- ------- ------- -------
Primary Insurance
Number of Insured Loans in Force ... 905,906 820,213 749,591 714,210 698,831
Number of Loans in Default ......... 25,907 18,093 15,893 16,528 16,638
Default Rate ....................... 2.86% 2.21% 2.12% 2.31% 2.38%
At December 31, 2001, PMI's default rate for primary insurance acquired through
negotiated transactions was 5.5%. PMI's default rate for its pool insurance
portfolio excluding Old Pool at December 31, 2001 was approximately 1.3%
compared to approximately 0.7% at December 31, 2000.
We believe that the higher default rate for negotiated transactions than for
primary and pool insurance is due to the greater concentration of
non-traditional loans in negotiated transactions. We believe that loans in PMI's
developing non-traditional primary book (Alternative A or A- and less than A
quality loans) will have higher ultimate default and claim rates than loans in
PMI's traditional book. We expect the default rate on PMI's entire primary
insurance portfolio to increase in 2002 due to forecasted increases in
unemployment and the continuing maturation of the portfolio.
Primary default rates differ from region to region in the United States
depending upon economic conditions and cyclical growth patterns. The two tables
below set forth primary default rates by region for the various regions of the
United States and the ten largest states by PMI's risk in force as of.
Primary Default Rates by Region(1)
----------------------------------
As of Period End,
-----------------
2001 2000 1999
---- ---- ----
Region Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
- ------ ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Pacific(2) ...................2.67 2.49 2.09 2.16% 2.13% 2.01% 2.03% 2.19% 2.31% 2.31% 2.28% 2.64%
New England(3)................1.50 1.81 1.45 1.66 1.69 1.52 1.44 1.61 1.88 1.51 1.55 1.69
Northeast(4)..................3.07 2.87 2.42 2.72 2.64 2.37 2.37 2.53 2.64 2.62 2.54 2.87
South Central(5)..............2.75 2.43 2.00 1.98 2.01 1.75 1.65 1.73 1.81 1.74 1.64 1.78
Mid-Atlantic(6)...............2.50 2.26 1.97 2.17 2.09 2.01 1.97 2.07 2.11 2.17 2.04 2.21
Great Lakes(7)................3.47 3.06 2.52 2.31 2.45 2.02 1.94 1.78 1.95 1.91 1.85 1.91
Southeast(8)..................3.09 2.75 2.25 2.47 2.47 2.21 2.13 2.21 2.31 2.18 2.02 2.25
North Central(9)..............2.76 2.42 1.94 2.05 1.97 1.79 1.71 1.69 1.67 1.70 1.67 1.88
Plains(10)....................2.67 2.46 2.00 1.89 1.80 1.73 1.68 1.67 1.65 1.78 1.59 1.76
Total Portfolio...........2.86 2.57 2.12 2.22 2.21 1.99 1.93 2.01 2.12 2.07 1.99 2.22
- ----------
(1) Default rates are shown by region on location of the underlying property.
(2) Includes California, Hawaii, Nevada, Oregon and Washington.
(3) Includes Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island and
Vermont.
(4) Includes New Jersey, New York and Pennsylvania.
(5) Includes Alaska, Arizona, Colorado, Louisiana, New Mexico, Oklahoma, Texas
and Utah.
(6) Includes Delaware, Maryland, Virginia, Washington, D.C. and West Virginia.
(7) Includes Indiana, Kentucky, Michigan and Ohio.
(8) Includes Alabama, Arkansas, Florida, Georgia, Mississippi, North Carolina,
South Carolina and Tennessee.
(9) Includes Illinois, Minnesota, Missouri and Wisconsin.
(10) Includes Idaho, Iowa, Kansas, Montana, Nebraska, North Dakota, South Dakota
and Wyoming.
23
PMI's Default Rates for Top 10 States by
Primary Risk in Force(1)
------------------------
Percent
Of PMI's Default
Primary Risk in Rate
Force as of As of
December 31, December 31,
--------------- ------------
2001 2001 2000 1999 1998 1997
---- ---- ---- ---- ---- ----
California ............... 12.5% 2.56% 2.26% 2.59% 3.15% 3.73%
Florida .................. 8.5 3.03 2.91 3.00 3.08 2.93
Texas .................... 6.8 2.86 2.13 2.06 2.18 2.25
Illinois ................. 4.9 3.16 2.34 2.01 2.35 2.56
Washington ............... 4.4 2.72 1.75 1.62 1.58 1.66
New York ................. 4.7 3.22 2.94 2.85 2.98 2.94
Pennsylvania ............. 3.6 3.11 2.47 2.38 2.64 2.38
Georgia .................. 3.8 3.11 2.31 1.95 2.01 1.87
Virginia ................. 2.9 1.87 1.43 1.42 1.55 1.67
Massachusetts ............ 2.5 2.04 1.66 1.49 1.67 1.67
Total Portfolio .......... 2.86 2.21 2.12 2.31 2.38
- --------------
(1) Top ten states as determined by primary risk in force as of December 31,
2001. Default rates are shown by states based on location of the underlying
property.
Claim activity is not spread evenly throughout the coverage period of a primary
book of business. Based on PMI's experience, the majority of claims on
traditional primary loans occur in the third through sixth years after loan
origination, and relatively few claims are paid during the first two years after
loan origination. Primary insurance written from the period of January 1, 1996
through December 31, 1999 represented 34% of PMI's primary insurance in force at
December 31, 2001. This portion of PMI's book of business is in its expected
peak claim period with respect to traditional primary loans. (We believe that
loans in PMI's non-traditional primary book will have earlier incidences of
default than loans in PMI's traditional book. Non-traditional loans represented
15% of PMI's primary insurance in force at December 31, 2001, and 9% and 7% at
December 31, 2000 and 1999, respectively.) The following table sets forth the
dispersion of PMI's primary insurance in force and risk in force as of December
31, 2001, by year of policy origination and average annual mortgage interest
rate since PMI began operations in 1972.
Insurance and Risk in Force by Policy Year
and Average Coupon Rate
-----------------------
Average Primary Percent Primary Percent
Policy Year Rate(1) Insurance in Force of Total Risk in Force of Total
- ----------- ------- ------------------ --------- ------------- --------
(In thousands) (In thousands)
1972-1992................. 9.3% $ 2,615,139 2.4% $ 531,165 2.1%
1993...................... 7.3 3,632,710 3.3 738,210 2.9
1994...................... 8.4 2,629,919 2.4 565,120 2.2
1995...................... 7.9 2,251,172 2.1 593,615 2.3
1996...................... 7.8 3,525,997 3.2 946,531 3.7
1997...................... 7.6 4,122,341 3.8 1,099,208 4.3
1998...................... 6.9 13,256,673 12.1 3,369,698 13.1
1999...................... 7.4 16,544,382 15.2 4,144,761 16.1
2000...................... 8.1 15,815,895 14.5 3,695,786 14.3
2001...................... 7.0 44,763,453 41.0 10,087,763 39.1
------------ ----- ----------- -----
Total Portfolio........... $109,157,681 100.0% $25,771,857 100.0%
============ ===== =========== =====
(1) Average annual mortgage interest rate derived from Freddie Mac and Mortgage
Bankers Association data.
24
Claims and Policy Servicing
Direct primary claims paid by PMI in 2001 increased to $76.9 million from $66.7
million in 2000. GSE Pool claims paid by PMI in 2001 increased to approximately
$5.4 million from approximately $1.5 million in 2000.
The frequency of defaults does not directly correlate to the number of claims
PMI receives. This is because the rate at which defaults cure is influenced by
borrowers' financial resources and circumstances and regional economic
differences. Whether an uncured default leads to a claim principally depends on
the borrower's equity at the time of default and the borrower's or the insured's
ability to sell the home for an amount sufficient to satisfy all amounts due
under the mortgage loan. When the chance of a defaulted loan reinstating is
minimal, PMI works with the servicer of the loan for possible loan workout or
early disposal of the underlying property. Property dispositions typically
result in savings to PMI over the percentage coverage amount payable under the
master policy.
Under the terms of PMI's primary master policy, the insured is required to file
a claim with PMI no later than 60 days after it has acquired title to the
underlying property, usually through foreclosure. An insurance "claim amount"
includes:
. the amount of unpaid principal due under the loan;
. the amount of accumulated delinquent interest due on the loan,
excluding late charges, to the lesser of the date of claim filing or
sixty days following the acquisition of title to the underlying
property;
. certain expenses advanced by the insured such as hazard insurance
premiums, property preservation expenses and property taxes to the
date of claim filing; and
. certain foreclosure costs, including attorneys' fees.
The claim amount is subject to review and possible adjustment by PMI. Depending
on the applicable state foreclosure law, an average of about 12 months elapses
from the date of default to filing of a claim on an uncured default. PMI's
master policy excludes coverage for physical damage whether caused by fire,
earthquake or other hazard where the borrower's default was caused by an
uninsured casualty.
PMI has the right to rescind coverage and not pay a claim if the insured, its
agents or the borrower misrepresent material information in the insurance
application. According to industry practice, a misrepresentation is generally
considered material if the insurer would not have agreed to insure the loan had
the true facts been known at the time of certificate issuance.
Within 60 days after a claim and supporting documentation have been filed, PMI
has the option of:
. paying the coverage percentage specified in the certificate of
insurance multiplied by the claim amount;
. in the event the property is sold pursuant to an arrangement made
prior to or during the 60-day period after the claim is filed, which
we refer to as a prearranged sale, paying the lesser of (1) 100% of
the claim amount less the proceeds of sale of the property or (2) the
coverage percentage multiplied by the claim amount; or
. paying 100% of the claim amount in exchange for the insured's
conveyance to PMI of good and marketable title to the property, with
PMI then selling the property for its own account. Properties acquired
under this option are included on PMI's balance sheet in other assets
as residential properties from claim settlements, also known as REO.
25
PMI attempts to choose the claim settlement option which best mitigates the
amount of its claim payment. However, PMI generally settles by paying the
coverage percentage multiplied by the claim amount. In 2001 and 2000, PMI
settled 21% and 27%, respectively, of the primary claims processed for payment
on the basis of a prearranged sale. In both 2001 and 2000, PMI exercised the
option to acquire the property on approximately 12% of the primary claims
processed for payment. At December 31, 2001, PMI owned $31.1 million and at
December 31, 2000 PMI owned $26.8 million of REO valued at the lower of cost or
estimated realizable value. This increase resulted primarily from increases in
the number and value of REO.
The ratio of the claim paid to the original risk in force relating to such loan
is referred to as "claim severity" and is a factor that influences PMI's losses.
The main determinants of claim severity are the age of the mortgage loan, the
value of the underlying property, accrued interest on the loan, expenses
advanced by the insured and the foreclosure expenses. These amounts depend in
part on the time required to complete foreclosure, which varies depending on
state laws. Pre-foreclosure sales and other early workout efforts help to reduce
overall severity. The average primary claim severity level has decreased from
100% in 1994 to 76% in 2001. PMI's primary claim severity level in 2000 was 72%.
Technology for Claims and Policy Servicing
Technology is an integral part of the claims and policy servicing process and
PMI believes that technology will continue to take on a greater role in
increasing internal efficiencies, mitigating losses and improving customer
service. With increasing frequency, PMI's customers expect PMI to offer them
technological solutions with respect to claims submission, claim payment and
policy servicing.
Defaults and Claims. PMI, through its automatic default reporting process, or
ADR, allows paperless reporting of default information by the insured. PMI uses
an automated claim-for-loss worksheet program that compiles pertinent data while
automatically calculating the claim amount and predicting the best settlement
alternative. To enhance efficiencies and ease of use for its customers, PMI
developed Document Free ClaimEaseSM, which is designed to require only an
addendum to the uniform claim-for-loss worksheet, thereby reducing paperwork and
resulting in more rapid claims settlements. PMI offers customers the option of
receiving claim payments by direct deposit to their bank accounts rather than by
check. To contain costs and expand internal efficiencies, PMI uses optical
imaging in its claims functions allowing PMI to eliminate the transfer and
storage of documents relating to claims.
Policy Servicing. PMI has developed several technology tools with respect to
policy servicing and claims. Introduced in 2001, e-PMI ServicingSM provides
access to PMI's servicing database via the Internet, allowing customers and
servicers to initiate policy coverage and servicing transfers, notify PMI of
defaults, file primary insurance claims, and verify premium, payment and refund
information. In addition, PMI offers pmiPHONE-CONNECT, a voice response
application that enables the insured to access PMI's database via telephone to
initiate policy coverage, inquire on the status of coverage, and to obtain
information on billing, refunds and renewals. Similar inquiries and exchanges of
information between customers and PMI are available via EDI.
Loan Performance
The table below shows cumulative losses paid by PMI at the end of each
successive year after the year of original policy issuance ("policy year"),
expressed as a percentage of the cumulative premiums written on such policies.
26
Years Percentage of Cumulative Losses Paid
Since To Cumulative Premiums Written
Policy
Issue Policy Issue Year (Loan Closing Year)
-------------------------------------------------------------------------------
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990
-------------------------------------------------------------------------------
1 0.4 0.4 0.9 0.3 0.2 -- 0.1 0.0 -- -- --
2 11.8 23.3 38.1 14.8 9.8 4.5 1.5 0.4 0.1 0.3 0.7
3 39.2 90.4 112.1 47.3 44.0 18.7 5.2 2.0 2.0 3.6 7.1
4 74.2 139.3 166.3 83.0 83.1 35.2 8.7 5.1 6.1 10.8 17.8
5 95.5 168.3 180.9 129.3 114.3 47.4 12.2 9.7 11.6 21.9 31.7
6 100.8 168.0 229.6 165.9 127.1 56.4 15.6 13.1 18.5 32.4 41.8
7 90.8 184.8 251.0 177.5 135.9 60.7 18.5 17.5 23.1 40.3 50.5
8 98.5 197.3 265.4 184.6 139.3 63.0 21.3 20.7 26.2 45.7 56.2
9 107.8 203.6 265.7 187.7 141.9 65.0 24.1 23.0 29.1 49.6 59.2
10 111.4 205.6 264.4 189.8 142.6 65.3 25.8 25.1 31.5 51.7 60.9
11 113.0 207.1 263.8 191.0 142.9 65.9 27.4 26.5 33.6 52.8 61.4
12 114.1 208.8 264.4 191.3 142.6 65.8 28.4 27.8 34.6 53.1 61.4
13 114.6 208.9 263.3 191.1 142.1 65.8 28.8 28.4 35.0 53.3
14 115.0 209.8 262.2 190.6 141.7 65.9 29.0 28.6 35.2
15 115.1 209.5 261.5 190.1 141.5 66.0 29.1 28.5
16 115.3 209.2 260.8 189.8 141.3 66.0 29.1
17 115.5 208.9 260.4 189.5 141.0 66.0
18 115.5 208.5 259.8 189.5 140.9
19 115.5 208.1 259.6 189.5
20 115.4 208.1 259.6
21 115.4 208.0
22 115.3
-------------------------------------------------------------------------------
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-------------------------------------------------------------------------------
1 -- -- -- -- 0.1 0.0 0.0 -- 0.1 1.2 1.1
2 0.8 1.1 1.0 1.0 2.8 2.9 2.3 1.2 2.7 10.2
3 6.6 6.9 5.5 6.5 10.4 8.3 5.8 3.8 5.9
4 16.9 16.3 13.4 13.7 15.4 11.9 8.7 5.7
5 28.9 28.3 18.7 18.0 18.2 14.2 10.4
6 39.8 36.1 21.1 20.1 19.2 15.3
7 47.4 40.3 21.9 20.9 20.1
8 51.3 41.5 22.0 21.3
9 52.7 41.3 21.8
10 52.6 41.1
11 52.7
The above table shows that, measured by cumulative losses paid relative to
cumulative premiums written ("cumulative loss payment ratios"), the performance
of policies originally issued in the years 1980 through 1984 was adverse, with
cumulative loss payment ratios for those years ranging from 115.3% to 259.6% at
the end of 2001. Such adverse experience was significantly impacted by
deteriorating economic and real estate market conditions in the "Oil Patch"
states. In 1985, PMI adopted substantially more conservative underwriting
standards that, along with increased premium rates and generally improving
economic
27
conditions, are believed by us to have contributed to the lower cumulative loss
payment ratios in subsequent years.
The table also shows the general improvement in PMI's cumulative loss payment
ratios since policy year 1982. This reflects both improved claims experience for
the more recent years and the higher premium rates charged by PMI beginning in
1985. Policy years 1986 through 1988 generally have had the best cumulative loss
payment ratios of any years since 1980. Policy years 1989 through 1992 displayed
somewhat higher loss payment ratios than 1986 through 1988 at the same age of
development. This was due primarily to the increased refinancings of mortgages
originating in policy years 1989 to 1992 which resulted in reduced aggregate
premiums and led to higher default rates on California loans. For policy years
1993 through 1999, cumulative losses have been developing at a favorable rate
for PMI due to improving economic conditions.
In 2000 and 2001, PMI expanded its product offerings to include insurance for
non-traditional loans. Non-traditional loans generally have shorter lives and
earlier incidences of default than traditional "A quality" loans. These earlier
incidences of default have resulted in a larger than normal number of claims
already paid in calendar years 2000 and 2001 on loans insured during those
years. Claim payments, when divided by the relatively small amount of written
premium on loans insured, have resulted in a cumulative claim payment ratio for
the 2000 policy year of 10.2% at December 31, 2001. This ratio represents 784
policies issued in 2000 upon which claims were paid in 2000 and 2001.
Loss Reserves
A significant period of time may elapse between the occurrence of the borrower's
default on mortgage payments (the event triggering a potential future claims
payment), the reporting of such default to PMI and the eventual payment of the
claim related to such uncured default. To recognize the liability for unpaid
losses related to the default inventory PMI, in accordance with industry
practice, establishes loss reserves in respect of defaults included in such
inventory, based upon the estimated claim rate and estimated average claim
amount. Included in loss reserves are loss adjustment expense ("LAE") reserves,
and incurred but not reported ("IBNR") reserves. These reserves are estimates
and there can be no assurance that PMI's reserves will prove to be adequate to
cover ultimate loss developments on reported defaults. Consistent with industry
accounting practices, PMI does not establish loss reserves in respect of
estimated potential defaults that may occur in the future.
PMI's reserving process for primary insurance is based on default notifications
received by PMI in a given year (the "report year method"). In the report year
method, ultimate claim rates and average claim amounts selected for each report
year are estimated based on past experience. Claim rates and amounts are also
estimated by region for the most recent report years to validate nationwide
report year estimates that are then used in the normal reserving methodology.
For each report year the claim rate, estimated average claim amount and the
number of reported defaults are multiplied together to determine the amount of
direct incurred losses for that report year. Losses paid to date for that report
year are subtracted from the estimated report year incurred losses to obtain the
loss reserve for that report year. The sum of the reserves for all report years
yields the total loss reserve on reported defaults.
Pool business loss reserving is subject to the same assumptions and economic
uncertainties as primary insurance and generally involves the following process.
PMI divides all currently pending pool insurance delinquencies into six
categories of delinquency, which connote progressively more serious stages of
default (e.g., delinquent less than four months, delinquent more than four
months, in foreclosure but no sale date set). A claim rate is selected for each
category based on past experience and management judgment. Expected claim sizes,
stated as a percentage of the outstanding loan balance on the delinquent loan,
are
28
similarly selected. The loss reserve is then generally calculated as the sum
over all delinquent loans of the product of the outstanding loan balance, the
claim rate and the expected claim size percentage.
PMI reviews its claim rate and claim amount assumptions on at least a quarterly
basis and adjusts its loss reserves accordingly. The impact of inflation is not
explicitly isolated from other factors influencing the reserve estimates
although inflation is implicitly included in the estimates. PMI does not
discount its loss reserves for financial reporting purposes.
PMI's reserving process is based upon the assumption that past experience,
adjusted for the anticipated effect of current economic conditions and projected
future economic trends, provides a reasonable basis for estimating future
events. However, estimation of loss reserves is a highly subjective process
especially in light of changing economic conditions. In addition, economic
conditions that have affected the development of the loss reserves in the past
may not necessarily affect development patterns in the future.
PMI's Actuarial Services department performs the loss reserve analysis. On the
basis of such loss reserve analysis, we believe that the loss reserves are, in
the aggregate, computed in accordance with commonly accepted loss reserving
standards and principles and meet the requirements of the insurance laws and
regulations to which it is subject. We also believe that the loss reserves are a
reasonable provision for all unpaid loss and LAE obligations under the terms of
its policies and agreements.
Such reserves are necessarily based on estimates and the ultimate net cost may
vary from such estimates. These estimates of ultimate losses are based on
management's analysis of various economic trends including the real estate
market and unemployment rates and their effect on recent claim rate and claim
severity experience. These estimates are regularly reviewed and updated using
the most current information available. Any resulting adjustments are reflected
in current financial statements. (For a reconciliation of the beginning and
ending reserve for losses and loss adjustment expenses, see Part II, Item 8.
Financial Statements Note 5 - Loss Reserves.)
9. Reinsurance
The use of reinsurance as a source of capital and as a risk management tool is
well established within the mortgage insurance industry. Reinsurance does not
discharge PMI, as the primary insurer, from liability to a policyholder. The
reinsurer simply agrees to indemnify PMI for the reinsurer's share of losses
incurred under a reinsurance agreement, unlike an assumption arrangement, where
the assuming reinsurer's liability to the policyholder is substituted for that
of PMI's.
Effective August 20, 1999, PMI entered into an excess-of-loss reinsurance treaty
relating to aggregate stop loss limit pool insurance contracts issued by PMI
during 1997 and 1998. The participating reinsurers have claims-paying ratings of
AA or AAA from Standard and Poor's. PMI also has a 5% quota share reinsurance
agreement in place with a participating reinsurer relating to primary business
written by PMI during 1993-1997. Under the terms of this arrangement, the
reinsurer indemnifies PMI for 5% of all losses paid under the reinsured primary
business to which it cedes 5% of the related premiums less a ceding commission.
Effective January 1, 2001, PMI commenced reinsuring its wholly owned Australia
subsidiary, PMI Mortgage Insurance Ltd, on an excess-of-loss basis. Under the
terms of the agreement, for each of the 2001-2005 calendar years, PMI is
obligated to indemnify PMI Mortgage Insurance Ltd for losses that exceed 130% of
PMI Mortgage Insurance Ltd's net earned premiums for each year, but not losses
that exceed 220% of such net earned premiums.
Certain states limit the amount of risk a mortgage insurer may retain to 25% of
the indebtedness to the insured and, as a result, the deep coverage portion of
such insurance over 25% must be reinsured. To
29
minimize reliance on third party reinsurers and to permit PMI and CMG to retain
the premiums (and related risk) on deep coverage business, The PMI Group formed
several wholly owned subsidiaries including Residential Guaranty Co., or RGC,
Residential Insurance Co., or RIC, PMI Mortgage Guaranty Co., or PMG, and,
together with CMIC (CMG's co-owner), CMG Re to provide reinsurance of such deep
coverage to PMI and CMG. PMI and CMG use reinsurance provided by its reinsurance
subsidiaries solely for purposes of compliance with statutory coverage limits.
The PMI Group's reinsurance subsidiaries generally have the ability to write
direct mortgage insurance and to provide reinsurance to unaffiliated mortgage
insurers.
In 1997, PMI began offering GSE pool insurance to select lenders and
aggregators. In connection with the pool policies issued, PMI may only retain
25% of the risk covered by such policies. PMI reinsures the remaining risk
though RGC, PMG and RIC.
In addition, in 1999, PMI acquired Pinebrook Mortgage Insurance Company, or
Pinebrook, from Allstate Insurance Company. Pinebrook's sole business at the
present time is to provide excess-of-loss coverage to PMI on certain pool
insurance policies issued by PMI during the early 1990s.
As discussed in Section B.1, Products, above, PMI also reinsures portions of its
risk written on loans originated by certain lenders with captive reinsurance
companies affiliated with such lenders.
10. Regulation
State Regulation
General. Our insurance subsidiaries are subject to comprehensive, detailed
regulation intended for the protection of policyholders, rather than for the
benefit of investors, by the insurance departments of the various states in
which they are licensed to transact business. Although their scope varies, state
insurance laws generally grant broad powers to supervisory agencies or officials
to examine companies and to enforce rules or exercise discretion touching almost
every significant aspect of the insurance business. These include the licensing
of companies to transact business and varying degrees of scrutiny of and control
over claims handling practices, reinsurance arrangements, premium rates, the
forms and policies offered to customers, financial statements, periodic
financial reporting, permissible investments and adherence to financial
standards relating to statutory surplus, dividends and other criteria of
solvency intended to assure the performance of contractual obligations to
policyholders.
Mortgage insurers are generally restricted by state insurance laws and
regulations to writing mortgage insurance business only. This restriction
prohibits our mortgage insurance subsidiaries from directly writing other types
of insurance. The non-insurance subsidiaries of The PMI Group are not subject to
regulation under state insurance laws except with respect to transactions with
their insurance affiliates.
Insurance Holding Company Regulation. All states have enacted legislation that
requires each insurance company in a holding company system to register with the
insurance regulatory authority of its state of domicile and to furnish to such
regulatory authority financial and other information concerning the operations
of, and the interrelationships and transactions among, companies within the
holding company system that may materially affect the operations, management or
financial condition of the insurers within the system. The states also regulate
transactions between insurance companies and their parents and affiliates.
Generally, such regulations require that all transactions within a holding
company system between an insurer and its affiliates be fair and reasonable and
that the insurer's statutory policyholders' surplus following any transaction
with an affiliate be both reasonable in relation to its outstanding liabilities
and adequate to its needs.
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The PMI Group is treated as an insurance holding company under the laws of the
State of Arizona based on its ownership and affiliation with PMI, PMG, RGC and
RIC ("Arizona Insurers"). The Arizona insurance laws regulate, among other
things, certain transactions in our common stock and certain transactions
between The PMI Group and its Arizona Insurers, or any one of them with each
other or with any other affiliate. Specifically, no person may, directly or
indirectly, offer to acquire or acquire beneficial ownership of more than 10% of
the voting securities of The PMI Group or any one of the Arizona Insurers unless
such person files a statement and other documents with the Arizona Director of
Insurance and obtains the Director's prior approval after a public hearing is
held on the matter. In addition, material transactions between The PMI Group,
PMI, PMG, RGC and RIC and their affiliates are subject to certain conditions,
including that they be "fair and reasonable." These restrictions generally apply
to all persons controlling or under common control with PMI or PMG, RGC and RIC.
"Control" is presumed to exist if 10% or more of PMI's or PMG's, RGC's and RIC's
voting securities is owned or controlled, directly or indirectly, by a person,
although the Arizona Director of Insurance may find that "control" in fact does
or does not exist where a person owns or controls either a lesser or greater
amount of securities. In addition, Arizona law requires that the Arizona
Director of Insurance be given 30-day prior notice of most types of agreements
and transactions between an insurance company and any affiliate, including, but
not limited to, investments, loans, sales, purchases, exchanges, guarantees,
reinsurance agreements, and management/cost allocation/service agreements, and
the Director is authorized to deny any transactions that do not meet applicable
standards of fairness and soundness.
The Insurance Holding Company laws and regulations are substantially similar in
Florida (where APTIC is domiciled), Illinois (where Pinebrook is domiciled) and
Wisconsin (where CMG, CMG Re, CMGA, CLIC and WMAC Credit are domiciled), and
transactions among these subsidiaries, or any one of them and another affiliate
(including The PMI Group) are subject to regulatory review and approval in the
respective state of domicile. Under Florida law, however, regulatory approval
must be obtained prior to the acquisition, directly or indirectly, of 5% or more
of the voting securities of APTIC or The PMI Group (compared to 10% in Arizona).
The applicable requirements of Wisconsin law are similar to those of Arizona law
regulating insurance holding companies. Similarly, Pinebrook, an
Illinois-domiciled insurer is subject to that state's holding company laws,
which are substantially similar to Arizona's. For purposes of Arizona, Florida,
Illinois and Wisconsin law, "control" means the power to direct or cause the
direction of the management of an insurer, whether through the ownership of
voting securities, by contract or otherwise, subject to certain exceptions.
Reserves. PMI, RGC, PMG and RIC are required under the insurance laws of Arizona
and many other states, including New York and California, to establish a special
contingency reserve with annual additions of amounts equal to 50% of premiums
earned. Pinebrook is subject to the same requirement under Illinois law, as are
CMG, CMG Re, CMGA, CLIC and WMAC Credit under Wisconsin law. The insurance laws
of the various states, including Florida, impose additional reserve requirements
applicable to title insurers such as APTIC. For example, title insurers must
maintain, in addition to reserves for outstanding losses, an unearned premium
reserve computed according to statute, and are subject to limitations with
respect to the level of risk they can assume on any one contract. At December
31, 2001, PMI had statutory policyholders' surplus of $190.8 million and
statutory contingency reserve of $1.7 billion.
Dividends. PMI's ability to pay shareholder dividends is limited, among other
things, by the insurance laws of Arizona and other states. (Although none of the
other Arizona insurers have ever paid shareholder dividends, they are subject to
the same statutory limitations as PMI.) Under Arizona law, PMI may pay dividends
out of available surplus without prior approval of the Arizona Insurance
Director, as long as such dividends during any 12-month period do not exceed the
lesser of (i) 10% of policyholders' surplus as of the preceding calendar year
end, or (ii) the preceding calendar year's investment income. In accordance with
the foregoing, PMI is permitted to pay ordinary dividends (as such are termed
under the Arizona statute) to The PMI Group of $19.7 million in 2002 without
prior approval of the Arizona Director. Any
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dividend in excess of this amount (either alone or together with other
dividends/distributions made in the last 12 months) is an extraordinary dividend
and requires the prior approval of the Arizona Director. In 2001, PMI paid
shareholder dividends to The PMI Group of $50 million, which was paid in two $25
million installments in October and December. These amounts would be added to
any proposed dividends to be paid within the subsequent twelve months to
determine if such future dividends were "extraordinary" and, as such, would
require the Director's prior approval. The Director may approve of an
extraordinary dividend if he or she finds that, following the distribution, the
insurer's policyholders' surplus is reasonable in relation to its liabilities
and adequate to its financial needs. The Director is also required to approve a
return of capital from PMI's contributed capital.
In addition to Arizona, other states may limit or restrict PMI's ability to pay
shareholder dividends. For example, California, New York and Illinois prohibit
mortgage insurers from declaring dividends except from undivided profits
remaining on hand over and above the aggregate of their paid-in capital, paid-in
surplus and contingency reserves.
CMG faces shareholder dividends/distributions restrictions under Wisconsin laws
similar to those faced by PMI in Arizona. CMG, like PMI, is also subject to
other state laws restricting or limiting a mortgage insurer's ability to declare
or pay shareholder dividends, including California, Illinois and New York. CMG
Re and CMGA in Wisconsin and Pinebrook in Illinois are subject to substantially
similar requirements and limitations on shareholder dividends, but none of these
entities has paid a shareholder dividend or expects to do so in the near future.
PMI acquired CLIC and WMAC Credit in August of 2001 from WMAC Investment Corp.,
an affiliate of Leucadia National Corporation. Although these Wisconsin
domiciled insurers paid extraordinary dividends under their prior ownership, PMI
does not expect them to declare or pay shareholder dividends in the immediate
future. (Our title insurance company, American Pioneer Title Insurance Co., also
faces shareholder dividend/distributions restrictions. These and other
regulatory restrictions are discussed in Item 1.C.2, Title Insurance.)
In addition to the dividend restrictions described above, insurance regulatory
authorities have broad discretion to limit the payment of dividends by insurance
companies. For example, if insurance regulators determine that payment of a
dividend or any other payments to an affiliate (such as payments under a tax
sharing agreement, payments for employee or other services, or payments pursuant
to a surplus note) would, because of the financial condition of the paying
insurance company or otherwise, be hazardous to such insurance company's
policyholders or creditors, the regulators may block payments that would
otherwise be permitted without prior approval.
Premium Rates and Policy Forms. PMI and CMG's premium rates and policy forms are
subject to regulation in every state in which each is licensed to transact
business in order to protect policyholders both against the adverse effects of
excessive, inadequate or unfairly discriminatory rates and to encourage
competition in the insurance marketplace. In most states premium rates and
policy forms must be filed prior to their use. In some states, such rates and
forms must also be approved prior to use. Changes in premium rates are subject
to being justified, generally on the basis of the insurer's loss experience,
expenses and future trend analysis. The general default experience in the
mortgage insurance industry may also be considered.
Reinsurance. Regulation of reinsurance varies by state. Except for Arizona,
Illinois, Wisconsin, New York and California, most states have no special
restrictions on mortgage guaranty reinsurance other than standard reinsurance
requirements applicable to property and casualty insurance companies. Certain
restrictions apply under Arizona law to domestic companies and under the laws of
several other states to any licensed company ceding business to unlicensed or
unaccredited reinsurers. Under such laws, if a reinsurer is not admitted or
accredited in such states, the domestic company ceding business to the reinsurer
(e.g., PMI) cannot take credit in its statutory financial statements for the
risk ceded to such reinsurer absent
32
compliance with certain reinsurance security requirements. Arizona prohibits
reinsurance unless the reinsurance arrangements meet certain requirements even
if no statutory financial statement credit is to be taken. In addition, Arizona
and several other states limit the amount of risk a mortgage insurer may retain
with respect to coverage of an insured loan to 25% of the entire indebtedness to
the insured. Coverage in excess of 25% must be reinsured.
Examination. PMI, PMG, RGC, RIC, APTIC, CMG, CMG Re, CMGA, CLIC, WMAC Credit and
Pinebrook are subject to examination of their affairs by the insurance
departments of each of the states in which they are licensed to transact
business. The Arizona Director of Insurance periodically conducts a financial
examination of insurance companies domiciled in Arizona. In lieu of examining a
foreign insurer, the Commissioner may accept an examination report by a state
that has been accredited by the National Association of Insurance Commissioners.
Likewise, the Insurance Departments of Florida, Illinois and Wisconsin perform
periodic financial and market conduct examinations of insurers domiciled in
their jurisdictions.
Federal Laws and Regulation
In addition to federal laws that directly affect mortgage insurers, private
mortgage insurers including PMI are impacted indirectly by federal legislation
and regulation affecting mortgage originators and lenders; by purchasers of
mortgage loans such as Freddie Mac and Fannie Mae; and by governmental insurers
such as the FHA and VA. For example, changes in federal housing legislation and
other laws and regulations that affect the demand for private mortgage insurance
may have a materially adverse effect on PMI. Legislation that increases the
number of persons eligible for FHA or VA mortgages could have a materially
adverse effect on our ability to compete with the FHA or VA.
The Homeowners Protection Act, effective July 29, 1999, provides for the
automatic termination, or cancellation upon a borrower's request, of private
mortgage insurance upon satisfaction of certain conditions. The Homeowners
Protection Act applies to owner-occupied residential mortgage loans regardless
of lien priority and to borrower-paid mortgage insurance closed after the
effective date of the Act. FHA loans are not covered by the Homeowners
Protection Act. Under the Homeowners Protection Act, automatic termination of
mortgage insurance would generally occur once the loan-to-value ratio, or LTV,
reaches 78%. A borrower may generally request cancellation of mortgage insurance
once the LTV reaches 80% of the home's original value or when actual payments
reduce the loan balance to 80% of the home's original value, whichever occurs
earlier. For borrower initiated cancellation of mortgage insurance, the borrower
must have a "good payment history" as defined by the Act.
The Real Estate Settlement and Procedures Act of 1974, or RESPA, applies to most
residential mortgages insured by PMI and related regulations provide that
mortgage insurance is a "settlement service" for purposes of loans subject to
RESPA. Subject to limited exceptions, RESPA prohibits persons from accepting
anything of value for referring real estate settlement services to any provider
of such services. Although many states including Arizona prohibit mortgage
insurers from giving rebates, RESPA has been interpreted to cover many non-fee
services as well. The recently renewed interest of HUD in pursuing violations of
RESPA has increased awareness of both mortgage insurers and their customers of
the possible sanctions of this law.
Home Mortgage Disclosure Act. Most originators of mortgage loans are required to
collect and report data relating to a mortgage loan applicant's race,
nationality, gender, marital status and census tract to HUD or the Federal
Reserve under the Home Mortgage Disclosure Act of 1975, or HMDA. The purpose of
HMDA is to detect possible discrimination in home lending and, through
disclosure, to discourage such discrimination. Mortgage insurers are not
required pursuant to any law or regulation to report HMDA data although, under
the laws of several states, mortgage insurers are currently prohibited from
discriminating
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on the basis of certain classifications. Mortgage insurers have, through their
trade association Mortgage Insurance Companies of America, or MICA, entered
voluntarily into an agreement with the Federal Financial Institutions
Examinations Council, or MFIEC, to report the same data on loans submitted for
insurance as is required for most mortgage lenders under HMDA.
Mortgage lenders are subject to various laws, including HMDA, RESPA, the
Community Reinvestment Act, and the Fair Housing Act. Fannie Mae and Freddie Mac
are also subject to RESPA and various laws, including laws relating to
government sponsored enterprises, which may impose obligations or create
incentives for increased lending to low and moderate income persons or in
targeted areas.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act became effective on March 11,
2000 and allows, among other things, bank holding companies to engage in a
substantially broader range of activities, including insurance underwriting, and
allows insurers and other financial service companies to acquire banks. The
Gramm-Leach-Bliley Act also imposes new consumer information privacy
requirements on financial institutions, including obligations to protect and
safeguard consumers' nonpublic personal information and records, and limitations
on the re-use of such information.
National Association of Insurance Commissioners. The National Association of
Insurance Commissioners, or NAIC, has developed a rating system, the Insurance
Regulatory Information System, or IRIS, primarily intended to assist state
insurance departments in overseeing the statutory financial condition of all
insurance companies operating within their respective states. IRIS consists of
11 key financial ratios, which are intended to indicate unusual fluctuations in
an insurer's statutory financial position and/or operating results. The NAIC
applies its IRIS financial ratios to PMI on a continuing basis in order to
monitor PMI's financial condition.
11. Financial Strength; Ratings
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard &
Poor's, "Aa2" (Excellent) by Moody's and "AA+" (Very Strong) by Fitch. In March
2002, Standard and Poor's affirmed PMI's AA+ rating and stable ratings outlook.
In October 2000, Moody's announced that it changed PMI's and The PMI Group's
ratings outlook from negative to stable and also confirmed its Aa2 financial
strength rating of PMI. In April 2001, Fitch affirmed PMI's AA+ financial
strength rating. In February 2002, Standard & Poor's informed us that it had
completed a new U.S. mortgage insurance stress model as part of its mortgage
insurance rating methodology.
PMI's claims-paying ability ratings from certain national rating agencies have
been based in part on the third party reinsurance arrangements discussed above
and on various capital support commitments from Allstate Insurance Company.
Under the terms of a runoff support agreement with Allstate, in the event (i)
PMI's risk-to-capital ratio exceeds 23 to 1, (ii) PMI's statutory policyholder
surplus is less than $15.0 million, or (iii) a third party beneficiary brings a
claim under the runoff support agreement, then Allstate may, at its option, in
satisfaction of certain obligations it may have under such agreement (A) pay to
PMI (or to The PMI Group for contribution to PMI) an amount equal to claims
relating to policies written prior to termination of the Allstate support
arrangements which are not paid by PMI or (B) pay such claims directly to the
policyholder. In the event Allstate makes any payment contemplated by the runoff
support agreement (which possibility we believe is remote and, in the event
unexpected losses or unforeseen events cause the risk-to-capital ratio to
increase, there are several courses of action available to us to maintain PMI's
risk-to-capital ratio below 23 to 1), Allstate will be entitled to receive, at
its option, subordinated debt or preferred stock of PMI or The PMI Group, as
applicable, in return.
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Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. In order to
be Fannie Mae and Freddie Mac eligible, PMI must maintain an AA- rating with any
public national rating agency.
C. International Operations and Other Residential Lender Services
In keeping with our goal of being a global provider of credit enhancement
products and lender services while achieving profitable growth, our key
strategies include focusing on our core mortgage insurance business while
diversifying and expanding our lines of business and international operations.
Revenues for the year ended December 31, 2001 from our consolidated
subsidiaries, excluding PMI, were approximately 25% of our consolidated revenues
compared with approximately 19% in 2000. The growth in revenue attributed to
these subsidiaries was approximately 64% in 2001. These percentages exclude
revenue from RAM Holdings Ltd. and RAM Holdings II Ltd., or RAM Re, a financial
guaranty reinsurance company based in Bermuda in which The PMI Group owns 45%
interest, and Fairbanks Capital Holding Corporation, or Fairbanks, which offers
mortgage loan servicing to residential lenders. Ram Re and Fairbanks are
accounted for on the equity method in our consolidated financial statements.
They contributed approximately $10.2 million of investment and other income in
2001, compared to $3.5 million in 2000.
1. International Mortgage Insurance
Australia and New Zealand
We offer mortgage insurance in Australia and New Zealand through our indirect,
wholly owned subsidiaries, PMI Mortgage Insurance Ltd ("PMI Ltd") and PMI
Indemnity Limited. PMI Ltd was founded in 1965 and was acquired by PMI in August
1999. PMI Ltd is headquartered in Sydney, Australia, and has offices in
Melbourne, Brisbane, Adelaide, and Perth in Australia and in Auckland, New
Zealand. In September 2001, PMI acquired CGU LMI, now renamed PMI Indemnity
Limited. PMI Indemnity is the fourth largest mortgage insurer in Australia and
the largest in New Zealand. The integration of PMI Indemnity's operations into
PMI Ltd has commenced and this integration is expected to be completed in 2002.
The combined operations of PMI Ltd and PMI Indemnity are referred to as PMI
Australia.
At December 31, 2001, the total assets of PMI Australia were $337.5 million. The
PMI Group does not hedge the foreign exchange exposure in Australia dollars to
US dollars. The average exchange rate was 0.520 in 2001 compared to 0.585 in
2000.
Following PMI's acquisition of PMI Indemnity, the Australian and New Zealand
mortgage insurance markets are served by three mortgage insurance companies: PMI
Australia, Royal Sun Alliance and GE.
Single premiums and 100% coverage characterize Australian mortgage insurance,
known as "lenders mortgage insurance" or "LMI." As in the United States, lenders
usually collect the single premium from the prospective borrowers and remit the
amount to the mortgage insurer. The mortgage insurer in turn invests the
proceeds and reports the single premium in its financial statements over time
according to an actuarially determined multi-year schedule. The premium is
potentially partly refundable if the policy is cancelled within the first year
only.
LMI provides insurance coverage for the unpaid loan balance following the sale
of the security property up to a maximum of 100% of the loan amount.
Historically, losses normally range from 20% to 30% of the original loan amount
on defaulted loans. "Top cover" predominates in New Zealand where the total loss
(including expenses) is paid up to a prescribed percentage of the original loan
amount. Typical top cover in New Zealand is 20% to 30%.
35
The majority of the loans insured by PMI Australia are ARM's with loan terms of
between twenty and thirty years. Changes in interest rates impact the frequency
of defaults and claims with respect to these loans. Because of the preponderance
of ARM loans that simultaneously adjust with prevailing market rates, borrowers
have little incentive to refinance their mortgages. Initial period, "teaser" or
"honeymoon" rates represent the only real inducement for borrowers to refinance
their existing mortgage loan with another mortgage lender. In fact, given that
mortgage interest is not tax deductible in Australia or New Zealand, borrowers
have a strong incentive to reduce their principal balance by amortizing or
prepaying their mortgages. These actions commensurately lower loss exposure.
In 2001, PMI Australia launched pmi97, a three percent down payment product, and
pmi100, a no down payment product, utilizing PMI's experience to determine risk
profiles and pricing levels. Also in 2001, the Australian Federal Government
announced an increase in the grant amounts available under the first home owners
grant scheme (FHOGS). This increase provided a significant stimulus to new
housing construction in 2001. In response to this development, PMI Australia
began offering pmiFHOGS, a product to support first-time home buyers who are
eligible for FHOGS grants. The FHOGS initiative and a significant decline in
mortgage interest rates during 2001 contributed to the growth in mortgage
lending and property price appreciation in the major real estate markets in
Australia in 2001.
PMI Australia's applicable regulator is the Australian Prudential Regulatory
Authority ("APRA"), which regulates all financial institutions in Australia
including mortgage insurers. APRA, among other things, sets statutory reserve
levels and regulates the payments of dividends. APRA also sets the capital
requirements for regulated institutions and provides for reduced capital
requirements for depository institutions that insure residential mortgages above
80% LTV with an "A" Standard & Poor's or equivalent rated mortgage insurance
company. In 2001, APRA announced that it will introduce new regulatory standards
for all insurers, effective July 1, 2002. We believe that the new standards will
continue to require that Australian mortgage insurers, including PMI Australia,
be monoline insurers.
The four major Australian banks, Westpac, Commonwealth, Australia New Zealand
Bank and National Australia Bank, collectively provide 60% or more of
Australia's residential housing finance. Other participants in Australian
mortgage lending include regional banks, building societies, credit unions, and
non-bank mortgage originators, called "mortgage managers." Mortgage managers
typically fund their lending activities via the domestic and global capital
markets and mortgage backed securitizations.
Securitization for seasoned mortgages is actively pursued by depository
institutions in Australia. Mortgage insurance is the most frequently used form
of credit enhancement for these bond issues and mortgage insurance is ultimately
placed on all loans (whether high or low LTV) destined for securitization.
Mortgage managers tend to place mortgage insurance on the lower LTV loans at
origination to be assured that each individual loan is an acceptable risk to the
mortgage insurer. Banks generally purchase mortgage insurance on lower LTV loans
immediately prior to securitization. In either case, the coverage follows the
standard 100% coverage, primary insurance. This segment of the residential MBS
market grew in 2001 and PMI Ltd provided credit enhancement with respect to a
number of large MBS transactions in 2001.
A significant portion of PMI Australia's business is acquired through captive
mortgage insurance and reinsurance arrangements with its lending customers.
These captive arrangements typically contain a contractual period under which
the lender commits to send PMI Australia a prescribed volume of business. PMI
Ltd wrote approximately 50% of its new business premium under these arrangements
in 2001.
Generally the captive or reinsurance arrangements operate in one of three ways.
In one arrangement, loans are 100% insured by PMI Australia and then a
proportion of each loan is reinsured on a quota share basis by the lender's
captive insurer. In exchange for this loss risk transfer PMI Australia pays a
negotiated
36
premium to the captive. Under another arrangement, a lender's wholly owned
captive writes the insurance risk and cedes a large portion of the risk on a
quota share reinsurance basis to PMI Ltd. In this case, PMI Australia receives a
reinsurance premium from the captive for the risk it assumes. Alternatively,
under a joint venture captive arrangement with PMI Australia, PMI manages and
reinsures the risk of the joint venture captive. In the event that the lender or
PMI Australia wishes to terminate the captive arrangement, PMI Australia
generally has the first right to purchase the lender's equity interest in the
captive.
As of December 31, 2001, PMI Australia's insurance in force totaled
$43.3 billion compared to $20.1 billion at year end 2000. PMI Australia's net
premiums written was $55.9 million in 2001 and $36.8 million in 2000. Reserves
for losses for PMI Australia at December 31, 2001 was $14.4 million compared to
$5.4 million at year end 2000.
Undertakings provided by PMI in 2001 supported an upgrade in PMI Ltd's S&P
rating from AA- to AA, an upgrade by Moody's from an A1 rating to Aa3, and an
affirmation by Fitch of its AA rating. PMI Indemnity is rated AA- by S&P, Aa3 by
Moody's, and AA by Fitch.
Europe
In February 2001, PMI formed PMI Mortgage Insurance Company Limited ("PMI
Europe"), a mortgage insurance and credit enhancement company incorporated and
located in Dublin, Ireland, and an affiliated sales company incorporated in
England and located in London. In May 2001, PMI Europe was fully authorized to
provide credit, suretyship and miscellaneous financial loss insurance by the
Irish Minister for Enterprise Trade & Employment. PMI Europe's claims-paying
ability is rated AA by Standard & Poor's and Fitch and Aa3 by Moody's Investors
Service. These ratings are based upon PMI Europe's initial capitalization, its
management expertise, a capital support agreement provided by PMI, and a
guarantee by The PMI Group of PMI's obligations under the capital support
agreement.
PMI Europe's authorization enables it to offer its products in all of the
European Union member states. The applicable regulator of PMI Europe is the
Minister for Enterprise Trade & Employment. Ireland is a member of the European
Union and applies the harmonized system of regulation set out in the European
Union directives. This system requires all insurance companies to obtain
authorization before conducting business. The criteria for authorization are set
out in the directives. Insurers are only entitled to provide insurance in the
classes for which they have authorization. The regulatory regime requires PMI
Europe to maintain appropriate technical provisions against risks accepted and
an additional solvency margin of unencumbered assets. It must also maintain an
equalization reserve in respect of credit insurance risks. The regulator
requires actuarial certification of the technical provisions and imposes a
solvency margin in excess of the minimum set out in the European Union
Directives. The regulator has broad powers of intervention including the right
(i) to appoint inspectors to an insurer, (ii) to prohibit an insurer from taking
on new business or making investments, (iii) to require an insurer to limit its
premium income, to make a deposit, or to furnish information (iv) to require an
insurer to realize assets or to produce a business plan to put it on a sound
commercial footing and (v) to withdraw an authorization in appropriate
circumstances. Auditors of insurers are obliged to inform the regulator of
certain matters. Irish insurance companies are required to submit comprehensive
annual financial returns to the regulator. Changes in significant shareholdings
(direct or indirect) must be approved in advance.
PMI Europe expects to derive most of its opportunities from the larger, more
mature mortgage markets in Europe, including the United Kingdom, Germany, Spain,
France, Italy, the Netherlands, and Ireland.
37
Additional opportunities may arise in the smaller or emerging European markets,
including Sweden, Poland and the Czech Republic.
PMI Europe currently offers capital markets products, stop loss insurance and
primary insurance. Capital markets products are designed to support secondary
market transactions, notably mortgage-backed securities transactions or
synthetic securities transactions (principally "credit default swaps").
Mortgage-backed securities are issued as a tool of capital management or
funding. Lenders typically engage in these transactions to reduce the capital
they must hold pursuant to local banking capital regulations.
In 2001, PMI Europe participated in two credit default swap transactions,
designed to allow the mortgage lenders involved to reduce their amounts of
regulatory capital. In each transaction, PMI Europe assumed a specific layer of
risk in a portfolio of prime-quality, residential mortgages. In the first
transaction, which closed in November 2001, PMI assumed $220 million of mortgage
default risk on $1.5 billion of mortgages on properties located in the
United Kingdom. The risk assumed by PMI Europe in this credit default swap
covers a spectrum rated BBB up to AAA by the three major ratings agencies, S&P,
Moody's and Fitch. In the second transaction, which closed in December 2001, PMI
Europe assumed $31.3 million of mortgage default risk on a $1.2 billion German
residential loan portfolio originated and serviced by one of Europe's largest
mortgage lenders. In the second transaction, PMI Europe guaranteed the AA
tranche of the credit default swap. In each transaction, PMI Europe established
a special purpose vehicle as the direct swap counterparty, with PMI Europe
guaranteeing the obligations of the special purpose vehicle. The special purpose
vehicles were used to meet regulatory requirements and their operations are
reflected in the financial statements of The PMI Group. Competitors in this
product line include U.S. mortgage insurance companies, financial guaranty
insurance companies, banks, and traditional bond investors. Many of these
competitors have significantly greater financial resources than PMI Europe.
PMI Europe also offers stop loss insurance coverage. These products are
typically provided to a lender's captive mortgage insurance company to reduce
that lender's "catastrophic" risk exposure. These transactions are believed to
be risk-remote in that the lender or its captive assumes a significant amount of
first loss risk. This insurance structure is used frequently in the United
Kingdom by its largest mortgage lenders. PMI Europe did not complete any stop
loss insurance/reinsurance transactions in 2001. Potential competitors with
respect to these products include mortgage insurance companies and multi-line
insurers.
PMI Europe's third product line, primary insurance, is similar to the products
offered in the US, Australia and New Zealand. Primary insurance is mortgage
insurance applied to, priced, and settled on each loan. (The coverage does not
typically vary or address any aspects of the total group of loans.) In Europe
today, this product is only purchased regularly in the United Kingdom and
Ireland. PMI Europe is attempting to develop greater interest and use of primary
insurance in other European countries. In 2001, PMI Europe did not write any
primary insurance. Competitors in this area are more limited than for the other
products discussed above. Potential competitors at the moment include mortgage
insurers and multi-line insurers.
Hong Kong
In 1999, PMI opened its Hong Kong branch and entered into a reinsurance
arrangement with the Hong Kong Mortgage Corporation, or HKMC, a public sector
entity created to add liquidity to the Hong Kong residential mortgage market.
The HKMC is a direct insurer of residential mortgages with LTVs of up to 90%.
PMI, among other insurers, provides reinsurance coverage on amounts over 70%
LTV. For the year ended December 31, 2001, PMI reinsured $395.2 million of
loans, as compared to $252.9 million in 2000. In 2001, Centre Solutions
announced an exclusive deal with Standard Chartered Bank, or SCB, to provide a
mortgage insurance product nearly identical to the HKMC's program. Prior to this
announcement, SCB had been the largest lender-participant in the HKMC program,
contributing approximately 25% of the overall business.
38
2. Title Insurance
In 1992, we acquired American Pioneer Title Insurance Co. ("APTIC"), a
Florida-based title insurance company, as part of its strategy to provide
additional mortgage-related services to its customers. APTIC is licensed in 46
states and the District of Columbia. A title insurance policy protects the
insured party against losses resulting from title defects, liens and
encumbrances existing as of the effective date of the policy and not
specifically excepted from the policy's coverage.
Based on direct premiums written during 2000, APTIC is ranked 5 among the 27
active title insurers conducting business in the State of Florida. For the year
ended December 31, 2001, 51% of APTIC's premiums earned came from its Florida
operations.
APTIC generates title insurance business through both direct and indirect
marketing to realtors, attorneys and lenders. As a direct marketer, APTIC
operates under the name Chelsea Title Company, a branch network of title
production facilities and real estate closing offices. As an indirect marketer
APTIC recruits and works with corporate title agencies, attorney agencies and
approved attorneys. Its agency business accounted for 96% of APTIC's premiums
earned for the years ended December 31, 2001 and 2000.
While the industry trend in the residential market appears to be towards direct
operations consisting of underwriter owned or controlled entities, APTIC's
operational plan is geared towards developing and cultivating agency
relationships. APTIC has created a suite of computerized software designed to
assist its agents in the areas of real estate settlement, real property
examination and electronic commerce. These products, together with APTIC's
assistance to its policy issuing agents in the areas of underwriting, claims,
audit, and title agency management, create an atmosphere for the development and
continuous cultivation of long term contractual relationships. Title policy
issuing agency relationships are memorialized by written contracts and are
generally long-term in nature without the right of immediate unilateral
termination by either party.
As part of APTIC's risk management program, it has, since 1986, entered into
reinsurance treaties with other insurers covering policies issued. Currently,
APTIC has a reinsurance agreement with ACE Capital Title Reinsurance Company
("ACE") which, in general, provides for automatic reinsurance of title policies
in excess of $1.0 million but not greater than $26.0 million. Policies in excess
of $10.0 million require written consent of ACE. Policies in excess of $26.0
million are reinsured through the use of facultative agreements with ACE and/or
other reinsurers.
APTIC's claims-paying ability is currently rated AA (very high) by Fitch, A" by
Demotech, Inc. and A by LACE. APTIC's claims-paying rating by Fitch is based in
part on a capital support agreement provided by PMI and the reinsurance
agreement discussed in the preceding paragraph.
APTIC is subject to comprehensive regulation in the states in which it is
licensed to transact business. Among other things, such regulation requires
APTIC to adhere to certain financial standards relating to statutory reserves
and other criteria of solvency. Generally, title insurers are restricted to
writing only title insurance, and may not transact any other kind of insurance.
This restriction prohibits APTIC from using its capital and resources in support
of other types of insurance businesses. The insurance laws of the various
states, including Florida, impose reserve requirements on APTIC. For instance,
title insurers such as APTIC must maintain, in addition to reserves for
outstanding losses, an unearned premium reserve computed according to statute
and are subject to limitations with respect to the level of risk they can assume
on any one contract. The laws of Florida, in general, limit the payment of
dividends by APTIC to The PMI Group in any one year to the greater of either 10%
of APTIC's statutory surplus as to policyholders derived from realized net
operating profits on its business and realized net capital gains or
39
APTIC's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year. As a result, APTIC may be
limited in its ability to pay dividends to The PMI Group. APTIC made a $2.5
million dividend to The PMI Group in 2001, which was paid in $1 million and $1.5
million installments in April and June. The dividend was not "extraordinary"
under Florida law and did not require the prior approval of the Florida
Insurance Commissioner, although APTIC was required to provide the Commissioner
with ten days advanced notice of each of the dividend installments.
3. Financial Guaranty Reinsurance
We own 24.9% of RAM Re, the first AAA rated financial guaranty reinsurance
company based in Bermuda. RAM Re commenced business in the first quarter of
1998. Three of our executives serve as directors of RAM Re. RAM Re's financial
results are reported in our financial statements under the equity method of
accounting.
4. Mortgage Loan Servicing
We acquired our initial interest in Fairbanks Capital Holdings Corp., or
Fairbanks, in March 2000. Fairbanks, through its wholly owned subsidiary,
acquires and services single-family residential mortgages and specializes in the
resolution of non-performing and under-performing mortgages. As of December 31,
2001, Fairbanks serviced approximately $36 billion in mortgages compared to
approximately $12 billion as of December 31, 2000. This increase primarily was
due to Fairbanks' acquisition of mortgage servicing rights from BA/EquiCredit in
December 2001. In December 2001, we made two additional investments in
Fairbanks, increasing our investment in Fairbanks to $55.8 million and our
ownership interest in Fairbanks to 45.7%. Fairbanks' financial results are
reported in our financial statements under the equity method of accounting.
D. Investment Portfolio
Excluding our investments in unconsolidated affiliates, approximately 88% of our
investment portfolio is managed under The PMI Group and Subsidiaries Investment
Policy Statement, and includes the investment portfolios of The PMI Group and
The PMI Group's subsidiaries. The remaining 22% of our investment portfolio is
managed by APTIC, PMI Australia and PMI Europe under separate investment
policies that are reviewed at least annually by PMI's Treasury personnel. Our
pre-tax income from our total investments (including equity earnings from our
unconsolidated affiliates) represented 16% of our 2001 and 2000 pre-tax
revenues.
The Policy's goal is to attain consistent after tax total returns. Emphasis is
placed on providing a predictable level of income and on the maintenance of
adequate levels of liquidity, safety and preservation of capital; growth is a
secondary consideration. In addition to satisfying state regulatory limits on
the amount that can be invested in any single investment category, e.g., no more
than 20% of assets may be invested in common stocks, a minimum average fixed
income credit quality of "A" rating must be maintained and no single credit risk
may exceed 5% of total investments. At December 31, 2001, based on market value,
approximately 92% of our fixed income investments under the Policy were invested
in securities rated "A" or better, with 59% rated "AAA" and 18% rated "AA," in
each case by at least one nationally recognized securities rating organization.
The balance of the portfolio under the Policy was invested in equity securities.
Under Arizona law, PMI may invest up to 10% of its assets in investments that
are not otherwise expressly authorized, including derivative instruments.
Additionally, PMI is subject to other state regulations regarding investment
activities with which PMI currently comply. Our policy is also to limit our
derivative transactions to currency and interest rate swaps necessary to
minimize revenue fluctuations related to our
40
international operations. The Policy is subject to change depending upon state
regulatory, economic and market conditions and our existing or anticipated
financial condition and operating requirements, including our tax position. (PMI
Europe provides credit default protection to various European banks with respect
to residential mortgage loans. These transactions, which are structured as
guarantees of credit derivatives, do not represent, nor are they recorded as,
investment or hedging activities of PMI Europe. Rather, they are central to PMI
Europe's business of providing credit default protection to European mortgage
lenders.)
At December 31, 2001, the market value of our investment portfolio (excluding
investments in affiliates) was approximately $2.4 billion. At December 31, 2001
the amortized cost of our total investment portfolio (excluding investments in
affiliates) was approximately $2.3 billion. At that date, the market value of
the investments under the Policy was approximately $2.1 billion. At December 31,
2001, municipal securities represented 65% of the market value of the
investments under the Policy. Fixed income securities due in less than one year,
within one to five years, within five to ten years; after ten years, and other
represented 5.5%, 26.0%, 16.1%, 52.2% and 0.2%, respectively, of such total
market value.
As of December 31, 2001, APTIC's investment portfolio had a market value of
approximately $41.7 million. APTIC's investment portfolio is managed internally
in accordance with APTIC's investment policies. As of December 31, 2001,
approximately 93% of APTIC's portfolio consisted of bonds rated AA and higher.
PMI Australia's investment portfolio of approximately $288.6 million as of
December 31, 2001 is managed externally in accordance with PMI Australia's
investment policies. As of December 31, 2001 approximately 91% of PMI
Australia's portfolio consisted of bonds rated AA and higher. As of December 31,
2001, PMI Europe's investment portfolio had a market value of approximately
$77.9 million, of which $61.3 million was invested in high grade U.S. dollar
denominated money market funds with the remaining $16.6 million invested in FNMA
Mortgage-backed securities.
E. Employees
As of December 31, 2001, The PMI Group, its wholly-owned subsidiaries and CMG,
had 1,235 full-time and part-time employees, of which 749 persons performed
services primarily for PMI, 136 were employed by PMI Australia, 21 performed
services primarily for CMG, and an additional 329 persons were employed by
APTIC. Our employees are non-union and we consider our employee relations to be
good. In addition, MSC had 737 temporary workers and contract underwriters as of
December 31, 2001.
Item 2. Properties
PMI currently leases its home office in San Francisco, California, which
contains approximately 100,000 square feet of space. The lease expires in 2004.
In December 2000, PMI entered into a contract to purchase a seven-story office
building site in Walnut Creek to serve as its world headquarters. Construction
is underway on the office building and completion of the approximately 195,000
square foot building is scheduled to occur in 2002. PMI also leases space for
its 23 branch offices throughout the United States comprising
approximately 79,750 square feet with lease terms of no more than five years.
During 2000, PMI transferred its operation data center to Rancho Cordova,
California, which consists of approximately 15,000 square feet of office space.
PMI believes its existing properties are well utilized and are suitable and
adequate for its operations.
Item 3. Legal Proceedings
On December 17, 1999, G. Craig Baynham and Linnie Baynham, or Plaintiffs, filed
a putative RESPA class action lawsuit against PMI. This action was filed by
Plaintiffs in the U.S. District Court for the Southern District of Georgia,
Augusta Division, or Court.
41
On December 15, 2000, we announced that PMI had entered into an agreement with
Plaintiffs to settle the action. PMI denied all facts and allegations in the
lawsuit that related to Section 8 of the RESPA and related state law claims. A
final order approving the settlement was entered on June 25, 2001. An appeal has
been filed to overturn the Court's decision to not allow certain individuals to
intervene in the case prior to the entry of the final order. If the appeal is
successful, such individuals could have standing to challenge the terms of the
settlement and final order. Our obligation to fund payment of claims and
expenses pursuant to the approved settlement is stayed during the pendency of
the appeal. We currently estimate that the gross amount of the settlement will
be approximately $20 million. To account for the settlement, PMI took an
after-tax charge against fourth quarter 2000 earnings of $3.7 million, and
subsequently, incurred an additional $1.0 million charge, net of tax, in the
third quarter of 2001. These charges, in aggregate, are the estimated cost of
settlement less anticipated insurance recoveries. The aggregate charge is based,
in part, upon an estimate of insurance payments we will receive from our
insurance carriers as reimbursement for certain costs and expenses incurred by,
and to be incurred by, us in connection with our defense and settlement of the
action. We participated without success in non-binding mediation with our
insurance carriers with respect to the amount of any such payments and now must
commence litigation to obtain reimbursement. There can be no assurance that our
estimate of the amount of insurance payments will be realized through
litigation. If we do not realize the estimated amount of insurance proceeds, we
will be required to take an additional charge against earnings and this could
harm our results of operations.
The settlement agreement contains a three year injunction, terminating on
December 31, 2003, which extends to all members, present and future, of the
putative class. The injunction provides that so long as certain products and
services challenged in the lawsuit, including agency pool insurance, contract
underwriting, reinsurance agreements with reinsurance affiliates of lenders and
mortgage insurance restructuring transactions with the GSEs, meet the minimum
requirements for risk transfer and cost recovery specified in the injunction
they will be deemed to be in compliance with RESPA and other applicable laws.
The injunction also prohibits lawsuits by class members for any mortgage
insurance related claims, including but not limited to such products and
services, for any loan transaction closed on or before December 31, 2003.
Under the terms of the agreement, all borrowers who have obtained, or will
obtain, a "federally-related" mortgage loan that is insured by a certificate of
primary mortgage insurance issued by PMI between December 18, 1996 and November
30, 2000 (with exceptions for borrowers whose loans were insured as
bulk/seasoned loans) are entitled to receive a payment. As part of the
settlement agreement, the class members will give a general release to us,
lenders and the GSEs for all claims including claims under RESPA and related
state law claims.
Various other legal actions and regulatory reviews are currently pending that
involve us and specific aspects of our conduct of business. In the opinion of
management, the ultimate liability or resolution in one or more of the foregoing
actions is not expected to have a material adverse effect on our financial
condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of 2001 to a vote of
stockholders through the solicitation of proxies or otherwise.
42
EXECUTIVE OFFICERS OF REGISTRANT
Set forth below is certain information regarding The PMI Group's executive
officers as of December 31, 2001, including age as of March 31, 2002, and
business experience for at least the past five years.
W. ROGER HAUGHTON, 54, is Chairman of the Board and Chief Executive Officer of
The PMI Group and PMI. He brings more than 32 years of experience to his
position. Mr. Haughton came to PMI in 1985 from Allstate Insurance Company. He
was appointed President and Chief Executive Officer of PMI in January 1993. He
became President, Chief Executive Officer and a Director of The PMI Group when
the Company went public in April 1995, and was elected Chairman of the Board in
May 1998. A graduate of the University of California at Santa Barbara, Mr.
Haughton holds a B.A. in economics. He is a member of the Executive Committee
and past President of Mortgage Insurance Companies of America, the industry
trade association. Mr. Haughton has a long history of active volunteerism with
various affordable housing organizations, including Habitat for Humanity, and is
on the board and former Chairman of Social Compact, a Washington D.C.
organization dedicated to promoting revitalization of America's inner cities. He
is also on the board of San Francisco's Bay Area Council. Mr. Haughton is a
Trustee for the University of California at Santa Barbara, and he also serves on
the policy advisory boards for both the Fisher Center for Real Estate & Urban
Economics at UC Berkeley and the School of Real Estate at the University of San
Diego. He is an Ex Officio member of the Governance and Nominating Committee.
L. STEPHEN SMITH, 52, has been President and Chief Operating Officer of The PMI
Group and PMI since September 1998. Prior thereto he was Executive Vice
President of Marketing and Field Operations of PMI since May 1994 and was
elected to the same positions with The PMI Group in January 1995. Prior thereto,
he held various executive positions since 1991. Mr. Smith joined PMI in 1979.
Mr. Smith is a member of The PMI Group's Board of Directors.
CLAUDE J. SEAMAN, 55, has been President International and Strategic Investments
of The PMI Group and PMI since February 2001. Prior thereto, he was Group
Executive Vice President Strategic Investments of The PMI Group and PMI since
February 1999. Prior thereto, he was Executive Vice President of Insurance
Operations of PMI since May 1994, and was elected to the same positions with The
PMI Group in January 1995. Prior thereto, he was PMI's Senior Vice President of
Insurance Operations from March 1993 to May 1994.
JOHN M. LORENZEN, Jr., 57, has been Executive Vice President of PMI since May
1994 and Chief Financial Officer of PMI since April 1989, and was elected to the
same positions with The PMI Group in January 1995. Mr. Lorenzen joined the
Company in 1985.
BRADLEY M. SHUSTER, 47, has been Executive Vice President Corporate Development
of The PMI Group and PMI since February 1999. Prior thereto, he was Senior Vice
President, Treasurer and Chief Investment Officer of PMI since August 1995, and
was elected to the same position with The PMI Group, in September 1995. Prior
thereto, he was an audit partner with the accounting firm of Deloitte & Touche
LLP from May 1988 to July 1995.
VICTOR J. BACIGALUPI, 58, has been Executive Vice President, General Counsel and
Secretary of The PMI Group and PMI since August 1999. Prior thereto he was
Senior Vice President, General Counsel and Secretary of The PMI Group and PMI
since November 1996. Prior to joining The PMI Group, he was a partner in the law
firm of Bronson, Bronson & McKinnon LLP, San Francisco, California since
February 1992.
43
JOHN H. FULFORD, 52, has been Executive Vice President, National Sales of The
PMI Group and PMI since August 2001. Prior thereto Mr. Fulford was Senior Vice
President, National Sales of The PMI Group and PMI since August 1997. Prior to
joining The PMI Group, he served as Senior Vice President, Marketing at Fannie
Mae from February 1996 to March 1997. Prior thereto, Mr. Fulford was a Vice
President at Fannie Mae since 1983.
DANIEL L. ROBERTS, 51, has been Executive Vice President, Chief Information
Officer of The PMI Group and PMI since March 1, 2000. Prior thereto he was
Senior Vice President, Chief Information Officer of The PMI Group and PMI since
December 1997. Prior to joining The PMI Group, he was Vice President and Chief
Information Officer of St. Joseph Health System, a position he held since he
joined the company in October 1994. Prior thereto, he was Vice President,
Information Services and Chief Information Officer for a division of Catholic
Healthcare West, positions he held since joining the company in December 1990.
Mr. Roberts was a consulting partner with the accounting firm of Deloitte &
Touche from July 1985 to December 1990.
DAVID H. KATKOV, 46, has been Executive Vice President, Product Development and
Pricing of The PMI Group and PMI since August 2001. Mr. Katkov is also
responsible for the portfolio management functions within PMI. He commenced his
employment with PMI in 1992 and has held executive positions in marketing and
related functions. Prior to joining PMI, Mr. Katkov was a Vice President of
First Bank National Association.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Common Stock
The PMI Group is listed on the New York Stock Exchange and the Pacific Exchange
under the trading symbol PMI. As of December 31, 2001 there were 44,581,302
shares issued and outstanding. As of February 28, 2002, there were 44,746,841
shares issued and outstanding held by approximately 39 stockholders of record
and approximately 8,400 beneficial owners of shares held by brokers and
fiduciaries.
The following table shows the high, low and closing common stock prices by
quarter from the New York Stock Exchange Composite Listing for the two years
ended December 31, 2001 and 2000:
2001 2000
--------------------- ---------------------
High Low Close High Low Close
----- ----- ----- ----- ----- -----
First quarter $67.69 $48.38 $64.98 $48.81 $33.50 $47.44
Second quarter 74.50 58.00 72.66 54.75 44.19 47.52
Third quarter 72.76 54.10 62.39 72.38 48.75 67.75
Fourth quarter 67.58 54.05 67.01 74.94 56.50 67.69
The Board of Directors of The PMI Group has proposed that stockholders approve
an amendment to The PMI Group's Restated Certificate of Incorporation to
increase the number of shares of authorized common stock of The PMI Group from
125,000,000 to 250,000,000 shares. On February 20, 2002, the Board of Directors
indicated its intent to declare a 2-for-1 stock split in the form of a stock
dividend if, and only if, the proposed amendment to the Restated Certificate of
Incorporation is approved by the stockholders at The PMI Group's Annual Meeting
on May 16, 2002.
44
Preferred Stock
The PMI Group's Board of Directors is authorized to issue up to 5,000,000 shares
of preferred stock of The PMI Group in classes or series and to fix the
designations, preferences, qualifications, limitations or restrictions of any
class or series with respect to the rate and nature of dividends, the price and
terms and conditions on which shares may be redeemed, the amount payable in the
event of voluntary or involuntary liquidation, the terms and conditions for
conversion or exchange into any other class or series of the stock, voting
rights and other terms. The Company may issue, without the approval of the
holders of common stock, preferred stock that has voting, dividend or
liquidation rights superior to the common stock and which may adversely affect
the rights of the holders of common stock. The Company has reserved for issuance
under the Rights Plan described below up to 400,000 shares of preferred stock.
Preferred Share Purchase Rights Plan
On January 13, 1998, the Company adopted a Preferred Share Purchase Rights Plan
("Rights Plan"). Under the Rights Plan, all shareholders of record as of January
26, 1998 received rights to purchase shares of a new series of preferred stock
on the basis of one right for each common stock held on that date. However,
rights issued under the Rights Plan will not be exercisable initially. The
rights will trade with the Company's common stock and no certificates will be
issued until certain triggering events occur. The Rights Plan has a 10-year term
from the record date, but the Company's Board of Director's will review the
merits of redeeming or continuing the Rights Plan not less than once every three
years. Rights issued under the plan will be exercisable only if a person or
group acquires 10% or more of the Company's common stock or announces a tender
offer for 10% or more of the common stock. If a person or group acquires 10% or
more of the Company's common stock, all rightholders except the buyer will be
entitled to acquire the Company's common stock at a discount and/or under
certain circumstances to purchase shares of the acquiring company at a discount.
The Rights Plan contains an exception that would allow passive institution
investors to acquire up to a 15% ownership interest before the rights would
become exercisable.
Payment of Dividends and Policy
Payment of future dividends is subject to a declaration by The PMI Group's Board
of Directors. The dividend policy is also dependent on the ability of PMI to pay
dividends to The PMI Group, which is subject to, among other factors, regulatory
restrictions by the Arizona Department of Insurance and The PMI Group's credit
agreements and the Runoff Support Agreement. (See Part I, Item 1.B(9),
"Regulation" and Part II, Item 8, Financial Statement Note 14 - "Dividends and
Shareholders' Equity".)
During the second quarter of 1995, The PMI Group's Board of Directors declared
its first dividend on common stock of $0.05 per share (pre-split basis), and has
declared and paid a quarterly dividend of $0.05 per share (pre-split basis)
through the second quarter of 1999. In connection with the Company's 3-for-2
stock split on August 16, 1999, the quarterly dividend was adjusted to $0.04 per
share for the third and fourth quarters of 1999 and continued to be $0.04 per
share for 2000 and 2001.
As described above, the Board of Directors has indicated its intent to declare a
2-for-1 stock split in the form of a stock dividend if, and only if, the
proposed amendment to the Restated Certificate of Incorporation is approved by
the stockholders at The PMI Group's Annual Meeting on May 16, 2002. In this
event, it is the Board of Directors' intention that the additional stock
representing the dividend will be distributed on June 17, 2002, to record
holders of common stock as of the close of business on May 31, 2002. The Board
of Directors also has indicated its intent to increase the cash dividend,
effective with the third quarter 2002 dividend declaration, to $0.10 cents per
share from $0.08 cents on a post-split basis, subject to shareholder approval of
the proposal to amend the Restated Certificate of Incorporation.
45
Item 6. Selected Financial Data
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 2001 Annual Report to Stockholders under the heading
"Eleven-Year Summary of Financial Data" filed as part of Exhibit 13.1.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 2001 Annual Report to Stockholders under the heading
"Management's Discussion and Analysis" as part of Exhibit 13.1.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
At December 31, 2001, the average duration of the Company's fixed income
investment portfolio was 5.9 years, and the Company had no derivative financial
instruments in its investment portfolio. The result of a 100 basis points
increase in interest rates would be a 5.6% decrease in the value of the
Company's investment portfolio, while the result of a 100 basis points decrease
in interest rates would be a 4.7% increase in the value of the Company's
investment portfolio.
Item 8. Financial Statements and Supplementary Data
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 2001 Annual Report to Stockholders as part of Exhibit
13.1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information concerning The PMI Group's Directors as required by this Item is
incorporated by reference from The PMI Group's Proxy Statement for its 2002
Annual Meeting of Stockholders under the captions "Nominees For Director of The
PMI Group" and "Section 16(a) Beneficial Ownership Reporting Compliance."
Information regarding Executive Officers of The PMI Group is included in a
separate item captioned "Executive Officers of Registrant" in Part I of this
report.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference from The PMI
Group's Proxy Statement for its 2002 Annual Meeting of Stockholders under the
captions "Directors-Compensation and Benefits," "Executive Compensation" and
"Compensation Committee Interlocks and Insider Participants."
46
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is incorporated by reference from The PMI
Group's Proxy Statement for its 2002 Annual Meeting of Stockholders under the
caption "Security Ownership of Certain Beneficial Owners and Management".
Item 13. Certain Relationships and Related Transactions
None.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements: The financial statements listed in the
accompanying Index to Consolidated Financial Statements and Financial
Statement Schedules are filed as part of this Form 10-K.
2. Financial Statement Schedules: The financial statement schedules listed
in the accompanying Index to Consolidated Financial Statements and
Financial Statement Schedules are filed as part of the Form 10-K. All other
schedules are omitted because of the absence of conditions under which they
are required or because the required information is included in the
consolidated financial statements or notes thereto.
3. Exhibits: Exhibits listed in the accompanying Index to Exhibits are
filed as part of this Form 10-K.
(b) Reports on Form 8-K:
(i) On November 2, 2001, we filed with the SEC a report on Form 8-K
relating to our financial results for the quarter ended September 30,
2001.
(ii) On November 5, 2001, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to our estimated operating
earnings for 2002.
(iii) On November 8, 2001, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to our estimated domestic primary
claims paid and domestic losses in 2002.
(iv) On January 24, 2002, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to our estimated operating
earnings for 2002.
(v) On March 29, 2002, we furnished the SEC, pursuant to Regulation FD,
with a report on Form 8-K, relating to PMI's claims paid in January
and February 2002.
47
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
[Item 14(a) 1 and 2]
Consolidated Financial Statements
- ---------------------------------
(all contained in Exhibit 13.1)
Consolidated Statements of Operations for the years ended December 31, 2001,
2000 and 1999
Consolidated Balance Sheets as of December 31, 2001 and 2000
Consolidated Statements of Shareholders' Equity for the years ended December 31,
2001, 2000 and 1999
Consolidated Statements of Cash Flows for the years ended December 31, 2001,
2000 and 1999
Notes to Consolidated Financial Statements
Reports of Independent Auditors
Financial Statement Schedules
- -----------------------------
(schedules immediately follow Form 10-K signature pages; reports contained in
Exhibits 23.1 and 23.3)
Reportsof independent auditors on financial statement schedules as of and for
the specified years in the three-year period ended December 31, 2001:
Schedule I - Summary of investments other than in related parties
Schedule II - Condensed financial information of Registrant
Schedule III -Supplementary insurance information
Schedule IV - Reinsurance
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San
Francisco, State of California, on the 29th day of March, 2002.
The PMI Group, Inc.
BY: /s/ W. Roger Haughton
-------------------------------------------------
W. Roger Haughton
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Name Title
---- -----
/s/ W. Roger Haughton Chairman of the Board and
- --------------------- Chief Executive Officer
W. Roger Haughton
/s/ John M. Lorenzen, Jr.
- -------------------------
John M. Lorenzen, Jr. Executive Vice President,
Chief Financial Officer, and
Assistant Secretary
(Principal Financial Officer)
/s/ Brian P. Shea Vice President, Controller and
---------------- Assistant Secretary
Brian P. Shea (Controller and Principal
Accounting Officer)
/s/ L. Stephen Smith Director, President and Chief
- -------------------- Operating Officer
L. Stephen Smith
/s/ Mariann Byerwalter Director
- ----------------------
Mariann Byerwalter
/s/ James C. Castle Director
- -------------------
Dr. James C. Castle
/s/ Donald C. Clark Director
- -------------------
Donald C. Clark
/s/ Wayne E. Hedien Director
- -------------------
Wayne E. Hedien
/s/ Louis G. Lower II Director
- ---------------------
Louis G. Lower II
49
/s/ Raymond L. Ocampo Jr. Director
- -------------------------
Raymond L. Ocampo Jr.
/s/ John D. Roach Director
- -----------------
John D. Roach
/s/ Kenneth T. Rosen Director
- --------------------
Dr. Kenneth T. Rosen
/s/ Richard L. Thomas Director
- ---------------------
Richard L. Thomas
/s/ Mary Lee Widener Director
- --------------------
Mary Lee Widener
/s/ Ronald H. Zech Director
- ------------------
Ronald H. Zech
50
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE 1 - SUMMARY OF INVESTMENTS
The information required by this schedule is incorporated by reference from
portions of The PMI Group, Inc. 2001 Annual Report to Stockholders under the
heading "Notes to Consolidated Financial Statements" as part of Exhibit 13.1.
51
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
PARENT COMPANY ONLY
December 31, 2001 and 2000
2001 2000
----------- -----------
(Dollars in thousands)
Investments available-for-sale, at fair value:
Fixed income securities (cost: $328,840; $63,645) $ 330,553 $ 58,342
Short-term investments 4,540 39,117
----------- -----------
Total investments 335,093 97,459
Cash 372 7,918
Investment in subsidiaries, at equity in net assets 1,912,698 1,582,906
Other assets 31,575 27,916
----------- -----------
Total Assets $ 2,279,738 $ 1,716,199
=========== ===========
Liabilities:
Long-term debt $ 422,950 $ 100,000
Accounts payable - affiliates 15,292 5,567
Other liabilities 6,308 11,812
----------- -----------
Total liabilities 444,550 116,988
----------- -----------
Commitments and contingent liabilities (Note A):
Junior subordinated deferrable interest debenture
held solely by subsidiary trust 48,500 100,000
Shareholders' equity:
Common stock - $0.01 par value; 125,000,000 shares
authorized and 52,793,777 shares issued 528 528
Additional paid-in capital 267,762 267,762
Accumulated other comprehensive income 40,791 62,501
Retained earnings 1,811,839 1,511,751
Treasury stock, at cost (8,212,475 and 8,484,082 shares) (334,232) (343,331)
----------- -----------
Total shareholders' equity 1,786,688 1,499,211
----------- -----------
Total liabilities and shareholders' equity $ 2,279,738 $ 1,716,199
=========== ===========
See accompanying supplementary notes to Parent company condensed financial
statements.
52
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
PARENT COMPANY ONLY
Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
--------- --------- ---------
(In thousands)
Revenues
Equity in undistributed net income of subsidiaries $ 277,611 $ 273,501 $ 112,029
Subsidiary dividends 52,500 3,000 97,339
Investment income 14,328 6,174 8,913
Net realized investment (gains) and losses (141) 807 329
--------- --------- ---------
Total revenues 344,298 283,482 218,610
--------- --------- ---------
Expenses
Operating expenses 19,107 13,257 6,456
Interest expense 12,569 7,486 7,244
Distributions on preferred capital securities 7,861 8,566 8,566
--------- --------- ---------
Total expenses 39,537 29,309 22,266
--------- --------- ---------
Income before income taxes and extraordinary item 304,761 254,173 196,344
Income tax benefit 7,256 6,039 8,122
--------- --------- ---------
Income before extraordinary item 312,017 260,212 204,466
Extraordinary loss on early extinguishment of debt,
net of income tax benefit of $2,588 4,805 - -
--------- --------- ---------
Net income $ 307,212 $ 260,212 $ 204,466
========= ========= =========
See accompanying supplementary notes to Parent company condensed financial
statements
53
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
PARENT COMPANY ONLY
Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
--------- --------- ---------
(In thousands)
Net income $ 307,212 $ 260,212 $ 204,466
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising during
period, net of tax (11,324) 50,575 (53,945)
Reclassification adjustment for realized gains
included in net income, net of tax (7) (281) (331)
Currency translation adjustment (10,379) (7,979) -
--------- --------- ---------
Other comprehensive income (loss), net of tax (21,710) 42,315 (54,276)
--------- --------- ---------
Comprehensive income $ 285,502 $ 302,527 $ 150,190
========= ========= =========
See accompanying supplementary notes to Parent company condensed financial
statements.
54
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
PARENT COMPANY ONLY
Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
----------- ---------- ----------
(In thousands)
Cash flows from operating activities:
Net income $ 307,598 $ 260,212 $ 204,466
Adjustments to reconcile net income to net cash
used in operating activities:
Extraordinary loss on early extinguishment of debt 7,393 - -
Net realized capital (gains) and losses 141 (807) (329)
Equity in earnings of affiliates (330,111) (276,501) (209,368)
Amortization 1,410 99 278
Payable to affiliates 9,725 3,937 (48)
Other (9,623) 3,908 (6,471)
---------- ---------- ----------
Net cash used in operating activities (13,467) (9,152) (11,472)
---------- ---------- ----------
Cash flows from investing activities:
Proceeds from sales of fixed income securities 44,205 10,680 22,110
Proceeds from sale of equity securities 4,819 - -
Investment purchases:
Fixed income securities (309,667) (40,771) (3,887)
Equity securities - (5,569) (14,840)
Net (increase) decrease in short-term investments 34,577 21,856 (57,251)
Investment in affiliates (78,445) - (2,038)
Dividends from subsidiaries (Note B) 52,500 3,000 97,339
Return of capital from subsidiaries (Note B) - 50,000 -
---------- ---------- ----------
Net cash provided by (used in) investing activities (252,011) 39,196 41,433
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 351,900 - -
Repayment of long-term debt (39,974) - -
Extinguishment of Capital Securities (55,969) - -
Purchase of common stock - (24,017) (27,469)
Issuance of treasury stock 9,099 8,577 2,641
Dividends paid to shareholders (7,124) (7,093) (5,199)
---------- ---------- ----------
Net cash provided by (used in) financing activities 257,932 (22,533) (30,027)
---------- ---------- ----------
Net increase (decrease) in cash (7,546) 7,511 (66)
Cash at beginning of year 7,918 407 473
---------- ---------- ----------
Cash at end of year $ 372 $ 7,918 $ 407
========== ========== ==========
See accompanying supplementary notes to Parent company condensed financial
statements.
55
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
SUPPLEMENTARY NOTES
Note A
The accompanying Parent Company ("The PMI Group") financial statements should be
read in conjunction with the Consolidated Financial Statements and Notes to
Consolidated Financial Statements (including Notes 10, 11 and 12 related to
long-term obligations, commitments and contingent liabilities and the junior
subordinated debenture) appearing in The PMI Group, Inc. 2001 Annual Report to
Shareholders.
Note B
During 2001, 2000 and 1999, The PMI Group received $52.5 million, $53.0 million
and $97.3 million, respectively, of ordinary and extraordinary cash
dividends/returns of capital from subsidiaries.
Note C
Certain prior year amounts have been reclassified to conform to the current year
presentation.
56
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
As of and for the Years Ended December 31, 2001, 2000 and 1999
Reserve for
Losses and Investment Losses and Amortization
Deferred Loss Net Income and Loss Of Deferred Other
Acquisition Adjustment Unearned Premiums Premiums Equity Adjustment Acquisition Operating
Segment Costs Expenses Premiums Written Earned Earnings Expenses Costs Expenses
- -------------- ----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
(Dollars in thousands)
2001
MI (1) $ 64,345 $ 289,432 $ 87,112 $544,055 $553,407 $ 101,261 $ 102,856 $ 76,586 $ 60,667
Internat'l (2) 13,558 14,383 121,468 56,233 43,813 24,467 9,287 5,196 7,852
Title - 10,775 - 157,551 157,551 2,061 5,905 - 141,929
Other (3) - - - - - 22,198 - - 57,967
----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
Total $ 77,903 $ 314,590 $208,580 $757,839 $754,771 $ 149,987 $ 118,048 $ 81,782 $ 268,415
=========== =========== ======== ======== ======== ========== ========== ============ =========
2000
MI (1) $ 63,295 $ 281,704 $ 96,561 $498,255 $503,750 $ 96,585 $ 95,308 $ 77,337 $ 54,362
Internat'l (2) 3,714 5,384 74,305 36,823 6,628 11,475 5,684 - 7,220
Title - 8,001 - 103,984 103,984 1,890 2,087 - 94,302
Other (3) - - - - - 9,249 - - 33,887
----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
Total $ 67,009 $ 295,089 $170,866 $639,062 $634,362 $ 119,199 $ 103,079 $ 77,337 $ 189,771
=========== =========== ======== ======== ======== ========== ========== ============ =========
1999
MI (1) $ 67,281 $ 269,931 $102,022 $459,065 $447,214 $ 80,922 $ 110,465 $ 80,252 $ 54,017
Internat'l (2) 2,298 3,714 80,067 12,071 11,291 3,673 1,213 - 4,472
Title - 8,355 - 100,118 100,118 1,634 1,004 - 88,244
Other (3) - - - - - 8,913 - - 23,506
----------- ----------- -------- -------- -------- ---------- ---------- ------------ ---------
Total $ 69,579 $ 282,000 $182,089 $571,254 $558,623 $ 95,142 $ 112,682 $ 80,252 $ 170,239
=========== =========== ======== ======== ======== ========== ========== ============ =========
(1) Represents Domestic Mortgage Insurance Operations.
(2) Represents International Mortgage Insurance Operations.
(3) Represents ancillary services and parent company investment income.
57
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
Years Ended December 31, 2001, 2000 and 1999
Percentage
Assumed Ceded of Amount
Gross From Other To Other Net Assumed
Premiums earned Amount Companies Companies Amount To Net
- ------------------------ -------- --------- --------- -------- ----------
(In thousands except percentages)
2001
Mortgage Guaranty $661,054 $ 3,950 $ 67,784 $597,220 0.7%
Title 157,892 4 345 157,551 0.0
-------- -------- -------- --------
Total $818,946 $ 3,954 $ 68,129 $754,771 0.7
======== ======== ======== ========
2000
Mortgage Guaranty $567,258 $ 1,800 $ 38,680 $530,378 0.3%
Title 104,344 - 360 103,984 0.0
-------- -------- -------- --------
Total $671,602 $ 1,800 $ 39,040 $634,362 0.3
======== ======== ======== ========
1999
Mortgage Guaranty $486,235 $ 6,443 $ 34,173 $458,505 1.4%
Title 100,355 2 239 100,118 0.0
-------- -------- -------- --------
Total $586,590 $ 6,445 $ 34,412 $558,623 1.2
======== ======== ======== ========
58
INDEX TO EXHIBITS
[Item 14(a) 3]
Exhibit
Number Description of Exhibits
- -------- -------------------------------------------------------------------
3.1(b) Restated Certificate of Incorporation of the Registrant.
3.2(g) By-laws of the Registrant as amended and restated September 15,
1998.
4.1(b) Specimen common stock Certificate.
4.2(d) Indenture dated as of November 19, 1996 between The PMI Group,
Inc. and the Bank of New York, as Trustee in connection with sale
of $100,000,000 aggregate principal amount of 6 3/4% Notes due
November 15, 2006.
4.3(e) The Junior Subordinated Indenture dated February 4, 1997 between
The PMI Group, Inc. and The Bank of New York, Inc., as Trustee.
4.4(e) Form of Right Certificate, relating to Rights Agreement dated as
of January 26, 1998.
4.5(j) Credit Agreement, dated as of August 3, 1999 by and among PMI
Mortgage Insurance Australia (Holdings) Pty Limited, The PMI Group,
Inc., and Bank of America, N.A. The Company agrees to furnish to
the Securities and Exchange Commission, upon request, copies of all
instruments defining the rights of holders of long-term debt of the
Company where the total amount of securities authorized under each
issue does not exceed ten percent of the Company's total assets.
4.6(j) Credit Agreement, dated as of February 13, 1996, between The PMI
Group, Inc., and Bank of America National Trust and Savings
Association, as amended. The Company agrees to furnish to the
Securities and Exchange Commission, upon request, copies of all
instruments defining the rights of holders of long-term debt of the
Company where the total amount of securities authorized under each
issue does not exceed ten percent of the Company's total assets.
4.7(n) Indenture dated as of July 16, 2001 between The PMI Group, Inc.
and The Bank of New York, as Trustee.
4.8(n) Resale Registration Rights Agreement, dated as of July 16, 2001,
among The PMI Group, Inc., Bank of America Securities LLC and
Lehman Brothers Inc.
10.1(i)* PMI Mortgage Insurance Co. Bonus Incentive Plan dated as of
February 18, 1999.
10.2(o)* The PMI Group, Inc. Amended and Restated Equity Incentive Plan,
effective as of June 1, 2000.
10.3(o)* Amendment No. 1 to The PMI Group, Inc. Amended and Restated Equity
Incentive Plan, dated June 11, 2001.
10.4(l)* The PMI Group, Inc. Stock Plan for Non-Employee Directors
(restated as of August 16, 1999).
10.5(m)* Amendment No. 1 to The PMI Group, Inc. Stock Plan for Non-Employee
Directors (restated as of August 16, 1999).
10.6(o)* Amendment No. 2 to The PMI Group, Inc. Stock Plan for Non-Employee
Directors (restated as of August 16, 1999).
10.7(k) The PMI Group, Inc. Directors Deferred Compensation Plan. (amended
and restated as of July 21, 1999).
10.8(a) Form of 1984 Master Policy of PMI Mortgage Insurance Co.
59
10.9(a) Form of 1994 Master Policy of PMI Mortgage Insurance Co.
10.10(a) CMG Shareholders Agreement dated September 8, 1994 between CUNA
Mutual Investment Corporation and PMI Mortgage Insurance Co.
10.11(b) Runoff Support Agreement dated October 28, 1994 between Allstate
Insurance Company, the Registrant and PMI Mortgage Insurance Co.
10.12(b) Form of Tax Sharing Agreement among the Registrant, the
Registrant's subsidiaries, The Allstate Corporation, Allstate
Insurance Company and Sears, Roebuck and Co.
10.13(a) Mortgage Insurance Variable Quota Share Reinsurance Treaty
effective January 1, 1991 issued to PMI Mortgage Insurance Co. by
Hannover Ruckversicherungs-Aktiengesellschaft ("Hannover").
10.14(a) First Amendment to Mortgage Insurance Variable Quota Share
Reinsurance Treaty made as of January 1, 1992 between Hannover and
PMI Mortgage Insurance Co.
10.15(j) Supplemental Employee Retirement Plan (amended and restated as of
May 20, 1999).
10.16(a) First Amendment to the Quota Share Primary Mortgage Reinsurance
Agreement (No. 15031-940) made as of October 1, 1994 between PMI
Mortgage Insurance Co. and Capital Mortgage Reinsurance Company.
10.17(a) Form of Indemnification Agreement between the Registrant and its
officers and directors.
10.18(a) Per Mortgage Excess of Loss Reinsurance Treaty effective January
1, 1994 issued to PMI Mortgage Insurance Co. by Hannover.
10.19(j) The PMI Group, Inc. Additional Benefit Plan, dated as of February
18, 1999.
10.20(e) The Guarantee Agreement, dated February 4, 1997 between The PMI
Group, Inc. (As Guarantor) and The Bank of New York (as Trustee).
10.21(e) Amended and Restated Trust Agreement dated as of February 4, 1997
among The PMI Group, Inc., as Depositor, The Bank of New York, as
Property Trustee, and The Bank of New York (Delaware), as Delaware
Trustee.
10.22(e) Form of Change of Control Employment Agreement.
10.23(k) The PMI Group, Inc. Officer Deferred Compensation Plan (amended
and restated as of September 16, 1999).
10.24(l) Excess of Loss Reinsurance Treaty effective August 20, 1999 issued
by PMI Mortgage Insurance Co. to KRE Reinsurance Ltd, National
Union Fire Insurance Company of Pittsburgh and Federal Insurance
Co. The Company agrees to furnish to the Securities and Exchange
Commission, upon request, copies of all agreements defining the
rights of reinsurers of pool insurance contracts where the total
amount of premiums paid does not exceed ten percent of the
Company's total assets.
11.1 Statement re: computation of per share earnings.
12.1 Statement re: computation of earnings to fixed charges.
13.1 Selected Financial Data, Management's Discussion and Analysis of
Financial Condition and Results of Operations and Financial
Statements and Supplementary Data portions of The PMI Group, Inc.'s
2001 Annual Report to Shareholders, Reports of Independent
Auditors.
60
21.1 Subsidiaries of the Registrant.
23.1 Consent of Independent Auditors (Ernst & Young LLP, March 26,
2002).
23.2 Independent Auditors' Consent (Deloitte & Touche LLP, March 26,
2002).
23.3(p) Independent Auditors' Report (Deloitte & Touche LLP, January 20,
2000).
(a) Previously filed with the Company's Form S-1 Registration Statement (No.
33-88542), which became effective in April 1995 ("Form S-1").
(b) Previously filed with Amendment No. 1 to Form S-1, filed with the SEC on
March 2, 1995.
(c) Previously filed with Amendment No. 2 to Form S-1, filed with the SEC on
March 13, 1995.
(d) Previously filed with Form 8-K, filed with the SEC on November 25, 1996.
(e) Previously filed with Form 10-K, filed with the SEC on March 27, 1998.
(f) Previously filed with Form 10-Q, filed with the SEC on August 13, 1998.
(g) Previously filed with Form 8-K, filed with the SEC on September 29, 1998.
(h) Previously filed with the Company's Form S-3 Registration Statement (No.
33-66829) which became effective in November 1998.
(i) Previously filed with Form 10-K, filed with the SEC on March 30, 1999.
(j) Previously filed with Form 10-Q, filed with the SEC on August 16, 1999.
(k) Previously filed with the Company's Form S-8 Registration Statement (No.
333-32190) which became effective on March 10, 2000.
(l) Previously filed with the Form 10-K, filed with the SEC on March 30, 2000.
(m) Previously filed with the Form 10-Q, filed with the SEC on August 11, 2000.
(n) Previously filed with the Form 8-K, filed with the SEC on July 18, 2001.
(o) Previously filed with the Form S-8 Registration Statement (No. 333-63122)
which became effective on June 15, 2001.
(p) Previously filed with the Form 10-K, filed with the SEC on March 31, 2001.
* Compensatory or benefit plan in which certain executive officers or
Directors of The PMI Group, Inc. or its subsidiaries are eligible to
participate.
61