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UNITED STATES
-------------
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, 1999
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 aggregate market value of the voting stock (common stock) held by non-
affiliates of the registrant as of the close of business on February 29, 2000
was $1,609,540,560 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 29, 2000: 44,324,697.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the fiscal year ended
December 31, 1999 are incorporated by reference into Items 6 through 8 of Part
II. Portions of the Proxy Statement for registrant's 2000 Annual Meeting of
Stockholders to be held on May 18, 2000 are incorporated by reference into Items
10 through 13 of Part III. The Exhibit Index is located on page 67.
1
TABLE OF CONTENTS
PART I.................................................................................................. 3
Cautionary Statement
Item 1. Business......................................................................................... 3
A. General........................................................................................ 3
B. Products....................................................................................... 4
C. Industry Overview.............................................................................. 8
D. Competition and Market Share................................................................... 11
E. Customers...................................................................................... 15
F. U.S. Business Composition...................................................................... 15
G. Sales, Product Development and Underwriting Personnel.......................................... 17
H. Underwriting Practices......................................................................... 18
I. Affordable Housing............................................................................. 23
J. Defaults and Claims............................................................................ 24
K. Reinsurance.................................................................................... 34
L. Claims Paying Ability Ratings.................................................................. 35
M. Investment Portfolio........................................................................... 35
N. Other Business................................................................................. 36
O. Regulation..................................................................................... 38
P. Employees...................................................................................... 44
Q. Cautionary Statements and Investment Considerations............................................ 44
Item 2. Properties....................................................................................... 49
Item 3. Legal Proceedings................................................................................ 49
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 50
PART II.................................................................................................... 52
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters........................ 52
Common Stock........................................................................................ 52
Preferred Stock..................................................................................... 52
Shareholder Rights Plans............................................................................ 52
Payment of Dividends and Policy..................................................................... 53
Item 6. Selected Financial Data.......................................................................... 53
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 53
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...................................... 53
Item 8. Financial Statements and Supplementary Data...................................................... 53
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............. 54
PART III................................................................................................... 54
Item 10. Directors and Executive Officers of the Registrant.............................................. 54
Item 11. Executive Compensation.......................................................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................. 54
Item 13. Certain Relationships and Related Transactions.................................................. 54
PART IV.................................................................................................... 54
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................ 54
INDEX TO EXHIBITS.......................................................................................... 67
2
CAUTIONARY STATEMENT
Certain written and oral statements made or incorporated by reference from time
to time by the Company or its representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, or are preceded by, followed by or
that include the words "believes", "expects", "anticipates", "estimates", or
similar expressions, and that relate to future plans, events or performance are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. When a forward-looking statement includes a
statement of the assumptions or bases underlying the forward-looking statement,
the Company cautions that, while it believes such assumptions or bases to be
reasonable and makes them in good faith, assumed facts or bases almost always
vary from actual results, and the difference between assumed facts or bases and
actual results can be material, depending on the circumstances. Where, in any
forward-looking statement, the Company or its management expresses an
expectation or belief as to future results, such expectations or belief is
expressed in good faith and believed to have a reasonable basis, but there can
be no assurance that the statement of expectation or belief will result or be
achieved or accomplished. The Company's actual results may differ materially
from those expressed in any forward-looking statements made by the Company.
These forward-looking statements involve a number of risks or uncertainties
including, but not limited to, the items addressed in section Q. "Cautionary
Statements and Investment Considerations" ("IC# 1-15") set forth below and other
risks detailed from time to time in the Company's periodic filings with the
Securities and Exchange Commission.
All forward-looking statements of the Company are qualified by and should be
read in conjunction with such risk disclosure. The Company undertakes no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
PART I
Item 1. Business
A. General
The PMI Group, Inc. ("TPG"), a Delaware corporation, is a holding company
which conducts its residential mortgage insurance business through its direct
and indirect wholly-owned subsidiaries PMI Mortgage Insurance Co. ("PMI"), an
Arizona corporation, Residential Guaranty Co. ("RGC"), an Arizona corporation,
Residential Insurance Co. ("RIC"), an Arizona corporation, TPG Insurance Co.
("TIC"), a Vermont corporation, PMI Mortgage Guaranty Co. ("PMG"), an Arizona
corporation, TPG Segregated Portfolio Company ("TSPC"), a Cayman Islands
corporation, and PMI's wholly owned subsidiaries PMI Mortgage Insurance Ltd
("PMI Ltd"), an Australian mortgage insurance company. TPG also conducts title
insurance business through its wholly-owned subsidiary American Pioneer Title
Insurance Company ("APTIC"), a Florida
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corporation. In addition, PMI owns all of the outstanding common stock of PMI
Mortgage Services Co. ("MSC"), a California corporation which is engaged in the
business of contract underwriting, and PMI Securities Co. ("SECO"), a Delaware
corporation, which is an inactive broker-dealer. PMI is licensed in all 50
states of the United States and the District of Columbia. TPG and its direct and
indirect wholly-owned subsidiaries are collectively referred to as the
"Company". PMI also owns 50% of the outstanding shares of common stock of CMG
Mortgage Insurance Company ("CMG"), a Wisconsin corporation, which also
conducts a residential mortgage insurance business and TPG owns 24.9% of RAM
Holdings Ltd. and RAM Holdings II Ltd. (collectively referred to as "RAM Re"), a
financial guaranty reinsurance company based in Bermuda. CMG and RAM Re are
accounted for on the equity method in the Company's consolidated financial
statements.
TPG, through PMI and CMG, is one of the leading residential mortgage insurers in
the United States. In addition to international and domestic primary mortgage
insurance, TPG subsidiaries provide title insurance, contract underwriting and
various services and products for the home mortgage finance industry. PMI was
founded in 1972. At December 31, 1999, the Company's total assets were $2.1
billion and its shareholders' equity was $1.2 billion.
B. Products
Domestic
There are two principal types of private residential mortgage insurance, both of
which insure a mortgage lender or investor in mortgage loans against borrower
default: "primary" and "pool." Primary insurance provides mortgage insurance
coverage to lenders who receive a down payment of less than 20% from a borrower.
This includes mortgage insurance coverage for lenders for mortgages with: (i)
loan-to-value ratios ("LTVs") of 85% and below, (ii) LTVs in excess of 85% and
less than or equal to 90% ("90s"); (iii) LTVs in excess of 90% and less than
or equal to 95% ("95s"); and (iv) LTVs in excess of 95% and less than or equal
to 97% ("97s"). During 1999, the Federal National Mortgage Association
("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"),
generally the primary investors in mortgage loans, required that 90s have
insurance coverage ranging from 12% to 25%, and 95s and 97s have insurance
coverage ranging from 18% to 35%. Fannie Mae and Freddie Mac are collectively
referred to as government-sponsored enterprises ("GSEs"). The GSEs' reduced
mortgage insurance coverage levels require additional fees to be paid by the
borrower at origination. (See "D. Competition and Market Share", below and IC3.)
The coverage percentage insured by PMI is determined by the lender, usually to
comply with investor requirements to reduce the loss exposure on loans purchased
by them. Pool insurance is generally used as an additional credit enhancement
for certain secondary market mortgage transactions. Pool insurance generally
covers the loss on a defaulted mortgage loan which exceeds the claim payment
under the primary coverage, if primary insurance is required on that mortgage
loan, as well as the total loss on a defaulted mortgage loan which did not
require primary insurance, in each case up to a stated aggregate loss limit.
4
Primary Insurance
PMI provides primary insurance coverage, insuring mortgage lenders and mortgage
loan investors against borrower default on individual first lien mortgage loans
on one-to-four unit residential properties, including condominiums. PMI and
other private mortgage insurers have no limit as to the maximum principal
balance of loans for which they may issue mortgage insurance. Primary coverage
can be used on any type of residential mortgage loan instrument approved by PMI
and is generally underwritten on a loan-by-loan basis. (See "H. Underwriting
Practices", below.) Primary mortgage insurance provides mortgage default
protection to lenders or investors on individual loans. PMI's obligation to an
insured with respect to a claim is determined by applying the appropriate
coverage percentage to the original loan amount. In lieu of paying the
calculated claim amount, PMI has the option of: (i) paying the entire loss and
taking title to the mortgaged property, or (ii) in the case of certain sales,
paying the difference between the sales proceeds received by the insured and the
claim amount up to a maximum of the coverage percentage. (See "J. Defaults and
Claims--Claims", below.)
PMI offers coverage ranging from 4% to 42% of the total of the outstanding loan
principal, delinquent interest and certain expenses associated with a default
and the subsequent foreclosure of a mortgage loan ("claim amount"). The
percentage of the total claim amount subject to payment by PMI in the event of a
claim on a mortgage loan that is the subject of primary insurance ("coverage
percentage") was predominantly in the 25% to 30% range for primary new
insurance written ("NIW") for the year ended December 31, 1999. The average
coverage percentage for PMI was 25% and 24% of NIW for the year ended December
31, 1999 and 1998, respectively. Certain states limit the amount of risk a
mortgage insurer may retain with respect to coverage of an insured loan to 25%
of the indebtedness to the insured. Coverage in excess of 25% of the
indebtedness to the insured ("deep coverage") must be reinsured. To minimize
reliance on third party reinsurers on deep coverage business, TPG formed RGC,
RIC and PMG to provide reinsurance of such deep coverage to PMI and CMG. (See
"K. Reinsurance", below.) At December 31, 1999, PMI's average coverage
percentage on insurance in force was 24.4%. (See "C. Industry Overview--Fannie
Mae and Freddie Mac", below.)
Mortgage insurance coverage cannot be canceled by PMI, except for nonpayment of
premiums or certain material violations of PMI's Master Policy. Mortgage
insurance coverage can be canceled by the insured at any time. The GSEs 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. In addition, the Home
Owners Protection Act of 1998 provides for automatic termination, or
cancellation of mortgage insurance upon a borrower's request upon satisfaction
of certain conditions (See IC4). Generally, mortgage insurance remains renewable
at the option of the insured at a 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 nonrenewal of insurance
coverage. Mortgage insurance premiums are usually charged to the borrower by the
mortgage lender or loan servicer, which in turn remits the premiums to the
mortgage insurer.
PMI has the following basic types of premium payment plans.
5
Monthly Premium. A premium payment plan in which premiums are paid monthly
over the term of the coverage ("Monthly Premium Plan"). Under PMI's Monthly
Premium Plan only one or two months' of premium is paid at the mortgage loan
closing, and thereafter, monthly premiums are collected by the loan servicer for
monthly remittance to PMI. PMI also offers a plan under which the first monthly
premium is payable at the time the first monthly mortgage payment is due ("pmiNU
MONTHLY/ SM/"). The pmiNU MONTHLY/ SM/ plan helps reduce the amount a borrower
would typically have to pay at closing, thereby increasing mortgage loan
affordability. Monthly Premium and pmiNU MONTHLY/ SM/ Plans represented 95.9%
of NIW in 1999. During April 1999, PMI began offering two new monthly premium
products, pmiNU MONTHLY Premier /SM/, and pmiMonthly Premier /SM/, which offer
the option to finance a portion of the premium, or to pay a larger portion of
the premium up-front to receive a lower monthly premium. These new products are
designed to compete with the GSEs' programs that require the payment of an
additional fee for a further reduction in mortgage insurance coverage (See "D.
Competition and Market Share", below and IC3).
Single Premium. A premium payment plan that requires an initial premium
payment that extends coverage for more than one year and involves a lump-sum
payment at the loan closing ("Single Premium Plan"), which may be refundable if
the coverage is canceled by the insured lender (which generally occurs when the
loan is repaid or the value of the property has increased significantly).
During May 1999, PMI began offering its Super Single/ SM/ product that provides
coverage on 97% LTV loans. The single premium can be financed by the borrower by
adding it to the principal amount of the mortgage and generally covers the
greater of 10 years or amortization of the underlying loan to an 80% LTV. Single
Premium Plans represented 3.0% of NIW in 1999.
Annual Premium. A premium payment plan that requires the payment of the
first-year premium at the time of mortgage loan closing and annual renewal
premium payments in advance each year thereafter ("Annual Premium Plan").
Renewal payments generally are collected in monthly installments from the
borrower along with the mortgage payment and held in escrow by the loan servicer
for annual remittance to PMI in advance of each renewal year. Annual Premium
Plans represented 1.1% of NIW in 1999.
Pool Insurance
During the fourth quarter of 1997, PMI began offering a pool insurance product,
primarily to Fannie Mae and Freddie Mac, as part of PMI's value added strategy.
This product was also sold to state housing finance authorities. Pool insurance
is generally used as an additional credit enhancement for certain secondary
market mortgage transactions and generally covers the loss on a defaulted
mortgage loan that exceeds the claim payment under the primary coverage, if
primary insurance is required on that mortgage loan. Pool insurance also
generally covers the total loss on a defaulted mortgage loan that did not
require primary insurance, in each case up to a stated aggregate loss limit.
New risk written for this product was $231 million and $450 million for the
years ended December 31, 1999 and 1998, respectively. This product is similar
in structure to the pool insurance product previously offered by PMI during 1990
- - 1993, but has better risk management characteristics, including lower stop
loss limits, improved nationwide
6
geographic diversification and lower LTVs. The average stop loss limit for this
product as of December 31, 1999 was 1.07%. Risk in force under pool insurance
programs with PMI's customers represented approximately three percent of the
$21.2 billion total primary risk in force at December 31, 1999 (See IC10.).
In July 1999, the California Department of Insurance approved a Recapture
Agreement between PMI and Forestview Mortgage Insurance Company ("Forestview")
relating to mortgage pool policies written prior to 1994. As a result of the
commutation and recapture of the Reinsurance Agreement with Forestview, PMI
received $45.5 million in cash in consideration of the recapture liability
(consisting of the returned unearned premium reserve, and the reimbursement of
the reserve for losses), the roll back of 1999 reinsurance transactions, and the
settlement of reimbursable fees and prepaid expenses. In connection with the
Recapture Agreement, PMI assumed mortgage insurance obligations of approximately
$42.8 million, net of expense allocations, previously insured by Forestview.
Risk in force for the recaptured Forestview portfolio was $1.41 billion at
December 31, 1999.
Risk-Sharing Products
In addition to standard primary and pool insurance, PMI offers: (i) layered co-
insurance, a primary mortgage insurance program for a covered loan for which a
mortgage originator or a state housing authority retains liability for losses
above a certain level of aggregate losses and below a second specified level of
aggregate losses, above which the mortgage insurer retains liability; (ii)
pmiADVANTAGE/SM/, a lender-paid primary mortgage insurance program that provides
reductions from standard rates based on the quality of the business generated;
(iii) pmiCAPTIVE/SM/, a captive reinsurance program that allows a reinsurance
company, generally an affiliate of the lender, to assume primary mortgage
insurance default losses at a specified entry point up to a maximum aggregate
exposure, up to an agreed upon amount of total coverage; (iv) performance
assurance agreements, for which PMI compensates lenders to cover a layer of
losses in excess of a specified level of losses associated with business
generated by the lender; and (v) pmiEXTRA/SM/ coverage, a product which provides
an additional layer of primary mortgage insurance coverage (up to 15%) on all
insured loans in a portfolio sold to GSEs. TPG also offers performance notes, a
program whereby TPG issues an unsecured, private placement note that pays a base
rate of interest plus, if appropriate, a performance addition. The interest rate
on the note varies based on the performance of the lender's book of business
written during the origination period. To date the risk-sharing products have
not represented a significant portion of PMI's or TPG's revenues. Several of the
above risk-sharing products, as well as pool insurance, are the subject of
pending regulatory reviews. Management is unable to predict the impact of these
regulatory issues on these products. (See "D. Competition and Market Share" and
IC2 and IC8.)
Joint Venture
CMG Mortgage Insurance Company ("CMG") offers mortgage guaranty insurance for
loans originated by credit unions. CMG is operated as a joint venture equally
owned between PMI and CUNA Mutual Investment Corporation (''CMIC''). PMI and
CMIC provide services to CMG, with CMIC providing primarily sales and marketing
services and PMI providing primarily
7
insurance operation services. CMIC is a part of the CUNA Mutual Group, which
provides insurance and selected financial services to credit unions and their
members in the United States and over 50 other countries. CMG's claims-paying
ability is currently rated AA by both Fitch IBCA and by Duff & Phelps Credit
Rating Co.
As of December 31, 1999, CMG was licensed and operational in 49 states and the
District of Columbia. CMG is approved as a mortgage insurer by both Fannie Mae
and Freddie Mac, as well as by other purchasers of credit union originated
mortgage loans. Since inception, CMG has issued approximately 1,300 master
policies to credit union and credit union affiliated organizations nationwide.
At December 31, 1999, CMG had $5.8 billion of primary insurance in force.
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.
International
The Company also provides mortgage guaranty insurance and reinsurance in
Australia, New Zealand and Hong Kong, which is described in more detail under
"Section N. Other Businesses."
C. Industry Overview
Fannie Mae and Freddie Mac
The GSEs are the predominant purchasers and sellers of conventional mortgage
loans in the United States, providing a direct link between the primary mortgage
origination markets and the capital markets. The GSEs are permitted to 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. 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 by the loan originations. Because loan
originators prefer to make loans that may be marketed in the secondary market to
Fannie Mae and/or Freddie Mac without having to hold such capital, they are
motivated to purchase mortgage insurance from insurers deemed eligible by the
GSEs. PMI is an authorized mortgage insurer for the GSEs. (See "O. Regulation",
below.)
During October 1998, Freddie Mac sought to amend its charter to allow it to use
any method of default loss protection that is financially equal or superior, on
an individual or pooled basis, to the protection provided by private mortgage
insurance companies. The legislation containing the proposed charter amendment
was subsequently rescinded. Subsequent to the withdrawal of the
8
legislation, Freddie Mac announced that it would pursue a charter amendment that
would allow it to utilize alternative forms of default loss protection or
otherwise forego the use of private mortgage insurance on higher loan-to-value
mortgages. Currently, Freddie Mac can purchase loans with down payments of less
than 20% only if the loans are insured or use other limited methods to protect
against default (See IC3).
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. One of the
GSEs eligibility requirements is that private mortgage insurers, including PMI,
must at least maintain an AA- rating with any public national rating agency. Any
change in PMI's existing eligibility status, primarily its claims-paying ability
rating from the various rating agencies, could have a material and adverse
effect on the Company's financial condition and results of operations. (See
IC5.)
Since the GSEs are the primary investors in mortgage loans, they have the
ability to implement new eligibility requirements for mortgage insurers, change
the pricing arrangements for purchasing retained participation mortgages as
compared to insured mortgages or alter or liberalize underwriting standards on
low down payment mortgages they purchase. Private mortgage insurers, including
PMI, are affected by such changes implemented by Fannie Mae or Freddie Mac. (See
"D. Competition and Market Share", "O. Regulation", and IC2 and IC3.)
Since 1992, Fannie Mae and Freddie Mac have been subject to oversight
legislation for GSEs by the Department of Housing & Urban Development (HUD)
which simultaneously tightened their capital requirements and set goals for
affordable housing. Their goals are based on the percentage of loans purchased
by the GSEs, determined by the number of dwelling units securing such loans.
Fannie Mae also expanded its Community Home Buyers Program to include a
commitment to purchase a certain volume of 97s.
Recently, HUD announced new affordable housing goals for the GSEs. Under the new
goals beginning for year 2001, at least 50% of all loans purchased by the GSEs
must support low- and moderate-income homebuyers. The GSEs' current goal for
affordable housing is that at least 48% of the units financed by each GSE be
low- and moderate-income housing, and that approximately 24% of such units be in
underserved areas (which are defined as census tracts with either a median
income no greater than 90% of area median, or with a median income no greater
than 120% of area median income and a minority population of at least 30%).
Under the proposal, this target would increase up to 31 percent. The special
affordable housing goal, which measures funding for families with very-low
household income or living in low-income areas, would increase from 14 percent
to 20 percent. The proposed goals are subject to review by the Office of
Management and Budget and would be subject to a public comment period prior to
final revisions or enactment by HUD. TPG believes that the GSEs' goals to
expand purchases of affordable housing loans have increased the overall size of
the total mortgage insurance market because such loans are traditionally in
excess of 80% LTV, with a majority being in excess of 90% LTV.
The Federal Housing Enterprises Financial Safety and Soundness Act of 1992,
requires the Office of Federal Housing Enterprise Oversight ("OFHEO") to develop
a risk-based capital regulations for the GSEs. In April 1999, a notice of
proposed rulemaking was published in the
9
Federal Register announcing OFHEO's development of proposed risk-based capital
regulations. The regulation specifies 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 proposed regulations could require a GSE to hold more than
double the capital it presently maintains for loans with loan-to-value ratios
("LTV") of 95 percent or higher. Further, the proposed capital regulations could
treat more favorably credit enhancements issued by private mortgage insurance
companies with a claims-paying ability rating of AAA compared with those
companies with a rating lower than AAA (See IC3).
Freddie Mac's and Fannie Mae's automated underwriting services, Loan
Prospector/SM/ and Desktop Underwriter, respectively, can be used by mortgage
originators to determine whether Freddie Mac or Fannie Mae will purchase a loan
prior to closing. Through these systems, lenders are able to obtain approval for
mortgage guaranty 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. (See "H. Underwriting Practices--Role of
Technology, and Delegated Underwriting", below.)
Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of
mortgage insurance generally provide that a borrower's written request to cancel
mortgage insurance should be honored if: (a) the borrower has a satisfactory
payment record with no payment more than 30 days delinquent in the 12 month
period preceding the request for cancellation; and (b) the unpaid principal
balance of the mortgage is not greater than 80% of the original value of the
property. The Home Owners Protection Act of 1998 (the "Act"), which became
effective on July 29, 1999, provides for the automatic termination, or
cancellation upon a borrower's request, of private mortgage insurance upon
satisfaction of certain conditions. The Act applies to owner-occupied
residential mortgage loans regardless of lien priority, with borrower-paid
mortgage insurance and which closed after the effective date of the Act. FHA
loans are not covered by the Act. Under the Act, automatic termination of
mortgage insurance would generally occur once the loan-to-value ratio ("LTV")
reaches 78%. A borrower may generally request cancellation of mortgage insurance
once the LTV reaches 80% of the home's original value, or when actual payments
reduce the loan balance to 80% of the home's original value, whichever occurs
earlier. For borrower initiated cancellation of mortgage insurance, the borrower
must have a good payment history. Good payment history generally requires that
there have been no payments during the 12-month period preceding the loan's
cancellation date 30 days or more past due, or 60 days or more past due during
the 12-month period beginning 24 months before the loan's cancellation date.
Loans which are deemed "high risk" by the GSEs, require automatic termination of
mortgage insurance coverage once the LTV is first scheduled to reach 77% of the
original value of the property without regard to the actual outstanding balance.
The Act preempts all but more protective, preexisting state laws. (See "O.
Regulation", and IC4, below.)
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D. Competition and Market Share
The U.S. private mortgage insurance industry consists of eight active mortgage
insurers, including Mortgage Guaranty Insurance Corporation ("MGIC"), GE
Capital Mortgage Insurance Corporation ("GEMICO"), an affiliate of GE Capital
Corporation, United Guaranty Residential Insurance Company ("UGC"), an
affiliate of American International Group, Inc., and Radian Group, Inc.
(Radian"). PMI, including CMG, is the third largest private mortgage insurer in
the United States based on new primary insurance written in 1999. (Source:
Inside Mortgage Finance.) In 1999, MGIC possessed the largest share of the
private mortgage insurance market, with approximately 24.3% of NIW, and Radian,
PMI, GEMICO and UGC had market shares of approximately 17.5%, 16.3%, 15.2% and
14.4%, respectively. (Source: Inside Mortgage Finance.) PMI's 1999 market share
percentage includes 1.3% of the market held by CMG. (See Part II, Item 7--
"Management's Discussion And Analysis Of Financial Condition And Results of
Operations", and IC2.)
The following table indicates the market share by private mortgage insurer based
on NIW over the past five years:
Private Mortgage Insurance Industry Market Share
Year Ended December 31,
------------------------------------------------------------
1999 1998 1997 1996 1995
-------- --------- --------- --------- ----------
Mortgage Guaranty Insurance Corp. 24.3 % 23.1 % 26.4 % 25.5 % 27.4
Radian Guaranty Inc. (1) 17.5 19.4 17.8 15.7 14.9
PMI Mortgage Insurance Co. (2) 16.3 16.2 13.8 14.7 13.5
GE Capital Mortgage Insurance Co. 15.2 16.4 16.5 18.5 20.1
United Guaranty Corp. 14.4 12.7 12.8 12.7 12.9
Republic Mortgage Insurance Co. 10.0 9.7 10.3 11.2 9.7
Triad Guaranty Insurance Corp. 2.3 2.5 2.4 1.7 1.5
-------- -------- ------- ------- -------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
======== ======== ======= ======= =======
Source: Inside Mortgage Finance
(1) Formerly CMAC & Amerin; market share data prior to the merger represents
combined pro forma results of CMAC & Amerin.
(2) Includes CMG.
The following table indicates the market share by private mortgage insurer for
each quarter in 1999:
11
Private Mortgage Insurance Industry Market Share
1999 by Quarter
--------------------------------------------------------------------------------
4Q 1999 3Q 1999 2Q 1999 1Q 1999
-------------------- ------------------ ---------------- ----------------
Mortgage Guaranty Insurance Corp. 24.5 % 24.4 % 24.5 % 23.9 %
PMI Mortgage Insurance Co. (1) 16.6 16.1 16.5 15.9
United Guaranty Corp. 16.3 14.2 13.8 13.7
Radian Guaranty Inc. (2) 16.3 17.6 17.9 18.1
GE Capital Mortgage Insurance Corp. 14.8 15.1 15.8 14.9
Republic Mortgage Insurance Co. 9.3 10.4 9.2 10.8
Triad Guaranty Insurance Corp. 2.2 2.2 2.3 2.7
--------------------- ------------------ ---------------- ----------------
Total 100.0 % 100.0 % 100.0 % 100.0 %
===================== ================== =============== ===============
Source: Inside Mortgage Finance
(1) Includes CMG.
(2) Formerly CMAC & Amerin; market share data prior to the merger represents
combined pro forma results of CMAC & Amerin
PMI and other private mortgage insurers also compete directly with federal and
state governmental and quasi-governmental agencies, principally the FHA and, to
a lesser degree, the VA. These agencies sponsor government-backed mortgage
insurance programs combined to accounted for 47.6%, 43.7%, 45.6%, and 44.8% for
1999, 1998, 1997 and 1996, respectively, of all loans insured or
guaranteed/(2)./ On January 1, 2000, the Department of Housing and Urban
Development announced a proposed increase in the maximum individual loan amount
that FHA can insure to $219,849 from $208,800. The maximum individual loan
amount that the VA can insure is $203,150 (See IC2). Private mortgage insurers
have no limit as to maximum individual loan amounts that they can insure.
(2) According to data from the Department of Housing and Urban Development
("HUD"), VA and Inside Mortgage Finance.
The Omnibus Spending Bill of 1999, streamlined the FHA down payment formula by
eliminating tiered minimum cash investment requirements and establishing maximum
loan-to-value ratios based on loan size and closing costs, making FHA insurance
more competitive with private mortgage insurance in areas with higher home
prices. (See IC2.)
The following table indicates the relative share of the mortgage insurance
market based on NIW by FHA/VA and private mortgage insurers over the past five
years.
Federal Government and Private Mortgage Insurance Market Share
Year Ended December 31,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------- ------------- ------------ ----------- ------------
FHA/VA 47.6 43.7 % 45.6 % 44.8 % 38.5 %
Private Mortgage Insurance 52.4 56.3 % 54.4 55.2 61.5 %
-------------- ------------- ------------ ----------- ------------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============== ============= ============= =========== ============
12
Source: Inside Mortgage Finance
Fannie Mae and Freddie Mac announced an increase in the maximum single-family
principal balance loan limit eligible for their purchase from $240,000 to
$252,700 effective in 2000. Since the GSEs are the predominant purchasers and
sellers of conventional mortgage loans in the United States, loan originators
prefer to make loans that may be marketed in the secondary market to Fannie Mae
and/or Freddie Mac. Loan originators are motivated to purchase mortgage
insurance from insurers deemed eligible by the GSEs. Because PMI is an
authorized mortgage insurer for the GSEs, management believes any increase in
the GSEs loan limit eligible for their purchase may positively affect the number
of loans eligible for mortgage insurance and may have the effect of increasing
the size of the mortgage insurance market. (See "C. Industry Overview",
above.)
Freddie Mac and Fannie Mae both introduced programs in 1999 that offer reduced
mortgage insurance coverage availability for lenders that generally deliver
loans approved by the GSE's automated underwriting services, Loan Prospector/SM/
and Desktop Underwriter, respectively. Generally, Fannie Mae's and Freddie Mac's
reduced mortgage insurance coverage options provide for: (i) across-the-board
reductions in required MI coverage on 30-year fixed-rate loans recommended for
approval by GSE's automated underwriting services to the levels in effect in
1994; (ii) reduction in required MI coverage, for loans with only a 5% down
payment (a 95% LTV), from 30% to 25% of the mortgage loan covered by MI; (iii)
reduction in required MI coverage, for loans with a 10% down payment (a 90% LTV
loan), from 25% to 17% of the mortgage loan covered by MI. In addition, the
GSE's announced programs to further reduce MI coverage upon the payment of an
additional fee by the lender. Under this option, a 95% LTV loan will require 18%
of the mortgage loan to have mortgage insurance coverage. Similarly, a 90% LTV
loan will require 12% of the mortgage loan have mortgage insurance. In order
for the homebuyer to have MI at these levels, such loans would require a payment
at closing or a higher note rate. Through 1999 the reduced MI coverage
programs have not produced any significant volume (See IC3.)
The Office of the Comptroller of the Currency has granted permission to certain
national banks to form a reinsurance company as a wholly-owned operating
subsidiary for the purpose of reinsuring mortgage insurance written on loans
originated or purchased by such bank. The Federal Reserve Board is in the
process of considering whether similar activities are permitted for bank holding
companies. The Office of Thrift Supervision has also recently granted permission
for subsidiaries of thrift institutions to reinsure private mortgage insurance
coverage on loans originated or purchased by affiliates of such thrift's parent
organization. The reinsurance subsidiaries of national banks, savings
institutions, or bank holding companies could become significant competitors of
the Company in the future. In addition, the Gramm-Leach-Bliley Act of 1999,
among other things, allows 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 (See "O.
Regulation", IC2 and IC15.)
PMI and other private mortgage insurers also 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%
13
LTV ratio, a 10% second mortgage lien, and 10% of the purchase price from
borrower's funds ("80/10/10"). This 80/10/10 product, as well as similar type
products, competes with mortgage insurance as an alternative for lenders selling
loans in the secondary mortgage market. On March 8, 2000, the Federal Deposit
Insurance Corporation, the Office of the Comptroller of the Currency and other
banking regulators issued a proposal to amend their risk-based capital standards
to treat direct credit substitutes and recourse obligations consistently and
would incorporate the use of credit ratings as an indicator of a bank's risk of
loss. It is believed that the proposal would increase the amount of capital
national banks and thrifts would be required to hold for 80/10/10 and similar
products when the lender holds the first and second mortgage. State-chartered
banks already are subject to the higher capital requirement (See IC2). Any
change in legislation which affects the risk-based capital rules imposed on
banks and savings institutions, or which change the GSEs' insurance requirements
may affect the desirability of foregoing insurance for lending institutions or
the GSEs and, therefore, affect the size of the insurance mortgage market (See
"O. Regulation", below).
In addition to captive reinsurance arrangements with subsidiaries of banks,
mortgage insurers like PMI reinsure some portion of coverage issued to certain
lenders with affiliates of those lenders and/or through uncaptive structures.
PMI is also pursuing various risk-sharing arrangements for certain of its
customers, including offering various premium rates based on the risk
characteristics, loss performance or class of business of the loans to be
insured, or 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 PMI or TPG for the risks associated with
the coverage provided to its customers. Management is unable to predict the
impact of these arrangements with non-bank captive reinsurers and uncaptive
reinsurers, or the performance notes or their long-term competitive effect (See
"K. Reinsurance", IC4 and IC8.)
The Gramm-Leach-Bliley Act of 1999 (the "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 Act
allows a bank holding company to form an insurance subsidiary, licensed under
state insurance law, to issue insurance products directly, including mortgage
insurance. However, any such mortgage insurance subsidiary would be subject to
and governed by state insurance regulations, including capital and reserve
requirements, diversification of risk 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 Fannie Mae and
Freddie Mac eligibility standards, which currently require, among other things,
a claims-paying ability rating of at least AA-, and the establishment of
comprehensive operating policies, procedures and processes.
Coinciding with the effective date of the Act, several national banks announced
that they meet the criteria to own financial subsidiaries, including sufficient
capitalization and stated plans to create one or more operating subsidiaries.
Two national bank holding companies indicated that they intend to use their
financial subsidiaries to sell insurance. The Federal Reserve Board recently
issued a proposed rule to allow state-chartered banks that are members of the
Federal Reserve System own financial subsidiaries. The proposed rule is
designed to establish parity
14
between state member banks and national banks. Because of the many aspects of
the Act which require clarification and promulgation of specific regulations,
the Company is not yet able to ascertain the full impact of the Act on the
Company (See IC15).
In addition to competition from federal agencies, PMI and other private mortgage
insurers face limited competition from state-supported mortgage insurance funds.
As of December 31, 1999, several states (among them California, Connecticut,
Maryland, Massachusetts, New York, and Vermont) have state housing insurance
funds which are either independent agencies or affiliated with state housing
agencies.
For the year ended December 31, 1999, total mortgage originations according to
the Mortgage Bankers Association of America were estimated to be $1.3 trillion
compared to $1.5 trillion for the year ended December 31, 1998.
E. Customers
PMI insures mortgage loans funded by mortgage originators. Mortgage originators
include mortgage bankers, savings institutions, commercial banks and other
mortgage lenders.
For the year ended December 31, 1999, PMI's primary customers were mortgage
bankers, with the balance of its customers being savings institutions,
commercial banks and other mortgage lenders. Mortgage brokers originate loans on
behalf of mortgage lenders and are not master policyholders. As a result,
mortgage brokers are not the beneficiaries of policies issued by PMI. The
beneficiary under the master policy is the owner of the insured loan and,
accordingly, when a loan is sold, the purchaser of the loan is entitled to the
policy benefits.
Because the GSEs are the predominant purchasers and sellers of conventional
mortgage loans in the United States, Fannie Mae and Freddie Mac are the
beneficiary of the majority of the Company's mortgage insurance coverage.
F. United States Business Composition
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. PMI's policies for
insurance coverage typically have a policy duration averaging five to seven
years. Insurance coverage may be canceled by the policy owner or servicer of the
loan at any time. PMI has no control over the owner's or servicer's decision to
cancel insurance coverage and self-insure or place coverage with another
mortgage insurance company. However, the GSE's have restrictions on changing
mortgage insurance providers. There can be no assurance that policies for
insurance coverage originated in a particular year or for a particular customer
will not be canceled at a later time or that the Company will be able to regain
such insurance coverage at a later time.
The composition of PMI's direct primary risk in force, as summarized on the
following table, reflects several changes over the five-year period from 1995 to
1999. The relatively low interest rates during this period resulted in an
increasing percentage of mortgages insured by PMI at a
15
fixed rate of interest, representing 91.4% of direct primary risk in force at
December 31, 1999, up from 76.8% at year-end 1995. Based on PMI's experience,
fixed rate loans represent less risk than adjustable rate mortgages ("ARMs")
because claim frequency on ARMs is generally higher than on fixed rate loans.
PMI charges higher premium rates for ARMs, 95s and 97s to compensate for the
higher risk associated with such loans, although there can be no certainty that
the differential in the higher premium rate will be adequate to compensate for
the higher risk.
In 1995, the GSEs increased their coverage requirements to 30% and 25%, on 95s
and 90s, respectively. PMI's percentage of risk in force with the higher
coverage requirements has steadily increased since 1995, and the percentage of
risk in force comprised of 95s with 30% coverage has increased from 34.4% for
the year ended December 31, 1998 to 37.6%, for the year ended December 31, 1999.
During the period between 1998 and 1999, PMI's direct primary risk in force
increased by 9.8% from $19.3 billion at December 31, 1998 to $21.2 billion at
December 31, 1999.
During 1999, Fannie Mae and Freddie Mac reduced the mortgage insurance coverage
requirements for borrowers recommended for approval by their automated loan
underwriting systems, Desktop Underwriter/SM/ and Loan Prospector/SM/,
respectively. Management believes it is too early to assess impact of the
Fannie Mae and Freddie Mac reduction of required levels of mortgage insurance on
the Company's financial condition and results of operations. However, during
1999, PMI's percentage of insurance in force with higher coverage levels
continued to increase as mortgage lenders and investors continue to prefer MI
policies with the higher coverage percentages. If the reduction in required
levels of mortgage insurance were to become widely accepted by mortgage lenders
and their customers, this shift could have a materially adverse impact on the
Company's financial condition and results of operations. (See "D. Competition
and Market Share", above and IC3.)
The composition of PMI's NIW has included an increasing percentage of mortgages
with LTVs in excess of 90% and less than or equal to 95% ("95s"). At December
31, 1999, 46.7% of PMI's risk in force consisted of 95s, which, in PMI's
experience, have had a claims frequency approximately twice that of mortgages
with LTVs equal to or less than 90% and over 85% ("90s"). "). At December 31,
1999, 48.4% of PMI's risk in force consisted of 90s and below. PMI also offers
coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"). At
December 31, 1999, 4.9% of PMI's risk in force consisted of 97s that have even
higher risk characteristics than 95s and greater uncertainty as to pricing
adequacy. PMI's NIW also includes coverage for adjustable rate mortgages
("ARMs"), which, although priced higher, have risk characteristics that exceed
the risk characteristics associated with PMI's book of business as a whole.
Although PMI charges higher premium rates for loans that have higher risk
characteristics, including ARMs, 95s and 97s, the premiums earned on such
products, and the associated investment income, may ultimately prove to be
inadequate to compensate for future losses from such products (See IC10.).
16
The following table reflects the percentage of PMI's direct primary risk in
force (as determined on the basis of information available on the date of
mortgage origination) by categories and as of the dates indicated:
Direct Risk in Force
As of December 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- ---------- ---------- ----------
Direct Risk in Force (In millions) $ 21,159 $ 19,324 $ 18,092 $ 17,336 $ 15,130
--------- --------- ---------- ---------- ----------
Lender Concentration:
Top 10 Lenders (by original applicant) 36.1 % 30.0 % 27.8 % 26.0 % 22.5 %
========= ========= ========= ========== ==========
LTV:
97s 4.9 % 3.3 % 1.8 % 0.0 % 0.0 %
95s 46.7 46.3 46.2 44.7 40.6
90s and below 48.4 50.4 52.0 55.3 59.4
--------- --------- --------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========= ========= ========= ========== ==========
Average Coverage Percentage 24.4 % 23.9 % 24.3 % 22.4 % 21.2 %
========= ========= ========= ========== ==========
Loan Type:
Fixed 91.4 % 89.7 % 83.3 % 80.6 % 76.8 %
ARM 7.9 9.2 15.2 17.7 21.3
ARM (scheduled/potential
negative amortization) 0.7 1.1 1.5 1.7 1.9
--------- --------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========= ========= ========== ========== ==========
Mortgage Term:
15 years and under 4.4 % 5.3 % 6.3 % 9.4 % 8.6 %
Over 15 years 95.6 94.7 93.7 90.6 91.4
--------- --------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========= ========= ========== ========== ==========
Property Type:
Single-family detached 87.5 % 87.1 % 86.3 % 86.7 % 86.7 %
Condominium 6.1 6.4 6.8 6.9 7.1
Other 6.4 6.5 6.9 6.4 6.2
--------- --------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========= ========= ========== ========== ==========
Occupancy Status:
Primary residence 98.0 % 98.6 % 99.0 % 99.2 % 99.3 %
Second home 1.2 1.0 0.8 0.6 0.5
Non-owner occupied 0.8 0.4 0.2 0.2 0.2
--------- --------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========= ========= ========== ========== ==========
Loan Amount:
$100,000 or less 24.0 % 26.4 % 27.3 % 28.3 % 28.8 %
Over $100,000 and up to $250,000 68.6 66.1 65.6 64.8 64.3
Over $250,000 7.4 7.5 7.1 6.9 6.9
--------- --------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========= ========= ========== ========== ==========
G. Sales, Product Development and Underwriting Personnel
PMI employs a sales force and underwriting staff located throughout the country
to sell its products, underwrite loans and provide services to lenders located
throughout the United States. At December 31, 1999, PMI had 30 sales and
underwriting service field and satellite offices located in 26 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
17
Department has primary responsibility for advertising, sales materials, pricing
and the creation of new products and services. PMI's product development and
underwriting personnel at the director level and above, are eligible to
participate in a bonus plan; all other personnel are compensated solely by
salary.
PMI's underwriting force have access to electronic data interchange, automated
mortgage scoring systems and automated underwriting systems which give them the
ability to more efficiently process and underwrite both conforming and non-
conforming loans to investors standards. (See "H. Underwriting Practices -
Technology and Underwriting Practices" below.) PMI's Certificate Priority Center
("CPC"), in Dallas Texas is the central processing facility for underwriting
data input and the issuance of PMI's insurance certificates. CPC was designated
to centralize the processing of data input and to enhance operational
productivity and efficiency, customer service and expense management. New
policies processed at the CPC represented 54.1% of PMI's NIW in 1999 compared
with 38.3% in 1998. During 1999, applications processed at the CPC represented
64% of all applications compared with 47.0% in 1998.
The Company, through MSC, provides contract underwriting services that enable
customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting. Such contract
underwriting services are provided for mortgage loans for which PMI provides
mortgage insurance and for loans on which PMI does not. MSC also performs all of
the contract underwriting activities of CMG. As a part of its contract
underwriting services, PMI provides remedies which may include the assumption of
some of the costs of repurchasing insured and uninsured loans from the GSEs and
other investors. Generally, the scope of these remedies are in addition to those
contained in PMI's master primary insurance policies. Contract underwriting
services have become increasingly important to mortgage lenders as they seek to
reduce costs. New policies processed by contract underwriters represented 28.8%
of PMI's NIW in 1999 compared with 35.0% in 1998.
H. Underwriting Practices
Risk Management Approach
PMI underwrites its primary business based upon the historical performance of
risk factors of individual loan profiles, and utilizes automated underwriting
systems in the risk selection process to assist the underwriter with decision
making. PMI's underwriting process evaluates five categories of risk:
. 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.
18
. Loan Characteristics. PMI analyzes four general characteristics of the
loan product to quantify risk: (i) LTV; (ii) type of loan instrument;
(iii) type of property; and (iv) 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, and loans originated using reduced documentation.
. Property Profile. PMI reviews appraisals regarding methodology used to
determine the property price.
. 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.
The national guidelines have developed over time and take into account PMI's
loss experience and the underwriting guidelines of Fannie Mae and Freddie Mac.
PMI expects its internal and contract 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- and
post-loan credit counseling to borrowers using the 97% product as an aid in
managing the greater risks associated with 97s compared to 95s. (See IC12.)
Underwriting Process
To obtain mortgage insurance on a specific mortgage loan, a master policyholder
typically submits an application to one of PMI's regional underwriting offices,
supported by various documents. Besides the standard full documentation
submission program, PMI also accepts applications for insurance under a reduced
documentation submission program (the "Quick Application Program"), which is
limited to those lenders with a track record of high quality business. PMI's
Quick Application 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
19
submitted under this program. (See "G. Sales, Product Development and
Underwriting Personnel", above.)
The documents submitted to PMI by the mortgage lender 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, a written credit report on the borrower and, under the
standard full documentation submission program, a verification of the borrower's
employment, income and funds needed for the loan closing (principally, down
payment) and the home purchase contract. Once the loan package is received by
PMI's home or field underwriting offices, key borrower, property and loan
product information is extracted from the file by an underwriting staff member
and analyzed by automated underwriting systems -- pmiAURA(SM) and pmiTERRA(SM).
During 1999, 56.6% of applications received were approved by the automated
underwriting systems. In 1998, 62.2% of applications received were approved by
the automated underwriting systems. Such applications generally have favorable
risk characteristics, such as strong borrower credit ratings, low borrower debt-
to-income ratios and stable borrower income histories. Any loans not
automatically approved are referred to an underwriter for review of the entire
insurance application package. The underwriter reviews the detailed systems
analysis and borrower, loan and property profiles to determine if the risk is
acceptable. The underwriter either approves, delays the final decision pending
receipt of more information or declines the application for insurance. PMI
generally responds within one business day after an application and supporting
documentation is received.
PMI's rejection rate remained consistent with 1998 at approximately 4.5% for the
year ended December 31, 1999. 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.
Delegated Underwriting
PMI's Partner Delivered Quality Program (the "PDQ Program"), introduced in
1991, is a delegated underwriting program whereby approved lenders are allowed
to determine whether loans meet program guidelines and requirements approved by
PMI and are thus eligible for mortgage insurance. At present, over 1,000 lenders
actively approve applications under the PDQ Program. PMI's delegated business
accounted for 56.2% and 52.7% of PMI's NIW in 1999 and 1998, respectively, and
represented 44.1% of PMI's total risk in force at December 31, 1999. Delegated
underwriting enables PMI to meet mortgage lenders' demands for immediate
insurance coverage of certain loans. Such types of programs have now become
standard industry practice.
Under the PDQ Program, customers utilize their own PMI-approved underwriting
guidelines and eligibility requirements in determining whether PMI is committed
to insuring a loan. Once the lender notifies PMI of an insured loan, key loan
risk characteristics are evaluated by the pmiAURA(SM) model to monitor the
quality of delegated business on an ongoing basis. Additionally, PMI audits a
representative sample of loans insured by each lender participating in the PDQ
Program on a regular basis to determine compliance with program requirements. If
a lender participating in the program tentatively commits PMI to insure a loan
which fails to meet
20
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 normal process. PMI's
PDQ Program is also accessed through a customer interface with Freddie Mac's
Loan Prospector(SM) system. PMI has currently limited its interface
participation with Loan Prospector(SM) customers and/or lenders who are approved
to use the PDQ program.
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 underwriting proficiency are
eligible for the program; (ii) only loans meeting average-to-above average
underwriting eligibility criteria are eligible for the program; and (iii) PMI
has the ability to monitor the quality of loans submitted under the PDQ Program
with proprietary risk management tools and an on-site audit of each PDQ lender.
Technology and Underwriting Practices
In September 1999, PMI began offering its products and services via the
Internet. PMI customers can order mortgage insurance directly from their Web
sites using an embedded link that "frames" e-PMI, which is PMI's all-purpose,
electronic delivery channel for mortgage insurance origination within the site
and provides access to PMI's online services under the customer's own branded
image. Framing, which provides connectivity to the e-PMI channel, is available
by request and tailored to a lender's specifications. Currently it offers users
immediate, real-time access to mortgage insurance origination services and
mortgage insurance rates. PMI offers e-PMI as a value-added service to better
meet the online mortgage origination needs of its customers. PMI will be
seeking to offer expanded services in the future through the phased introduction
of new capabilities to include access to Desktop Underwriter and Loan
Prospector(SM) decisioning, contract underwriting services, pmiAURA(SM)scoring,
and access to WEB-CONNECT(SM), PMI's online servicing update product.
PMI accepts applications for insurance electronically through an electronic data
interchange ("EDI") link with a lender. EDI links, through pmiPAPERLESS(SM),
serve to reduce paperwork for both PMI and its customers, streamline the process
by which mortgage insurance is applied for, reduce the number of errors
associated with re-entering information, and increase the speed with which PMI
is able to respond to applications, all of which can enhance PMI's relationship
with lenders while reducing underwriting costs.
pmiAURA(SM) employs claim and risk statistical models to predict the relative
likelihood of default by a mortgage borrower. pmiAURA(SM) assigns all
applications received by PMI a risk score predicting the likelihood of default,
and automatically refers certain applications to underwriters based on higher
risk characteristics, territorial underwriting guidelines or other
administrative requirements. The individual underwriter will then make the
final decision on those files referred by pmiAURA(SM). The pmiAURA(SM) database
contains performance data on over 2.8 million loans, and includes economic and
demographic information to enhance its predictive power. The pmiAURA(SM) system
generates three types of scores: a loan risk score that
21
assesses the risk solely due to the borrower, loan and property characteristics
independent of market risk; a market score which is a measure of the default
risk due solely to the metropolitan area economic conditions; and the
pmiAURA(SM) Score, which combines the information in the loan risk and market
scores. Also, the newest fifth generation includes a revised credit score
indicator that provides an enhanced predictor of the relative likelihood of
default by a mortgage borrower.
The pmiTERRA(SM) system complements pmiAURA(SM) by providing a fully automated
appraisal analysis, and currently contains over 900,000 residential property
profiles. This analysis determines if the appraiser adequately supported the
final estimate of value. A key ingredient in the pmiTERRA(SM) appraisal model is
a consideration of the health of the real estate market in which the property is
located.
The automated underwriting systems free underwriters from having to review the
highest quality applications, and enable the underwriters to focus on more
complex credit packages and market and lender analyses. In addition to their use
in underwriting almost all of PMI's mortgage insurance applications from
lenders, the automated underwriting systems provide daily reports that assist
underwriting management in monitoring the credit and property risk being
committed for mortgage insurance. On the basis of its experience with the
automated underwriting systems, PMI believes that, in addition to improving
underwriting results, these automated underwriting systems have improved PMI's
underwriting efficiency and have brought consistency to the underwriting
judgment process. PMI's contract underwriters and its field underwriting force
have access to PMI's automated underwriting systems.
PMI, through its internal underwriting systems, provides its customers access to
Freddie Mac's and Fannie Mae's automated underwriting services, Loan
Prospector(SM) and Desktop Underwriter(SM), respectively, which are used as
tools by mortgage originators to determine whether Freddie Mac or Fannie Mae
will purchase a loan prior to closing. 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. Currently, e-PMI customers are not offered access to the GSEs
automated underwriting programs.
As an added benefit, pmiAURA's(SM) 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. PMI currently licenses pmiAURA(SM) to
approximately 25 customers or lenders, including 6 of the top 10 mortgage
lenders, who use pmiAURA(SM) as a tool to help understand more completely the
risk profiles of the loans they originate and the applications PMI is most
likely to approve. PMI, through The Customer Technology Division of MSC, makes
available to all pmiAURA(SM) licensees customer service, technical support and
software upgrades. Currently, pmiAURA(SM), is approved by all four Wall Street
rating agencies as an effective tool for establishing levels of credit support
needed on securities backed by non-
22
conforming, conventional loans. During 1999, PMI developed a modified version of
pmiAURA(SM) for users of Desktop Underwriter(TM) to evaluate FHA loans.
I. Affordable Housing
In recent years expanding home ownership opportunities for low and moderate-
income borrowers and communities has taken on an increased priority. PMI and
its lender customers have placed increased importance on this business. PMI's
approach to low-mod, or affordable lending, is to develop products and services
which assist responsible borrowers who may not have qualified using traditional
underwriting practices. These "non-traditional" underwriting standards assist
home buyers in verifying their ability to meet obligations in a timely and
conscientious manner, rather than accommodating borrowers who have historically
not managed their affairs in a responsible manner. The beneficiaries of these
programs have included recent immigrants who have not yet established
traditional credit histories; borrowers not accustomed to using traditional
savings institutions, and home buyers who although consistently employed, lack
the normally desired job stability due the nature of their employment.
To further promote affordable housing, PMI has entered into risk-sharing
arrangements with certain institutional lenders. PMI refers to such arrangements
as Layered Co-insurance. Layered Co-insurance is utilized primarily by financial
institutions to meet Community Reinvestment Act (CRA) lending goals. Under such
arrangements, the mortgage insurance is structured so that financial
responsibility is shared between the lender and PMI. Typically, PMI is
responsible for the first, and usually expected, loss layer, as well as a third
catastrophic layer, with the lender assuming a predetermined second loss layer.
PMI has also established partnerships with numerous national organizations to
mitigate affordable housing risks and expand the understanding of the
responsibilities of home ownership. These community partners include the San
Francisco based Consumer Credit Counseling Services, Neighborhood Reinvestment
Corp. and the affiliated Neighborhood Housing Services of America, and the
National American Indian Housing Conference. In addition, PMI has developed
partnerships with local organizations in an effort to expand home ownership
opportunities and promote community revitalization. These organizations include
the Oakland, California based Hispanic Unity Council, the San Francisco China
Town Community Development Corporation, the Orange County Affordable Home
Ownership Alliance, as well as several Native American nations, including the
Chickasaw, Choctaw, Cherokee and Navajo. In 1999 PMI's work with the Native
American nations was recognized by Social Compact, a nonprofit organization that
promotes grassroots strategies that attract private investment to lower-income
communities.
Programs offered under PMI's affordable housing initiatives receive the same
credit and actuarial analysis as all other standard programs. Loans to low and
moderate income borrowers
23
and communities accounted for approximately 30% of NIW. Additionally, the
percentage of this production that relied on "special" affordable underwriting
guidelines as designated as such by lenders was 8.8% of new risk written in
1999, as compared to 6.5% in 1998. Management believes that affordable housing
loans have higher risks than its other insured business. As a result, PMI has
instituted various programs, including borrower counseling and risk-sharing
approaches, seeking to mitigate the higher risk characteristics of such loans.
J. Defaults and Claims
Defaults
PMI's default rate has decreased to 2.12% at December 31, 1999 from the December
31, 1998 rate of 2.31%. This decrease was primarily due to an improvement in the
national economy, and particularly California, and to an increase in policies in
force. (See IC12 and Part II Item 7 "Management's Discussion and Analysis of
Financial Condition And Results of Operations".)
PMI's claim process begins with the receipt of notification of a default from
the insured on an insured loan. Default is defined in the master policy as the
failure by the borrower to pay when due an amount equal to the scheduled monthly
mortgage payment under the terms of the mortgage. The master policy requires
insureds to notify PMI of defaults no later than 130 days after the initial
default. Generally, defaults are reported sooner, and the average time for
default reporting in 1999 by PMI insureds was within approximately 60 days of
the initial default. PMI has historically included all defaults reported by the
lenders in its default inventory, regardless of the time period since the
initial default. The incidence of default is affected by a variety of factors,
including the reduction of the borrower's income, unemployment, divorce,
illness, the inability to manage credit and the level of interest rates.
Defaults that are not cured result in a claim to PMI. (See "Claims and Policy
Servicing" below.) Borrowers may cure defaults by making all delinquent loan
payments or by selling the property in full satisfaction of all amounts due
under the mortgage.
The following table shows the number of loans insured by PMI, the number of
loans in default and the default rate.
U.S. Historical Domestic Default Rates
Total Insured Loans in Force
Year Ended December 31,
---------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ----------- ----------- ------------ ------------
Number of Insured Loans in Force 749,591 714,210 698,831 700,084 657,800
Number of Loans in Default 15,893 16,528 16,638 15,326 13,022
Default Rate 2.12 % 2.31 % 2.38 % 2.19 % 1.98 %
Default rates differ from region to region in the United States depending upon
economic conditions and cyclical growth patterns. The two tables below
illustrate the impact of economic cycles on the various regions of the United
States and the ten largest states by PMI's risk in force as of December 31,
1999.
24
Default Rates by Region(1)
As of Period End,
------------------------------------------------------------------------------------------------
1999 1998
--------------------------------- ---------------------------------
Region 4th Q 3rd Q 2nd Q 1st Q 4th Q 3rd Q 2nd Q 1st Q 1997 1996 1995
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Pacific(2) 2.31 % 2.31 % 2.28 % 2.64 % 2.69 % 2.67 % 2.72 % 3.03 % 3.14 % 3.22 % 3.34 %
New England(3) 1.88 1.51 1.55 1.69 1.79 1.68 1.64 1.81 1.81 1.80 1.93
Northeast(4) 2.64 2.62 2.54 2.87 2.91 2.77 2.68 2.88 2.79 2.52 2.22
South
Central(5) 1.81 1.74 1.64 1.78 1.92 1.78 1.73 1.87 1.98 1.67 1.51
Mid-Atlantic(6) 2.11 2.17 2.04 2.21 2.37 2.23 2.22 2.40 2.35 2.03 1.65
Great Lakes(7) 1.95 1.91 1.85 1.91 1.98 1.94 1.88 1.88 1.86 1.82 1.21
Southeast(8) 2.31 2.18 2.02 2.25 2.39 2.16 2.10 2.35 2.31 1.93 1.53
North
Central(9) 1.67 1.70 1.67 1.88 1.96 1.91 1.78 1.95 1.95 1.61 1.31
Plains(10) 1.65 1.78 1.59 1.76 1.73 1.63 1.45 1.53 1.56 1.21 0.89
Total Portfolio 2.12 2.07 1.99 2.22 2.31 2.20 2.16 2.36 2.38 2.19 1.98
(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.
25
PMI's Default Rates for Top 10 States by Total Risk in Force(1)
Percent of PMI's
Primary Risk in
Force as of Default Rate
December 31, as of December 31,
------------------- ---------------------------------------------------
1999 1999 1998 1997 1996 1995
---------------- -------- -------- -------- -------- --------
California 15.61 % 2.59 % 3.15 % 3.73 % 3.81 % 4.08 %
Florida 7.50 3.00 3.08 2.93 2.40 1.92
Texas 7.27 2.06 2.18 2.25 2.04 1.85
New York 4.86 2.85 2.98 2.94 2.59 2.30
Illinois 4.73 2.01 2.35 2.56 2.14 1.84
Washington 4.72 1.62 1.58 1.66 1.58 1.21
Pennsylvania 4.03 2.38 2.64 2.38 2.13 1.91
Georgia 3.91 1.95 2.01 1.87 2.59 2.26
Virginia 3.71 1.42 1.55 1.67 1.54 1.18
Massachusetts 3.54 1.49 1.67 1.67 1.73 1.91
Total Portfolio 100.00 % 2.12 % 2.31 % 2.38 % 2.19 % 1.98 %
(1) Top ten states as determined by total risk in force as of December 31,
1999. Default rates are shown by states based on location of the underlying
property.
Default rates on PMI's California policies decreased to 2.59% (representing
2,382 loans in default) at December 31, 1999, from 3.15% (representing 3,067
loans in default) at December 31, 1998. Claim sizes on California policies tend
to be larger than the national average claim size due to higher loan balances
relative to other states. (See "Claims and Servicing", below.) Policies
written in California accounted for approximately 29% and 48% of the total
dollar amount of claims paid for the year ended December 31, 1999 and 1998,
respectively.
The following table sets forth the dispersion of PMI's primary insurance in
force and risk in force as of December 31, 1999, by year of policy origination
since PMI began operations in 1972.
26
Insurance and Risk in Force by Policy Year
Primary Percent Primary Percent
Policy Year Insurance in Force of Total Risk in Force of Total
- ----------- ------------------- ---------- ------------------- ----------
($ in thousands) ($ in thousands)
1972-1992 $ 6,176,358 7% $ 1,249,042 6%
1993 7,451,202 9% 1,501,696 7%
1994 4,606,852 5% 988,217 5%
1995 4,632,861 5% 1,222,687 6%
1996 6,539,999 8% 1,742,731 8%
1997 8,173,685 9% 2,160,348 10%
1998 23,171,725 27% 5,822,036 28%
1999 25,923,340 30% 6,459,515 31%
------------------- --------- -------------------- ---------
Total Portfolio $ 86,676,022 100% $ 21,146,272 100%
=================== ========= ==================== =========
Claims and Servicing
The majority of claims under PMI policies have historically occurred during the
third through the sixth years after issuance of the policies. Insurance written
by PMI from the period January 1, 1993 through December 31, 1996 represents 27%
of PMI's insurance in force at December 31, 1999. This portion of PMI's book of
business is in its expected peak claim period. Despite increasing coverage
percentages and increasing mortgage principal amounts, direct primary claims
paid by PMI in 1999 decreased to $79.6 million compared with $118.4 million in
1998.
The frequency of claims does not directly correlate to the frequency of defaults
because the rate at which defaults cure is influenced by (i) the individual
borrower's financial resources and circumstances, and (ii) 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. During the default period, PMI works with
the insured for possible early disposal of the underlying property when the
chance of the loan reinstating is minimal. Such dispositions typically result in
a savings to PMI over the percentage coverage amount payable under the master
policy.
The following table sets forth the dispersion of PMI's primary insurance in
force as of December 31, 1999, by year of policy origination and average coupon
rate.
27
Insurance in Force by Policy Year
and Average Coupon Rate
As of December 31, 1999
-------------------------------------------------
Policy Average Percent
Year Rate (1) IIF of Total
---------- --------------- ---------
1972 - 1992 8.81 6,176,358 7.1
1993 7.39 7,451,202 8.6
1994 7.82 4,606,852 5.3
1995 8.03 4,632,861 5.3
1996 7.87 6,539,999 7.5
1997 7.81 8,173,685 9.4
1998 7.14 23,171,725 26.7
1999 7.42 % $ 25,976,313 30.0
-------------- ---------
Total $ 86,728,995 100.0 %
============== =========
(1) Average coupon rate on 30 year fixed rate mortgages
Under the terms of PMI's master policy, the lender 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 (i)
the amount of unpaid principal due under the loan; (ii) the amount of
accumulated delinquent interest due on the loan (excluding late charges) to the
date of claim filing; (iii) expenses advanced by the insured under the terms of
the master policy, such as hazard insurance premiums, property maintenance
expenses and property taxes to the date of claim filing; and (iv) certain
foreclosure and other expenses, including attorneys' fees. Such 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 payment of a claim on an uncured default. PMI's master policy
excludes coverage on loans secured by property with 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 lender, 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 has been filed, PMI has the option of: (i) paying
the coverage percentage specified in the certificate of insurance (usually 17%
to 30% multiplied by the claim amount); (ii) 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 (a "prearranged sale"), paying the lesser of (A) 100% of the
claim amount less the proceeds of sale of the property or (B) the coverage
percentage multiplied by the claim amount, or (iii) 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 through the last option are included on PMI's balance sheet
in other assets as residential properties from claim settlements (also known as
"REO"). PMI attempts to choose the claim settlement option which best
mitigates the amount
28
of its claim payment. Generally, however, PMI settles by paying the coverage
percentage multiplied by the claim amount. In 1999 and 1998, PMI settled 29.3%
and 22.1%, respectively, of the primary claims processed for payment on the
basis of a prearranged sale. In 1999 and 1998, PMI exercised the option to
acquire the property on less than 8.0 and 3.6%, respectively, of the primary
claims processed for payment. At December 31, 1999 and 1998, PMI owned $13.0
million and $8.6 million, respectively, of REO valued at the lower of cost or
estimated realizable value.
The ratio of the claim paid to the original risk in force relating to such loan
is referred to as claim severity and is a factor that influences PMI's losses.
The main determinants of claim severity are the accrued interest on the mortgage
loan 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 claim severity level has decreased from 99.9% in 1994 to
76.3% in 1999.
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 and improving customer service. PMI uses an
automated claim-for-loss worksheet programs, which compiles pertinent data while
automatically calculating the claim amount and predicting the best settlement
alternative. To enhance efficiencies and ease of use for its customers, PMI
developed Document Free ClaimEase/SM/, which is designed to require only an
addendum to the uniform claim-for-loss worksheet, reducing paperwork and
resulting in more rapid claims settlements. In addition, several technology
tools have also been developed by PMI: pmiPHONE-CONNECT/SM/, which is a voice
response application, enabling the insured to access PMI's database by using
their telephones to inquire on the status of their coverage and get information
on billings, refunds, coverage and renewals; pmiPC-CONNECT/SM/, which gives the
insured the ability to dial into PMI's database using a modem-equipped personal
computer to inquire about and update certain loan information, including the
filing of claims; pmiWEB-CONNECT/SM/ is an enhanced version of pmi-CONNECT and
provides access by the insured to PMI's database via the Internet; PMI is also
capable of receiving claims, handling premium billing, and loan sale transfers
via EDI. 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. PMI, through its automatic default
reporting process ("ADR"), allows paperless reporting of default information
by the insured.
Loss Payment Ratios
In 1985, the Company adopted substantially more conservative underwriting
standards that, along with increased prices and generally improving economic
conditions in various regions, are believed by the Company to have contributed
to the substantially lower cumulative loss payment ratios in 1985 and subsequent
years. While the cumulative loss payment ratios of policy years 1985 through
1998 will increase over time, the cumulative loss payment ratios for each such
year
29
at December 31, 1994 is lower than the cumulative loss payment ratios for each
of the years 1980 through 1984 at the same number of years after original policy
issuance.
The following table sets forth 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.
This table further 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 115.5% to 260.3% at
the end of 1994. Such adverse experience was significantly impacted by
deteriorating economic and real estate market conditions in the "Oil Patch"
states.
30
Years Percentage of Cumulative Losses Paid
Since to Cumulative Premiums Written
Policy
Issue Policy Issue Year
---------------------------------------------------------------------------
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989
---------------------------------------------------------------------------
(in percents)
1 0.4 0.4 0.9 0.3 0.2 - 0.1 - - -
2 11.8 23.3 38.1 14.8 9.8 4.5 1.5 0.4 0.1 0.3
3 39.2 90.4 112.1 47.3 44.0 18.7 5.2 2.0 2.0 3.6
4 74.2 139.3 166.3 83.0 83.1 35.2 8.7 5.1 6.1 10.8
5 95.5 168.3 180.9 129.3 114.3 47.4 12.2 9.7 11.6 21.9
6 100.8 168.0 229.6 165.9 127.1 56.4 15.6 13.1 18.5 32.4
7 90.8 184.8 251.0 177.5 135.9 60.7 18.5 17.5 23.1 40.3
8 98.5 197.3 265.4 184.6 139.3 63.0 21.3 20.7 26.2 45.7
9 107.8 203.6 265.7 187.7 141.9 65.0 24.1 23.0 29.1 49.6
10 111.4 205.6 264.4 189.8 142.6 65.3 25.8 25.1 31.5 51.7
11 113.0 207.1 263.8 191.0 142.9 65.9 27.4 26.5 33.6 52.8
12 114.1 208.8 264.4 191.3 142.6 65.8 28.4 27.8 34.6
13 114.6 208.9 263.3 191.1 142.1 65.8 28.8 28.4
14 115.0 209.8 262.2 190.6 141.7 65.9 29.0
15 115.1 209.5 261.5 190.1 141.5 66.0
16 115.3 209.2 260.8 189.8 141.3
17 115.5 208.9 260.4 189.5
18 115.5 208.5 259.8
19 115.5 208.1
20 115.4
---------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
---------------------------------------------------------------------------
(in percents)
1 - - - - - 0.1 - - - 0.1
2 0.7 0.8 1.1 1.0 1.0 2.8 2.9 2.3 1.2
3 7.1 6.6 6.9 5.5 6.5 10.4 8.3 5.8
4 17.8 16.9 16.3 13.4 13.7 15.4 11.9
5 31.7 28.9 28.3 18.7 18.0 18.2
6 41.8 39.8 36.1 21.1 20.1
7 50.5 47.4 40.3 21.9
8 56.2 51.3 41.5
9 59.2 52.7
10 60.9
The table also demonstrates 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 1984. Policy years 1986 through 1988 generally have had the best
cumulative loss payment ratios of any years since 1980. Policy years 1989
through 1992 display somewhat higher loss payment ratios than 1986 through 1988
at the same age of development. This is due primarily to the increased
refinancings of mortgages originated in policy years 1989 to 1992, resulting in
reduced aggregate premiums, and to higher default rates on California loans,
which have demonstrated relatively higher persistency. For policy years from
1993 through present, cumulative losses have been developing at a favorable rate
for the Company due to improving economic conditions.
31
Claim activity is not spread evenly throughout the coverage period of a primary
book of business. Based on the Company's experience, the majority of claims
occur in the third through sixth years after loan origination, and relatively
few claims are paid during the first two years after loan origination.
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 (similar to other mortgage
insurers) 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, 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. (See IC12.) 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 segments default notifications by
year of receipt of the notice by PMI (the "report year method"). In the report
year method, ultimate claim rates and average claim amounts selected for the
current and each of the four prior report years are estimated based on past
experience and management judgment. Claim rates and amounts are also estimated
by region for the most recent report years to validate nationwide report year
estimates, which 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 those five years,
together with a reserve for expected losses on the few defaults still pending
from prior years, yields the total loss reserve on reported defaults. 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 difficult process, especially
in light of the rapidly changing economic conditions over the past few years in
certain regions of the United States. 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. 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,
32
delinquent more than four months, in foreclosure but no sale date set, etc.). A
claim rate is selected for each category based on past experience and management
judgement. Expected claim sizes, stated as a percentage of the outstanding loan
balance on the delinquent loan, are 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's Actuarial Services department performs the loss reserve analysis. On the
basis of such loss reserve analysis, management believes 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. Management believes that the loss
reserves are a reasonable provision for all unpaid loss and LAE obligations
under the terms of its policies and agreements. (See IC12.)
Such reserves are necessarily based on estimates and the ultimate net cost may
vary from such estimates. These estimates are regularly reviewed and updated
using the most current information available. Any resulting adjustments are
reflected in current financial statements. The following table is a
reconciliation of the beginning and ending reserve for losses and loss
adjustment expenses for each of the last three years:
1999 1998 1997
------------- -------------- ------------
(In thousands)
Balance, January 1 $ 215,259 $ 202,387 $ 199,774
Less reinsurance recoverable 6,782 6,067 5,287
------------- ------------- -----------
Net balance, January 1 208,477 196,320 194,487
------------- ------------- -----------
Losses and loss adjustment expenses incurred (principally
in respect of defaults occurring in)
Current year 159,293 146,884 158,147
Prior years (46,611) (11,168) (5,890)
------------- ------------- -----------
Total losses and loss adjustment expenses 112,682 135,716 152,257
------------- ------------- -----------
Losses and loss adjustment expense payments (principally in respect
of defaults occurring in)
Current year 1,798 12,503 27,700
Prior years 95,797 111,056 122,724
------------- ------------- -----------
Total payments 97,595 123,559 150,424
------------- ------------- -----------
Plus acquisition of Forestview Reserves 42,528 - -
Plus acquisition of Pinebrook Reserves 1,093 - -
Plus acquisition of PMI Ltd 4,473 - -
------------- ------------- -----------
Net balance, December 31 271,658 208,477 196,320
Plus reinsurance recoverable 10,342 6,782 6,067
Balance, December 31 $ 282,000 $ 215,259 $ 202,387
============= ============= ===========
As a result of changes in estimates of ultimate losses resulting from insured
events in prior years, the provision for losses and loss adjustment expenses
(net of reinsurance recoverable) decreased by $46.6 million in 1999 due to the
impact of a favorable interest rate environment on loss
33
mitigation activities and to lower than expected claims in California. The
provision for losses and loss adjustment expenses decreased by $11.2 million and
$5.9 million in 1998 and 1997, respectively, due primarily to lower than
expected losses in California. Such estimates were based on management's
analysis of various economic trends (including the real estate market and
unemployment rates) and their effect on recent claim rate and claim severity
experience.
K. Reinsurance
The use of reinsurance as a source of capital and as a risk management tool is
well established within the mortgage insurance industry. In addition, certain
mortgage insurers, including PMI, have agreed to reinsure portions of the risk
written on loans originated by certain lenders with captive reinsurance
companies affiliated with such lenders. 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 to
the GSEs during 1997 and 1998. The participating reinsurers have claims-paying
ratings of AA or AAA from Standard and Poor's. (See Part II, Item 8, Financial
Statements Note 7--"Reinsurance.")
Reinsurance Subsidiaries; RGC, RIC, and PMG
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 minimize reliance on third party
reinsurers and to permit PMI and CMG to retain the premiums (and related risk)
on deep coverage business, TPG formed several wholly-owned subsidiaries RGC,
RIC, and PMG 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. While TPG's reinsurance
subsidiaries generally have the ability to write direct mortgage insurance and
to provide reinsurance to unaffiliated mortgage insurers, TPG currently intends
to have its reinsurance subsidiaries write reinsurance solely for PMI and CMG
(See IC2 and IC8).
During 1997 PMI began issuing pool insurance to select companies. In connection
with the pool policies issued, PMI may only retain 25% of the risk covered by
such policies. PMI reinsures the
34
remaining risk though its affiliates, including RGC, PMG and RIC, which was
formed and licensed to transact mortgage insurance in 1999. (See "B. Products",
above; "O. Regulation" and IC2, IC7, and IC8.)
L. Claims-Paying Ability Ratings
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard &
Poor's Rating Services ("S&P"), "AA+" (Very Strong) by Fitch IBCA, Inc.
("Fitch"), "AA+" (Very High) by Duff & Phelps Credit Rating Co. ("Duff &
Phelps") and "Aa2" (Excellent) by Moody's Investors Service, Inc.
("Moody's"). PMI's claims-paying ability ratings from certain national rating
agencies have been based in significant part on various capital support
commitments from Allstate ("Allstate Support Agreements"). During March 2000,
S&P affirmed the AA+ financial strength rating and claims paying ability rating
of PMI. During March 1999, Moody's announced that it changed PMI's and TPG's
rating outlook from stable to negative, stating such action was based on TPG's
stock repurchases, PMI's writing of GSE pool and diversification into new
sectors. On October 28, 1994, TPG entered into a runoff support agreement with
Allstate (the "Runoff Support Agreement") to replace various capital support
commitments that Allstate had previously provided to PMI. Allstate agreed to pay
claims on certain insurance policies issued by PMI prior to October 28, 1994 if
PMI's financial condition deteriorates below specified levels, or if a third
party brings a claim thereunder or, in the alternative, Allstate may make
contributions directly to PMI or TPG. In the event that Allstate makes payments
or contributions under the Runoff Support Agreement, (which possibility
management believes is remote), Allstate would receive subordinated debt or
preferred stock of PMI or TPG in return.
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. (See IC3 and IC5.)
M. Investment Portfolio
Cash flow from the Company's investment portfolio represented approximately 35%
of its total cash flow from operations during 1999, and pre-tax income from the
investment portfolio represented 33% of the Company's total pre-tax operating
income. PMI's investment policy is to attain consistent, competitive after tax
total returns. A strong emphasis is placed on providing a predictable, high
level of income, while maintaining adequate levels of liquidity, safety and
preservation of capital; growth is a secondary consideration. Fixed income
investment duration is restricted to the estimated range of liability and
surplus duration plus or minus 25%. In addition to satisfying state regulatory
limits, 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, 1999, based on market value, approximately 96% of the Company's
total investment portfolio was invested in securities rated "A" or better, with
64% rated "AAA" and 22% rated "AA," in each case by at least one nationally
recognized securities rating organization.
35
The Company's investment policies and strategies are subject to change depending
upon regulatory, economic and market conditions and the existing or anticipated
financial condition and operating requirements, including the tax position of
the Company. At December 31, 1999, approximately 94% of the Company's
investment portfolio was managed internally.
At December 31, 1999, the consolidated market value of the Company's investment
portfolio was approximately $1.8 billion. At December 31, 1999, municipal
securities represented 81.4% of the market value of the total investment
portfolio. Securities due in less than one year, within one to five years,
within five to ten years; after ten years, and other represented 0.9%, 10.2%,
13.8%, 72.1%, and 3.0%, respectively, of such total market value. The Company's
net pre-tax investment income (excluding capital gains) was $95.1 million for
the year ended December 31, 1999, which represented a pre-tax yield of 5.9% for
the year, a decline from 6.06% for 1998. This decrease was the result of a
decline in the average interest rate on investments in 1999 as compared to 1998.
Net realized capital gains on the investment portfolio were $509 thousand and
$24.6 million for 1999 and 1998, respectively. (See Part II, Item 8, Financial
Statements Note 3--"Investments.")
N. Other Businesses
In March 1999, TPG announced a plan to diversify its revenue sources through
strategic investments and the development of international mortgage insurance
operations. During the first quarter of 1999, PMI commenced operations in Hong
Kong. In August 1999, PMI completed the acquisition of MGICA Ltd., an Australian
mortgage guaranty insurer, and subsequently renamed the company PMI Mortgage
Insurance Ltd. ("PMI Ltd."). TPG also increased its financial investment in RAM
Re by approximately $15 million. In addition, the company provides title
insurance.
Total revenues recognized for the year ended December 31, 1999 from TPG's
businesses other than U. S. mortgage guaranty insurance constituted
approximately 21.5% of the Company's consolidated revenues, compared with
approximately 17.4% and 13.8%, in 1998 and 1997, respectively.
PMI Ltd.
On August 6, 1999 the Company acquired PMI Ltd. for approximately $78.0
million. PMI Ltd. is the second largest mortgage guaranty insurer in Australia
and New Zealand as measured by annual insurance written. Substantially all of
PMI Ltd.'s new insurance written and insurance in force consists of single
premium payment policies. PMI Ltd. is regulated in Australia by the Australian
Prudential Regulatory Authority.
For the year ended December 31, 1999, PMI Ltd.'s NIW totaled $4.5 billion and
insurance in force was $19.2 billion. PMI Ltd's reserves were $3.7 million.
Australian mortgage guaranty insurance generally provides 100% insurance
coverage. PMI Ltd. contributed $6.7 million of net income for the period August
6, 1999 through December 31, 1999.
36
Hong Kong
During 1999, PMI opened an office in Hong Kong and began to reinsure residential
mortgages in Hong Kong. PMI entered into an agreement with the Hong Kong
mortgage corporation ("HKMC"), a public sector entity created to add liquidity
to the Hong Kong residential mortgage market. HKMC is the direct insurer of
residential mortgages with LTVs of up to 85%, with PMI providing reinsurance
coverage on amounts over 70% LTV. For the year ended 1999, PMI reinsured $189
million of loans.
RAM Re
TPG is a principal investor in RAM Reinsurance Company Ltd. ("RAM Re"), the
first AAA rated financial guaranty reinsurance company based in Bermuda. This
strategic investment was consummated, in part, because of the perceived industry
need for additional sources of highly rated financial guaranty capacity and
because of the desire to diversify into similar business industries. Ram Re
commenced business in the first quarter of 1998. Three executives of the Company
serve as directors of Ram Re.
American Pioneer Title Insurance Co.
The Company acquired APTIC, a Florida-based title insurance company, in 1992 as
part of its strategy to provide additional mortgage-related services to its
customers. APTIC is licensed in 41 states and the District of Columbia. Although
APTIC is currently writing business in 33 states, it primarily provides real
estate title insurance on residential property in Florida. 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 1999, APTIC is ranked 5th among the 28
active title insurers conducting business in the State of Florida. For the year
ended December 31, 1999, 72.9% 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 95.2% and 93.8% of APTIC's
premiums earned for the years ended December 31, 1999 and 1998, respectively.
PMI Mortgage Services Co.
MSC provides a variety of technical products and mortgage underwriting services
through a staff of underwriters in 30 field offices. The Customer Technology
Division of MSC provides technical products and services to PMI's customers.
This department licenses the use of
37
pmiAURA (SM) and pmiTERRA (SM) to customers for a fee, assists PMI's customers
in establishing EDI links with PMI, and provides other value added services.
The Risk Management Division of MSC provides contract underwriting services that
enable customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting to MSC. Such
contract underwriting services are provided for mortgage loans for which PMI
provides mortgage insurance and for loans on which PMI does not. MSC also
performs all of the mortgage insurance underwriting activities of CMG. Contract
underwriting services have become increasingly important to mortgage lenders as
they seek to reduce costs. Competition increased in 1998 among mortgage
insurance companies for contract underwriting customers. Contract underwriting
on-site is generally more expensive for the Company than underwriting a loan in-
house, and is a popular method among mortgage lenders for processing loan
applications. Contract underwriting processed loans represented 28.8% of PMI's
NIW for the year ended December 31, 1999 compared to 35.0% for the year ended
December 31, 1998 (See H. Underwriting Practices, above).
O. Regulation
State Regulation, Federal Legislation, and Fannie Mae and Freddie Mac
State Regulation.
General. The Company's insurance subsidiaries are subject to comprehensive,
detailed regulation 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 in general 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
control over claims handling practices, reinsurance arrangements, premium rates,
the forms and policies offered to customers, financial statements, periodic
financial reporting, permissible investments (See "Investment Portfolio",
above.) and adherence to financial standards relating to statutory surplus,
dividends and other criteria of solvency intended to assure the satisfaction of
obligations to policyholders.
Mortgage insurers are generally restricted by state insurance laws and
regulations to writing residential mortgage insurance business only. This
restriction prohibits PMI, RGC, PMG, RIC and CMG from directly writing other
types of insurance. However, the non-insurance subsidiaries of TPG are not
generally subject to regulation under state insurance laws except with respect
to transactions with their insurance affiliates.
The Company's title insurance subsidiary, 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.
38
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
regulator financial and other information concerning the operations of companies
within the holding company system that may materially affect the operations,
management or financial condition of the insurers within the system. Most 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 for its needs. In addition, Arizona law requires that
the Arizona Director of Insurance be given 30-days prior notice of certain types
of agreements between an insurance company and an affiliate.
TPG is an insurance holding company under the laws of the State of Arizona based
on its affiliation with PMI, PMG, RGC, RIC, RAM Re and PMI Ltd. The Arizona
insurance laws regulate, among other things, certain transactions in the
Company's Common Stock and certain transactions between PMI and PMG, RGC and RIC
and their parent or affiliates. Specifically, no person may, directly or
indirectly, offer to acquire or acquire beneficial ownership of more than 10% of
any class of outstanding securities of TPG, PMI or PMG, RGC and RIC 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 PMI and PMG, RGC
and RIC and their parent or 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, since APTIC is domiciled in the State of
Florida, TPG is also regulated as an insurance holding company under Florida
law. The applicable requirements of Florida law are similar to the provisions of
the Arizona insurance laws regulating insurance holding companies, with the
exception that in Florida, regulatory approval must be obtained prior to the
acquisition, directly or indirectly, of 5% or more of the voting securities of
APTIC or TPG. Because CMG is domiciled in Wisconsin, TPG is also regulated as an
insurance holding company under Wisconsin law. The applicable requirements of
Wisconsin law are similar to those of Arizona law regulating insurance holding
companies, except that the hearing to approve a change in control is optional in
Wisconsin. For purposes of Arizona, Florida 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 other than a
commercial contract for goods or non-management services, or otherwise, unless
the power is the result of an official position with or corporate office held by
the person.
Reserves. PMI is required under the insurance laws of Arizona and certain other
states to establish a special contingency reserve with annual additions of
amounts equal to 50% of premiums earned. The insurance laws of the various
states, including Florida, impose additional reserve requirements applicable to
title insurers such as APTIC. For instance, title insurers must
39
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, 1999, PMI had statutory policyholders' surplus of $134.1 million and
statutory contingency reserve of $1.24 billion. (See Part II, Item 8, Financial
Statements Note 14--"Statutory Accounting.")
Dividends. PMI's ability to pay dividends is limited, among other things, by
the insurance laws of Arizona. Such laws provide that: (i) PMI may pay
dividends out of available surplus and (ii) without prior approval of the
Arizona Insurance Directory, such dividends during any 12-month period may not
exceed the lesser of 10% of policyholders' surplus as of the preceding year end,
or the last calendar year's investment income. In accordance with Arizona law,
PMI is permitted to pay ordinary dividends to TPG of $13.4 million in 2000
without prior approval of the Arizona Insurance Director. (See Part II, Item 8,
Financial Statements Note 13-- "Dividends and Shareholders Equity.")
The laws of Florida limit the payment of dividends by APTIC to PMI in any one
year to 10% of available and accumulated surplus derived from realized net
operating profits and net realized capital gains. As a result, APTIC may be
limited in its ability to pay dividends to PMI. CMG's ability to pay dividends
to PMI is subject to the laws of Wisconsin.
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's premium rates and policy forms are
subject to regulation in every state in which it is licensed to transact
business in order to protect policyholders against the adverse effects of
excessive, inadequate or unfairly discriminatory rates and to encourage
competition in the insurance marketplace. In all states, premium rates and, in
most states, 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
reinsurers. Under such laws, if a reinsurer is not admitted or approved in such
states, the company ceding business to the reinsurer cannot take credit in its
statutory financial statements for the risk ceded to such reinsurer absent
compliance with certain reinsurance security
40
requirements. Arizona prohibits reinsurance unless the reinsurance arrangements
meets certain requirements, even if no statutory financial statement credit is
to be taken. In addition, Arizona, Wisconsin 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 (See "K. Reinsurance", above).
Examination. PMI, APTIC, PMG, RGC and RIC and CMG 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 NAIC.
Federal Regulation.
Private mortgage insurers are indirectly, but significantly, impacted by
regulations affecting purchasers of mortgage loans, such as Freddie Mac and
Fannie Mae, and regulations affecting governmental insurers, such as the FHA and
VA, and mortgage lenders. As a result, changes in federal housing legislation
and other laws and regulations that affect the demand for private mortgage
insurance may have a material effect on private mortgage insurers, including
PMI. Legislation that increases the number of persons eligible for FHA or VA
mortgages could have an adverse affect on the Company's ability to compete with
the FHA or VA.
The Home Owners Protection Act of 1998 (the "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 Act applies to owner- occupied residential mortgage loans regardless of lien
priority, with borrower-paid mortgage insurance, closed after the effective date
of the Act. FHA loans are not covered by the Act. Under the Act, automatic
termination of mortgage insurance would generally occur once the loan-to-value
ratio ("LTV") reaches 78%. A borrower may generally request cancellation of
mortgage insurance once the LTV reaches 80% of the home's original value, or
when actual payments reduce the loan balance to 80% of the home's original
value, whichever occurs earlier. For borrower initiated cancellation of
mortgage insurance, the borrower must have a good payment history. Good payment
history generally requires that there have been no payments during the 12-month
period preceding the loan's cancellation date 30 days or more past due, or 60
days or more past due during the 12-month period beginning 24 months before the
loan's cancellation date. Loans which are deemed "high risk" by the GSEs,
require automatic termination of mortgage insurance coverage once the LTV is
first scheduled to reach 77% of the original value of the property without
regard to the actual outstanding balance. The Act preempts all but more
protective, preexisting state laws. Protected state laws are preempted if
inconsistent with the Act. Protected state laws are consistent with the Act if
they require: (i) termination of mortgage insurance at an earlier date or higher
mortgage principal balance than required by the Act, or (ii) disclosure of more,
earlier, or more frequent information. States which enacted mortgage insurance
cancellation laws on or before January 2, 1998, have until July 29, 2000 to make
their statutes consistent with the Act. States that currently have mortgage
insurance cancellation or
41
notification laws include: California, Connecticut, Illinois, Maryland,
Minnesota, Missouri, New York, Texas and Washington.
RESPA. The Real Estate Settlement and Procedures Act of 1974 ("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.
HMDA. 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 ("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 on the basis of
certain classifications. The active mortgage insurers, through their trade
association, MICA, have entered into an agreement with the Federal Financial
Institutions Examinations Council ("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 of 1999. The Gramm-Leach-Bliley Act of 1999 (the "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 Act allows a bank holding company to form an
insurance subsidiary, licensed under state insurance law, to issue insurance
products directly, including mortgage insurance. However, any such mortgage
insurance subsidiary would be subject to and governed by state insurance
regulations, including capital and reserve requirements, diversification of risk
and restrictions on the payments of dividends. Because of the many aspects of
the Act which require clarification and promulgation of specific regulations,
the Company is not yet able to ascertain the full impact of the Act on the
Company (See IC15).
Fannie Mae and Freddie Mac. TPG and PMI are also significantly, impacted by
laws and regulations affecting originators and purchasers of mortgage loans,
particularly Fannie Mae and Freddie Mac, eligibility requirements imposed by the
GSEs on private mortgage insurers for such insurers to be eligible to insure
loans sold to such agencies and regulations affecting
42
governmental insurers such as the FHA. Private mortgage insurers, including PMI,
are highly dependent upon federal housing legislation and other laws and
regulations which affect the demand for private mortgage insurance and the
housing market generally. (See "C industry Overview - Fannie Mae and Freddie
Mac", above and IC3.)
Fannie Mae and Freddie Mac announced an increase in the maximum single-family
principal balance loan limit eligible for their purchase from $240,000 to
$252,700 effective in 2000. Fannie Mae and Freddie Mac both recently announced
programs where reduced mortgage insurance coverage will be made available for
lenders that deliver loans approved by the GSEs' automated underwriting
services, Desktop Underwriter(TM) and Loan Prospector (SM), respectively.
Generally, Fannie Mae's and Freddie Mac's reduced mortgage insurance coverage
options provide for: (i) across-the-board reductions in required MI coverage on
30-year fixed-rate loans recommended for approval by GSE's automated
underwriting services to the levels in effect in 1994; (ii) reduction in
required MI coverage, for loans with only a 5% down payment (a 95% LTV), from
30% to 25% of the mortgage loan covered by MI; (iii) reduction in required MI
coverage, for loans with a 10% down payment (a 90 % LTV loan), from 25% to 17%
of the mortgage loan covered by MI. In addition, the GSE's announced programs to
further reduce MI coverage upon the payment of an additional fee by the lender.
Under this option, a 95% LTV loan will require 18% of the mortgage loan have
mortgage insurance coverage. Similarly, a 90% LTV loan will require 12 % of the
mortgage loan have mortgage insurance. In order for the homebuyer to have MI at
these levels, such loans would require a payment at closing or a higher note
rate.
During October 1998, Freddie Mac sought to amend its charter to allow it to use
any method of default loss protection that is financially equal or superior, on
an individual or pooled basis, to the protection provided by private mortgage
insurance companies. The legislation containing the proposed charter amendment
was subsequently rescinded. Subsequent to the withdrawal of the legislation,
Freddie Mac announced that it would pursue a permanent charter amendment that
would allow Freddie Mac to utilize alternative forms of default loss protection,
such as spread accounts, or otherwise forego the use of private mortgage
insurance on higher loan-to-value mortgages. In addition, Fannie Mae announced
it is interested in pursuing new risk management options and is working with
mortgage insurers and lenders on appropriate risk management and dispersion of
risk, which may include a reduction in the use of mortgage insurance. Fannie Mae
and Freddie Mac also have the discretion to reduce the amount of private
mortgage insurance they require on loans.
The Federal Housing Enterprises Financial Safety and Soundness Act of 1992
directed the Office of Federal Housing Enterprise Oversight ("OFHEO") to develop
risk-based capital regulations for the GSEs. Based on the initial regulations
published in April 1999, the GSEs will be subjected to a risk-based capital
stress test that will determine the amount of capital that a GSE must hold to
maintain positive capital throughout a 10-year period of severe economic
conditions. The proposed regulations could increase that amount of capital the
GSEs are presently required to maintain for certain loans with loan-to-value
ratios ("LTV") of 95 percent or higher. Because of the numerous aspects of the
OFHEO proposal which require clarification and which are likely to be revised
before being declared effective, it is considered extremely unlikely that OFHEO
will be able to finalize a rule before 2001.
43
National Association of Insurance Commissioners (NAIC). The NAIC has developed
a rating system, the Insurance Regulatory Information System (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.
P. Employees
At December 31, 1999, TPG, including its subsidiaries had 1,029 full and part-
time employees; 734 persons perform services primarily for PMI, 17 perform
services primarily for CMG and an additional 278 persons are employed by APTIC.
TPG's employees are not unionized and TPG considers its employee relations to be
good. In addition, MSC had 345 temporary workers and contract underwriters at
December 31, 1999.
Q. CAUTIONARY STATEMENTS AND INVESTMENT CONSIDERATIONS
GENERAL ECONOMIC CONDITIONS (IC1)
Changes in economic conditions, including economic recessions, declining housing
values, higher unemployment rates, deteriorating borrower credit, rising
interest rates, increases in refinance activity caused by declining interest
rates, or combinations of these factors could reduce the demand for mortgage
insurance, cause claims on policies issued by PMI to increase, and increase
PMI's loss experience.
MARKET SHARE AND COMPETITION (IC2)
The Company's financial condition and results of operations could be harmed by a
decline in its market share, or a decline in market share of the private
mortgage insurance industry as a whole. Numerous factors bear on the relative
position of the private mortgage insurance industry versus government and quasi-
governmental competition as well as the competition of lending institutions that
choose to remain uninsured, self-insure through affiliates, or offer residential
mortgage products that do not require mortgage insurance.
The mortgage insurance industry is highly competitive. Several of the Company's
competitors in the mortgage insurance industry have greater direct or indirect
capital reserves that provide them with potentially greater flexibility than the
Company.
PMI also competes directly with federal and state governmental and quasi-
governmental agencies, principally the FHA and, to a lesser degree, the VA. In
addition, the captive reinsurance subsidiaries of national banks, savings
institutions, or bank holding companies could become significant competitors of
the Company in the future. Other mortgage lenders are also forming reinsurance
affiliates that compete with the Company. The Gramm-Leach-Bliley Act of 1999
could lead to additional significant competitors of the Company in the future.
On October 4 1999, the Federal Housing Finance Board adopted resolutions which
authorizes each Federal Home Loan Bank ("FHLB") to offer programs to fund or
purchase single-family conforming mortgage loans originated by participating
member institutions under the single-family member mortgage assets program
program. Under this program, each FHLB is also authorized to provide credit
enhancement for eligible loans. Any expansion of the FHLBs' ability to issue
mortgage insurance or use alternatives to mortgage insurance could reduce the
demand for private mortgage insurance and harm the Company's financial condition
and results of operations.
Certain lenders originate a first mortgage lien with an 80% LTV ratio, a 10%
second mortgage lien, and 10% of the purchase price from borrower's funds
("80/10/10"). This 80/10/10 product, as well as similar products, competes with
mortgage insurance as an alternative for lenders selling loans in the secondary
mortgage market. If the 80/10/10 product or a similar product becomes a widely
accepted alternative to mortgage insurance, the Company's financial condition
and results of operations could suffer.
Legislation and regulatory changes affecting the FHA have affected demand for
private mortgage insurance. In particular, increases in the maximum loan amount
that the FHA can insure can reduce the demand for private mortgage insurance.
For example, management believes the decline in the MICA members' share of the
mortgage insurance business from 56.3% at December 31, 1998 to approximately
52.4% at December 31, 1999 resulted in part from the increase in the maximum
individual loan amount the FHA can insure. The Department of Housing and Urban
Development has announced a proposed increase in the maximum individual loan
amount that FHA can insure to $219,849 from $208,800. If this increase is
approved, demand for private mortgage insurance could decrease. In addition,
the Omnibus Spending Bill of 1999, signed into law on October 21, 1998,
streamlined the FHA down-payment formula and made FHA insurance more competitive
with private mortgage insurance in areas with higher home prices.
FANNIE MAE AND FREDDIE MAC (IC3)
Fannie Mae and Freddie Mac are collectively referred to as government-sponsored
enterprises ("GSEs"). The GSEs are permitted by charter to purchase
conventional high-LTV mortgages from lenders who obtain mortgage insurance on
those loans. Fannie Mae and Freddie Mac have some discretion to increase or
decrease the amount of private mortgage insurance coverage they require on
loans, provided the minimum insurance coverage requirement is met. During 1999,
Fannie Mae and Freddie Mac separately announced programs where reduced mortgage
insurance coverage will be made available for lenders that deliver loans
approved by the GSEs' automated underwriting services. Although management has
not seen any significant movement towards the reduced coverage programs offered
by the GSEs' to date, if the reduction in required levels of mortgage insurance
were to become widely accepted by mortgage lenders and their customers, the
reduction could harm the Company's financial condition and results of
operations.
On April 13, 1999 the Office of Federal Housing Enterprise Oversight announced
proposed risk-based capital regulations, which could treat more favorably credit
enhancements issued by private mortgage insurance companies with a claims-paying
ability rating of AAA or higher compared with those companies with an AA or
lower rating. Any shifts in the GSE's preferences for private mortgage
insurance to other forms of credit enhancement, including a tiering of mortgage
insurers based on their credit rating, could harm the Company's financial
condition and results of operations.
Freddie Mac has made several announcements that it would pursue a permanent
charter amendment that would allow it to utilize alternative forms of default
loss protection or otherwise forego the use of private mortgage insurance on
higher loan-to-value mortgages. In addition, Fannie Mae announced it is
interested in pursuing new risk management approaches, which may include a
reduction in the use of mortgage insurance.
Under Fannie Mae and Freddie Mac regulations, PMI needs to maintain at least an
"AA-" or equivalent claims-paying ability rating in order to provide mortgage
insurance on loans purchased by the GSEs. A loss of PMI's existing eligibility
status, either due to a failure to maintain the minimum claims-paying ability
rating from the various rating agencies or non-compliance with other eligibility
requirements, would have a material, adverse effect on the Company's financial
condition and results of operations.
INSURANCE IN FORCE (IC4)
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. The policy owner or
servicer of the loan may cancel insurance coverage at any time. A decline in
insurance in force as a result of a decrease in persistency due to policy
cancellations of older books of business could harm the Company's financial
condition and results of operations.
The Home Owners Protection Act of 1998, effective on July 29, 1999, provides for
the automatic termination, or cancellation upon a borrower's request, of private
mortgage insurance upon satisfaction of certain conditions. Management is
uncertain about the impact of this act on PMI's insurance in force, but believes
any reduction in premiums attributed to the act's required cancellation of
mortgage insurance will not have a significant impact on the Company's financial
condition and results of operations.
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans and PMI generally experiences an
increase in the prepayment rate of insurance in force, resulting from policy
cancellations of older books of business with higher rates of interest. Although
PMI has a history of expanding business during low interest rate environments,
the resulting increase of NIW may ultimately prove to be inadequate to
compensate for the loss of insurance in force arising from policy cancellations
RATING AGENCIES (IC5)
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard and
Poor's Rating Services, "Aa2" (Excellent) by Moody's Investors Service, Inc.,
"AA+" (Very Strong) by Fitch IBCA, and "AA+" (Very High) by Duff & Phelps Credit
Rating Co. These ratings are subject to revisions or withdrawal at any time by
the assigning rating organization. The ratings by the organizations are based
upon factors relevant to PMI's policyholders, principally PMI's capital
resources as computed by the rating agencies, and are not applicable to the
Company's common stock or outstanding debt. On March 10, 2000, Standard & Poor's
affirmed the AA+ financial strength rating and claims-paying ability rating of
PMI. During June 1999, Moody's affirmed the Aa2 financial strength rating and
claims-paying ability rating of PMI. During March 1999, Moody's announced that
it changed PMI's and TPG's rating outlook from stable to negative, stating such
action was based on TPG's stock repurchases, PMI's writing of GSE pool and
diversification into new sectors.
A reduction in PMI's claims-paying ratings below AA-would seriously harm effect
the Company's financial condition and results of operations (See IC3).
LIQUIDITY (IC6)
TPG's principal sources of funds are dividends from PMI and APTIC, investment
income and funds that may be raised from time to time in the capital markets.
Numerous factors bear on the Company's ability to maintain and meet its capital
and liquidity needs, including the level and severity of claims experienced by
the Company's insurance subsidiaries, the performance of the financial markets,
standards and factors used by various credit rating agencies, financial
covenants in credit agreements, and standards imposed by state insurance
regulators relating to the payment of dividends by insurance companies. Any
significant change in these factors could adversely affect the Company's ability
to maintain capital resources to meet its business needs.
CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS (IC7)
The Company provides contract underwriting services for a fee that enable
customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting. The Company also
generally agrees to assume the cost of repurchasing underwritten-deficient loans
that have been contract underwritten, a remedy not available under the Company's
master primary insurance policies. Due to the demand of contract underwriting
services, limitations on the number of available underwriting personnel, and
heavy price competition among mortgage insurance companies, PMI's inability to
recruit and maintain a sufficient number of qualified underwriters, or any
significant increase in the cost PMI incurs to satisfy its underwriting services
obligations, could harm the Company's financial condition and results of
operations.
TPG and PMI, from time to time, introduce new mortgage insurance products or
programs. The Company's financial condition and results of operations could
suffer if PMI or the Company experiences delays in introducing competitive new
products and programs or if these products or programs are less profitable than
the Company's existing products and programs.
INSURANCE REGULATORY MATTERS (IC8)
On January 31, 2000, the Illinois Department of Insurance issued a letter
addressed to all mortgage guaranty insurers licensed in Illinois. The letter
states that it may be a violation of Illinois law for mortgage insurers to offer
to Illinois mortgage lenders the opportunity to purchase certain notes issued by
a mortgage insurer or an affiliate, or to participate in loan guaranty programs.
The letter also states that a violation might occur if mortgage insurers offer
lenders coverage on pools of mortgage loans at a discounted or below market
premium in return for the lenders' referral of primary mortgage insurance
business. In addition, the letter stated that, to the extent a performance
guaranty actually transfers risk to the lender in return for a fee, the lender
may be deemed to be doing an insurance business in Illinois without
authorization. The letter announced that any mortgage guaranty insurer that is
participating in the described or similar programs in the State of Illinois
should cease such participation or alternatively, provide the Department with a
description of any similar programs, giving the reason why the provisions of
Illinois are not applicable or not violated. PMI is reviewing the Illinois
Letter. If the Illinois Department of Insurance were to determine that PMI was
not in compliance with Illinois law, the Company's financial condition and
results of operations could be harmed
In February 1999, the New York Department of Insurance stated in Circular Letter
No. 2, addressed to all private mortgage insurers licensed in New York that
certain pool risk-share and structured products and programs would be considered
to be illegal under New York law. PMI believes that it complies with the
requirements of Circular Letter No. 2 with respect to transactions that are
governed by it. In the event the New York Department of Insurance determined PMI
was not in compliance with Circular Letter No. 2, the Company's financial
condition and results of operations could suffer.
RISK-TO-CAPITAL RATIO (IC9)
The State of Arizona, PMI's state of domicile for insurance regulatory purposes,
and other regulators specifically limit the amount of insurance risk that may be
written by PMI, by a variety of financial factors. For example, Arizona law
provides that if a mortgage guaranty insurer domiciled in Arizona does not have
the amount of minimum policyholders position required, it must cease transacting
new business until its minimum policyholders position meets the requirements.
Under Arizona law, minimum policyholders position is calculated based on the
face amount of the mortgage, the percentage coverage or claim settlement option
and the loan to value ratio category, net of reinsurance ceded, but including
reinsurance assumed.
Other factors affecting PMI's risk-to-capital ratio include: (i) limitations
under the Runoff Support Agreement with Allstate, which prohibit PMI from paying
any dividends if, after the payment of any such dividend, PMI's risk-to-capital
ratio would equal or exceed 23 to 1; (ii) TPG's credit agreements and the terms
of its guaranty of the debt incurred to purchase PMI LTD; and (iii) TPG's and
PMI's credit or claims-paying ability ratings which generally require that the
rating agencies' risk-to-capital ratio not exceed 20 to 1.
Significant losses could cause a material reduction in statutory capital,
causing an increase in the risk-to-capital ratio and thereby limit PMI's ability
to write new business. The inability to write new business could harm the
Company's financial condition and results of operations.
CHANGES IN COMPOSITION OF INSURANCE WRITTEN; POOL INSURANCE (IC10)
The composition of PMI's NIW has included an increasing percentage of mortgages
with LTVs in excess of 90% and less than or equal to 95% ("95s"). At December
31, 1999, 46.7% of PMI's risk in force consisted of 95s, which, in PMI's
experience, have had a claims frequency approximately twice that of mortgages
with LTVs equal to or less than 90% and over 85% ("90s"). PMI also offers
coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"). At
December 31, 1999, 4.9% of PMI's risk in force consisted of 97s that have even
higher risk characteristics than 95s and greater uncertainty as to pricing
adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"), which,
although priced higher, have risk characteristics that exceed the risk
characteristics associated with PMI's book of business as a whole.
Since the fourth quarter of 1997, PMI has offered a new pool insurance product,
which is generally used as an additional credit enhancement for certain
secondary market mortgage transactions. New pool risk written was $231 million
for the year ended December 31, 1999 and $450 million for the year ended
December 31, 1998. Although PMI charges higher premium rates for loans that
have higher risk characteristics, including ARMs, 95s, 97s and pool insurance
products, the premiums earned on these products, and the associated investment
income, may ultimately prove to be inadequate to compensate for future losses
from these products.
POTENTIAL INCREASE IN CLAIMS (IC11)
Mortgage insurance coverage and premiums generally cannot be canceled by PMI and
remains renewable at the option of the insured until required to be canceled
under applicable Federal or state laws for the life of the loan. As a result,
the impact of increased claims from policies originated in a particular year
generally cannot be offset by premium increases on policies in force or
mitigated by nonrenewal of insurance coverage. There can be no assurance,
however, that the premiums charged will be adequate to compensate PMI for the
risks and costs associated with the coverage provided to its customers.
LOSS RESERVES (IC12)
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amounts, as well as the estimated costs, including legal and other fees,
of settling claims. Such reserves are based on estimates, which are regularly
reviewed and updated. There can be no assurance that PMI's reserves will prove
to be adequate to cover ultimate loss development on incurred defaults. The
Company's financial condition and results of operations could be materially and
adversely affected if PMI's reserve estimates are insufficient to cover the
actual related claims paid and expenses incurred.
REGIONAL AND INTERNATIONAL RISKS (IC13)
In addition to nationwide economic conditions, PMI could be particularly
affected by economic downturns in specific regions where a large portion of its
business is concentrated, particularly California, Florida, and Texas, where PMI
has 15.6%, 7.5% and 7.3% of its risk in force concentrated and where the default
rate on all PMI policies in force is 2.6%, 3.0% and 2.1% compared with 2.1%
nationwide as of December 31, 1999.
As the Company seeks to expand its business internationally, it will
increasingly be subject to risks associated with international operations,
including the need for regulatory and third party approvals, challenges
retaining key foreign-based employees and maintaining key relationships with
customers and business partners in international markets, the economic strength
of the mortgage origination markets in targeted foreign markets, including
Australia, New Zealand, and Hong Kong, changes in foreign regulations and laws,
foreign currency exchange and translation issues, potential increases in the
level of defaults and claims on policies insured by foreign-based subsidiaries,
and the need to integrate PMI's risk management technology systems and products
with those of its foreign operations.
CAPTIVE REINSURANCE ARRANGEMENTS; RISK-SHARING TRANSACTIONS (IC14)
PMI's customers have indicated an increasing demand for captive reinsurance
arrangements, which allow a reinsurance company, generally an affiliate of the
lender, to assume a portion of the mortgage insurance default risk in exchange
for a portion of the insurance premiums. An increasing percentage of PMI's NIW
is being generated by customers with captive reinsurance companies, and
management expects that this trend will continue. An increase in captive
reinsurance arrangements would decrease in net premiums written which may
negatively impact the yield obtained in the Company's net premiums earned for
customers with captive reinsurance arrangements. The inability of the Company to
provide its customers with acceptable risk-sharing structured transactions,
including potentially increasing levels of premium cessions in captive
reinsurance arrangements, would likely harm PMI's competitive position.
GRAMM-LEACH-BLILEY ACT (IC15)
On November 12, 1999, the President signed the Gramm-Leach-Bliley Act of 1999
(the "Act") into law. Among other things, the Act allows 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 Act allows a bank holding company to form an insurance
subsidiary, licensed under state insurance law, to issue insurance products
directly, including mortgage insurance. The Company expects that, over time,
the Act will allow consumers the ability to shop for their insurance, banking
and investment needs at one financial services company. The Company believes
that the Act may lead to increased competition in the mortgage insurance
industry by facilitating the development of new savings and investment products,
resulting in the Company's customers offering mortgage insurance directly rather
than through captive reinsurance arrangements with the Company's insurance
subsidiaries and encouraging large, well-capitalized financial service companies
to enter the mortgage insurance business.
Item 2. Properties
TPG leases its home office in San Francisco, California, which consists of
approximately 100,000 square feet of office space. The San Francisco lease
expires on December 31, 2004. In addition, TPG leases space for 34 PMI field
offices. Such field office leases cover an average of approximately 4,300 square
feet and have terms of not more than five years. During 1997, PMI established
its Certificate Priority Center, which is located in Dallas, Texas. The CPC
consists of approximately 18,000 square feet of office space.
TPG believes its existing properties are well utilized and are suitable and
adequate for its present circumstances.
Item 3. Legal Proceedings
On December 17, 1999, G. Craig Baynham and Linnie Baynham (collectively, the
"Plaintiffs") filed a putative class action suit against PMI Mortgage Insurance
Co. ("PMI"). The complaint,
44
captioned G. Craig Baynham and Linnie Baynham v. PMI Mortgage Insurance Co.,
(case no. CV199-241), was filed in the United States District Court For The
Southern District of Georgia, State of Georgia and alleges that PMI entered into
agreements or understandings with mortgage lenders that PMI would provide pool
insurance or other benefits to the lenders at preferential, below market rates,
in return for the lenders' designation of PMI as the mortgage insurer for
mortgages originated by the lenders. Based on the alleged conduct, Plaintiffs
assert a cause of action on behalf of the proposed class of mortgage insurees
against PMI for violation of section 8 of the Real Estate Settlement Procedures
Act ("RESPA") 12 U.S.C. (S)2607(a). Plaintiffs seek relief under RESPA's treble
damage provision, along with injunctive relief and attorneys' fees and expenses.
The complaint also seeks to certify a class of persons who, on or after January
1, 1996 obtained or obtain federally related mortgage loans for single-to four
family homes, whose loans include primary mortgage insurance, reinsurance
contracts, contract underwriting services, or financing agreements from PMI.
The Company understands that several other mortgage insurance companies have
been named as defendants in lawsuits with similar allegations recently filed in
the same federal court as the case pending against PMI. The Company intends to
contest this action vigorously, and based on information presently available to
the Company, management believes that the ultimate outcome of this matter will
not have a material adverse effect on the Company's financial position or
results of operations.
Various other legal actions and regulatory reviews are currently pending that
involve the Company and specific aspects of its conduct of business. In the
opinion of management, the ultimate liability or resolution in one or more of
the foregoing actions is not expected to have a material adverse effect on the
financial condition or results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of 1999 to a vote of
stockholders through the solicitation of proxies or otherwise.
EXECUTIVE OFFICERS OF REGISTRANT
Set forth below is certain information regarding TPG's executive officers as of
December 31, 1999, including age as of March 31, 2000, and business experience
for at least the past five years.
W. ROGER HAUGHTON, 52, has been Chairman of the Board of TPG since May 1998 and
has been Chief Executive Officer since January 1995. Mr. Haughton was President
of TPG from January 1995 until September 1998. Mr. Haughton has been Chairman,
Chief Executive Officer and President of PMI Mortgage Insurance Co. ("PMI")
since January 1993. Mr. Haughton joined PMI in 1985 as Vice President of
Underwriting, after 16 years with Allstate Insurance Company ("Allstate"). In
1987, he was promoted to Vice President/General Manager for PMI's Central Zone,
responsible for all sales and field office operations in that region. In 1989,
he became Group Vice President of Insurance Operations, Claims, Underwriting and
Actuarial Services
45
departments. Mr. Haughton has a long history of active volunteerism with various
affordable housing organizations, including Habitat for Humanity, and serves as
chairman of the board of Social Compact. Mr. Haughton has been a Director since
January 1995. He is an Ex Officio member of the Governance and Nominating
Committee.
L. STEPHEN SMITH, 50, President and Chief Operating Officer of TPG 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 TPG in January 1995. Prior thereto, he was PMI's Senior Vice President of
Field Operations from September 1993 to May 1994, Senior Vice President of
Marketing and Customer Technology from December 1991 to September 1993 and Vice
President/General Manager of PMI's Eastern Zone from September 1985 to December
1991.
CLAUDE J. SEAMAN, 53, has been Group Executive Vice President Strategic
Investments of TPG 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 TPG in January 1995. Prior thereto, he was PMI's Senior
Vice President of Insurance Operations from March 1993 to May 1994, Vice
President of Claims from December 1991 to March 1993 and Vice President of
Underwriting from January 1987 to December 1991.
JOHN M. LORENZEN, Jr., 55, 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 TPG in January 1995. Prior thereto, he was PMI's Senior Vice
President from April 1989 to May 1994 and Vice President of Finance from April
1985 to April 1989.
BRADLEY M. SHUSTER, 45, has been Executive Vice President Corporate Development
of TPG 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 TPG, 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, 56, has been Executive Vice President, General Counsel and
Secretary of TPG and PMI since August 1999. Prior thereto he was Senior Vice
President, General Counsel and Secretary of TPG and PMI since November 1996.
Prior to joining TPG, he was a partner in the law firm of Bronson, Bronson &
McKinnon LLP, San Francisco, California since February 1992.
DANIEL L. ROBERTS, 49, has been Executive Vice President, Chief Information
Officer of TPG and PMI since March 1, 2000. Prior thereto he was Senior Vice
President, Chief Information Officer of TPG and PMI since December 1997. Prior
to joining TPG, 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.
46
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Common Stock
TPG is listed on the New York Stock Exchange and the Pacific Exchange under the
trading symbol PMI. As of December 31, 1999 there were 44,702,080 shares issued
and outstanding. As of February 29, 2000 there were 44,324,697 shares issued
and outstanding held by approximately 45 stockholders of record and
approximately 4,100 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, 1999 and 1998:
1999 1998
-------------------------------------- -------------------------------------
High Low Close High Low Close
---------- ------------- ---------- ---------- ----------- ------------
First quarter 35 7/8 26 43/64 30 59/64 55 59/64 42 1/2 53 53/64
Second quarter 42 3/8 28 11/64 41 7/8 57 45 5/8 48 63/64
Third quarter 47 5/64 39 13/16 40 7/8 50 11/64 27 43/64 30 1/2
Fourth quarter 55 1/2 40 7/8 48 13/16 39 59/64 22 32 59/64
Preferred Stock
TPG's Board of Directors is authorized to issue up to 5,000,000 shares of
preferred stock of TPG in classes or series and to fix the designations,
preferences, qualifications, limitations or restrictions of any class or series
with respect to the rate and nature of dividends, the price and terms and
conditions on which shares may be redeemed, the amount payable in the event of
voluntary or involuntary liquidation, the terms and conditions for conversion or
exchange into any other class or series of the stock, voting rights and other
terms. The Company may issue, without the approval of the holders of common
stock, preferred stock which has voting, dividend or liquidation rights superior
to the common stock and which may adversely affect the rights of the holders of
common stock. The Company has reserved for issuance under the Shareholder Rights
Plan described below up to 400,000 shares of preferred stock.
Shareholder 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
47
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 TPG's Board of
Directors. The dividend policy is also dependent on the ability of PMI to pay
dividends to TPG, which is subject to, among other factors, regulatory
restrictions by the Arizona Department of Insurance and TPG's credit agreements
and the Runoff Support Agreement. (See Part I. "O. Regulation" and Part II,
Item 8, Financial Statement Note 14--"Dividends and Stockholders' Equity".)
During the second quarter of 1995, TPG's Board of Directors declared its first
dividend on common stock of $0.05 per share, and has declared and paid a
quarterly dividend of $0.05 per share 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 and increased to $0.04 per share for the third
and fourth quarters of 1999.
Item 6. Selected Financial Data
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 1999 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. 1999 Annual Report to Stockholders under the heading
"Management Discussion and Analysis" as part of Exhibit 13.1.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
At December 31, 1999, the average duration of the Company's fixed income
investment portfolio was 5.3 years, and the Company did not have a significant
amount of derivative financial instruments in its investment portfolio. The
result of a 1% increase in interest rates would be a 5.3% decrease in the value
of the Company's investment portfolio, while the result of a 1% decrease in
interest rates would be a 4.8% 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. 1999 Annual Report to Stockholders as part of Exhibit
13.1.
48
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Effective February 17, 2000, the Company's Board of Directors approved the
engagement of Ernst & Young LLP as the Company's independent auditors for the
fiscal year ending December 31, 2000, subject to the ratification of the
Company's stockholders.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information concerning TPG's Directors as required by this Item is
incorporated by reference from TPG's 1999 Proxy Statement under the captions
"Nominees For Director of TPG" and "Section 16(a) Beneficial Ownership
Reporting Compliance". Information regarding Executive Officers of TPG 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 TPG's
1999 Proxy Statement under the captions "Directors-Compensation and Benefits,"
"Executive Compensation" and "Compensation Committee Interlocks and Insider
Participants".
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is incorporated by reference from TPG's
1999 Proxy Statement under the caption "Security Ownership of Certain
Beneficial Owners and Management".
Item 13. Certain Relationships and Related Transactions
Not Applicable.
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.
49
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: The 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 December 29, 1999, TPG filed a report on Form 8-K to announce that
it issued a press release advising that its mortgage insurance
subsidiary, PMI Mortgage Insurance Co. ("PMI") had been named as a
defendant in a purported class action lawsuit filed in the United
States District Court for the Southern Division of Georgia, Augusta
Division, captioned G. Craig Baynham and Linnie Baynham v. PMI
Mortgage Insurance Company (Case # CV199-241).; and
(ii) On February 23, 2000, TPG filed a report on Form 8-K to announce that
on February 17, 2000, its Board of Directors approved the engagement
of Ernst & Young LLP as its independent auditors for the fiscal year
ending December 31, 2000 to replace the firm of Deloitte & Touche LLP.
There were no "reportable events" as that term is described in Item
304(a)(1)(v) of Regulation S-K.
50
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
[Item 14(a) 1 and 2]
Page
----------------------------------
Annual Report
Consolidated Financial Statements Form 10-K To Shareholders
--------------------------------- --------- ---------------
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997 N/A 30
Consolidated Balance Sheets as of December 31, 1999 and 1998 N/A 31
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1999, 1998 and 1997 N/A 32
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997 N/A 33
Notes to Consolidated Financial Statements N/A 34-53
Report of Independent Auditors N/A 56
Financial Statement Schedules
-----------------------------
Report of Independent Auditors on Financial Statement 54 N/A
Schedules as of and
for the specified years in the three-year period ended
December 31, 1999:
Schedule I-Summary of investments other than in related 55 N/A
parties
Schedule II-Condensed financial information of Registrant 56-59 N/A
Schedule III-Supplementary insurance information 60 N/A
Schedule IV-reinsurance 61 N/A
51
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 28th day of March, 2000.
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 on March 28, 2000 by the following persons on behalf of
the registrant and in the capacities indicated.
/s/ W. Roger Haughton Chairman of the Board and
- --------------------- Chief Executive Officer March 28, 2000
W. Roger Haughton
/s/ John M. Lorenzen, Jr. Executive Vice President, March 28, 2000
- ------------------------- Chief Financial Officer,
John M. Lorenzen, Jr. and Assistant Secretary
(Principal Financial Officer)
/s/ William A. Seymore Vice President, Controller March 28, 2000
- ---------------------- (Controller and Principal
William A. Seymore Accounting Officer)
/s/ James C. Castle Director March 28, 2000
- -------------------
Dr. James C. Castle
Director March __, 2000
- -------------------
Donald C. Clark
/s/ Wayne E. Hedien Director March 28, 2000
- -------------------
Wayne E. Hedien
/s/ Raymond L. Ocampo Jr. Director March 28, 2000
- -------------------------
Raymond L. Ocampo Jr.
/s/ John D. Roach Director March 28, 2000
- -----------------
John D. Roach
/s/ Kenneth T. Rosen Director March 28, 2000
- --------------------
Dr. Kenneth T. Rosen
/s/ Richard L. Thomas Director March 28, 2000
- ---------------------
Richard L. Thomas
52
/s/ Mary Lee Widener Director March 28, 2000
- --------------------
Mary Lee Widener
/s/ Ronald H. Zech Director March 28, 2000
- ------------------
Ronald H. Zech
53
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of The PMI Group, Inc.:
We have audited the consolidated financial statements of The PMI Group,
Inc. and subsidiaries as of December 31, 1999 and 1998, and for each of the
three years in the period ended December 31, 1999, and have issued our report
thereon dated January 20, 2000; such consolidated financial statements and
report are included in your 1999 Annual Report to Shareholders and are
incorporated herein by reference. Our audits also included the financial
statement schedules of The PMI Group, Inc. and subsidiaries, listed in item
14(a) 2. These consolidated financial statement schedules are the responsibility
of the Company's management. Our responsibility is to express an opinion based
on our audits. In our opinion, such consolidated financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, represent fairly in all material respects the information set forth
therein.
/s/ Deloitte & Touche LLP
San Francisco, California
January 20, 2000
54
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1999
Amount at which
Type of Investment Amortized Market Shown in the
------------------ Cost Value Balance Sheet
---------------- --------------- ---------------
(In thousands)
Fixed maturities:
Bonds:
United States government and
government agencies and authorities $ 87,223 $ 84,047 $ 84,047
States, municipalities and political subdivisions 1,260,409 1,261,308 1,261,308
All other corporate 137,764 133,955 133,955
---------------- --------------- ---------------
Total fixed maturities 1,485,396 $ 1,479,310 1,479,310
---------------- =============== ---------------
Equity securities:
Common stocks:
Banks, trust and insurance companies 3,189 $ 4,483 4,483
Industrial, miscellaneous and all other 41,525 79,407 79,407
Non-redeemable preferred stocks 17,660 17,582 17,582
---------------- --------------- ---------------
Total equity securities 62,374 $ 101,472 101,472
---------------- =============== ---------------
Short-term investments 145,087 145,093
---------------- ---------------
Total investments, other than related party $ 1,692,857 $ 1,725,875
================ ===============
55
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
PARENT COMPANY ONLY
December 31, 1999 and 1998
1999 1998
------------- -------------
(Dollars in thousands)
ASSETS
------
Investment portfolio, available for sale, at market value:
Fixed income securities (cost - $32,745 and $50,578) $ 31,696 $ 51,904
Short-term investments 60,973 3,722
Common Stock of affiliate, at underlying book value 36,746 20,471
------------- -------------
Total investments 129,415 76,097
------------- -------------
Cash 407 473
Investment in subsidiaries, at equity in net assets 1,279,336 1,217,738
Other assets 14,685 12,491
------------- -------------
Total assets $ 1,423,843 $ 1,306,799
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Long-term debt $ 99,542 $ 99,476
Accounts payable - affiliates 1,630 1,678
Other liabilities 3,235 5,997
------------- -------------
Total liabilities 104,407 107,151
------------- -------------
Commitments and contingent liabilities (Note A) - -
Junior subordinated deferrable interest debenture
held solely by subsidiary trust 102,168 102,133
Shareholders' equity:
Preferred stock-$.01 par value; 5,000,000 shares authorized - -
Common stock -- $.01 par value; 125,000,000 shares authorized,
52,793,777 and 35,196,002 shares issued 528 352
Additional paid-in capital 265,828 265,040
Accumulated other comprehensive income 20,186 74,462
Retained earnings 1,258,617 1,060,724
------------- -------------
1,545,159 1,400,578
Less treasury stock (8,091,924 and 4,917,401 shares at cost) 327,891 303,063
------------- -------------
Total shareholders' equity 1,217,268 1,097,515
------------- -------------
Total liabilities and shareholders' equity $ 1,423,843 $ 1,306,799
============= =============
See accompanying supplementary notes to Parent company
condensed financial statements.
56
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
PARENT COMPANY ONLY
December 31, 1999, 1998 and 1997
1999 1998 1997
-------------- -------------- --------------
(In thousands)
Revenue:
Equity in undistributed net income of subsidiaries $ 112,029 $ 90,696 $ 101,488
Subsidiary dividends 97,339 103,200 78,863
Investment income, net 8,913 9,600 8,990
Capital gains (losses), net 329 1,045 (2,405)
-------------- -------------- --------------
Total revenue 218,610 204,541 186,936
-------------- -------------- --------------
Expenses:
Operating expenses 6,456 722 642
Interest expense 15,810 15,592 14,618
-------------- -------------- --------------
Total expenses 22,266 16,314 15,260
-------------- -------------- --------------
Income before tax 196,344 188,227 171,676
Income tax expense (benefit) (8,122) (2,133) (3,633)
-------------- -------------- --------------
Net income $ 204,466 $ 190,360 $ 175,309
============== ============== ==============
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
PARENT COMPANY ONLY
Years Ended December 31, 1999, 1998 and 1997 (in thousands)
1999 1998 1997
-------------- -------------- --------------
Net income $ 204,466 $ 190,360 $ 175,309
------------ ------------ -----------
Other comprehensive income net of tax:
Unrealized gain on investments:
Unrealized holding gains (losses) arising during period (54,062) 3,205 19,664
Less: reclassification adjustment for (gains) losses included
in net income (214) (679) 1,563
------------ ------------ -----------
Other comprehensive income (loss), net of tax (54,276) 2,526 21,227
------------ ------------ -----------
Comprehensive income $ 150,190 $ 192,886 $ 196,536
============ ============ ===========
See accompanying supplementary notes to Parent company condensed financial
statements.
57
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STAEMENTS OF CASH FLOWS
PARENT COMPANY ONLY
December 31, 1999, 1998 and 1997
1999 1998 1997
--------------- ---------------- ---------------
(In thousands)
Cash flows from operating activities:
Net income $ 204,466 $ 190,360 $ 175,309
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization 278 1,063 848
Equity in net income of subsidiaries (209,368) (193,896) (180,351)
Capital (gains) losses, net (329) (1,045) 2,405
Increase (decrease) in payable to affiliates (48) 565 (4,246)
Other (7,435) 2,282 (10,437)
------------- ------------- ------------
Net cash provided by (used in) operating activities (12,436) (671) (16,472)
------------- ------------- ------------
Cash flows from investing activities:
Dividends from subsidiaries 97,339 103,200 78,863
Investment in affiliates (16,878) (24,173) (13,093)
Purchases of fixed income securities (3,887) (1,000) (92,350)
Investment collections of fixed income securities - 6,271 5,000
Proceeds from sales of fixed income securities 22,110 40,522 46,667
Proceeds from sales of equity securities - 93 -
Net (increase) decrease in short-term investments (57,251) 32,455 13,200
------------- ------------- ------------
Net cash provided by (used in) investing activities 41,433 157,368 38,287
------------- ------------- ------------
Cash flows from financing activities:
Issuance of junior subordinated debentures - - 102,093
Dividends paid to shareholders (5,199) (6,333) (6,733)
Proceeds from exercise of stock options 964 2,592 3,181
Purchase of The PMI Group, Inc. common stock (24,828) (152,920) (120,002)
------------- ------------- ------------
Net cash provided by (used in) financing activities (29,063) (156,661) (21,461)
------------- ------------- ------------
Net increase (decrease) in cash (66) 36 354
Cash at beginning of year 473 437 83
------------- ------------- ------------
Cash at end of year $ 407 $ 473 $ 437
============= ============= ============
See accompanying supplementary notes to Parent company condensed financial
statements.
58
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
SUPPLEMENTARY NOTES
Note A
The accompanying Parent Company ("TPG") financial statements should be read in
conjunction with the Consolidated Financial Statements and Notes to Consolidated
Financial Statements (including Notes 9, 11 and 12 related to long-term
obligations, commitments and contingent liabilities and the junior subordinated
debenture) appearing on pages 40-42 of The PMI Group, Inc. 1999 Annual Report to
Shareholders.
Note B
During 1999, 1998 and 1997, TPG received $97.3 million, $103.2 million, and
$78.9 million, respectively, of ordinary and extraordinary cash dividends from
subsidiaries.
59
THE PMI GROUP, INC.
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
As of and for the Years Ended December 31, 1999, 1998 and 1997
Reserve for
Losses and Losses and Amortization
Deferred Loss Net Loss of Deferred Other
Acquisition Adjustment Unearned Premiums Investment Adjustment Acquisition Operating Premiums
Segment Costs Expenses Premiums Earned Income Expenses Costs Expenses Written
- ------- ------------- ------------ ------------ ------------ ----------- ------------- ------------ ------------ ------------
(In thousands)
1999
MI (1) $ 67,281 $ 269,931 $ 102,022 $ 447,214 $ 80,922 $ 110,465 $ 80,252 $ 54,017 $ 459,065
Inter-
national (2) 2,298 3,714 80,067 11,291 3,673 1,213 - 4,472 12,071
Title - 8,355 - 100,118 1,634 1,004 - 88,244 100,118
Other (3) - - - - 8,913 - - 23,506 -
----------- ----------- ----------- ----------- ---------- ------------ ----------- ----------- ------------
Total $ 69,579 $ 282,000 $ 182,089 $ 558,623 $ 95,142 $ 112,682 $ 80,252 $ 170,239 $ 571,254
=========== =========== =========== =========== ========== ============ =========== =========== ============
1998
MI (1) $ 61,605 $ 206,132 $ 94,886 $ 411,922 $ 77,257 $ 135,097 $ 60,280 $ 44,293 $ 409,796
Title - 9,127 - 79,304 1,401 619 - 69,109 79,304
Other (3) - - - - 6,023 - - 29,223 -
----------- ----------- ----------- ----------- ---------- ------------ ----------- ----------- ------------
Total $ 61,605 $ 215,259 $ 94,886 $ 491,226 $ 84,681 $ 135,716 $ 60,280 $ 142,625 $ 489,100
=========== =========== =========== =========== ========== ============ =========== =========== ============
1997
MI (1) $ 37,864 $ 192,211 $ 94,150 $ 394,010 $ 73,007 $ 150,367 $ 43,395 $ 40,952 $ 372,114
Title - 10,176 - 59,938 1,257 1,890 - 53,085 59,938
Other (3) - - - - 8,872 - - 17,708 -
----------- ----------- ----------- ----------- ---------- ------------ ----------- ----------- ------------
Total $ 37,864 $ 202,387 $ 94,150 $ 453,948 $ 83,136 $ 152,257 $ 43,395 $ 111,745 $ 432,052
=========== =========== =========== =========== ========== ============ =========== =========== ============
(1) Represents Domestic Mortgage Insurance Operations
(2) Represents International Mortgage Insurance Operations
(3) Represents ancillary services and parent company investment income.
The 1997 amounts have been restated to conform to the SFAS 131
presentation of segments.
60
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
Years Ended December 31, 1999, 1998 and 1997
Percentage
Ceded Assumed of Amount
Premiums earned for the Gross to Other from Other Net Assumed
year ended December 31, Amount Companies Companies Amount to Net
----------------------- ------------ ----------- --------------- --------------- ------------
(In thousands, except percentages)
1999
Consolidated Mortgage Guaranty $ 474,096 $ 22,034 $ 6,443 $ 458,505 1.4%
Title 100,355 239 2 100,118 0.0%
------------ ----------- ----------- ----------- -------
Total $ 574,451 $ 22,273 $ 6,445 $ 558,623 1.2%
============ =========== =========== =========== =======
1998
Consolidated Mortgage Guaranty $ 426,613 $ 17,783 $ 3,092 $ 411,922 0.8%
Title 79,483 188 9 79,304 0.0%
------------ ----------- ----------- ----------- -------
Total $ 506,096 $ 17,971 $ 3,101 $ 491,226 0.6%
============ =========== =========== =========== =======
1997
Consolidated Mortgage Guaranty $ 398,904 $ 6,068 $ 1,174 $ 394,010 0.3%
Title 60,068 138 8 59,938 0.0%
------------ ----------- ----------- ----------- -------
Total $ 458,972 $ 6,206 $ 1,182 $ 453,948 0.3%
============ =========== =========== =========== =======
61
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 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.
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 1, 1996, between The PMI Group,
Inc., and The Chase Manhattan Bank, 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(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.
10.1(i) * PMI Mortgage Insurance Co. Bonus Incentive Plan dated as of February
18, 1999
10.2* The PMI Group, Inc. Equity Incentive Plan. (Restated as of August 16,
1999)
10.3* The PMI Group, Inc. Stock Plan for Non-Employee Directors. (restated
as of August 16, 1999).
10.4(k) The PMI Group, Inc. Directors Deferred Compensation Plan. (amended &
restated as of July 21, 1999).
10.5(a) Form of 1984 Master Policy of PMI Mortgage Insurance Co.
10.6(a) Form of 1994 Master Policy of PMI Mortgage Insurance Co.
10.7(a) CMG Shareholders Agreement dated September 8, 1994 between CUNA Mutual
Investment Corporation and PMI Mortgage Insurance Co.
62
10.8(b) Runoff Support Agreement dated October 28, 1994 between Allstate
Insurance Company, the Registrant and PMI Mortgage Insurance Co.
10.9(b) Form of Tax Sharing Agreement among the Registrant, the Registrant's
subsidiaries, The Allstate Corporation, Allstate Insurance Company and
Sears, Roebuck and Co.
10.10(a) Mortgage Insurance Variable Quota Share Reinsurance Treaty effective
January 1, 1991 issued to PMI Mortgage Insurance Co. by Hannover
Ruckversicherungs-Aktiengesellschaft ("Hannover").
10.11(a) First Amendment to Mortgage Insurance Variable Quota Share Reinsurance
Treaty made as of January 1, 1992 between Hannover and PMI Mortgage
Insurance Co.
10.12(j) Supplemental Employee Retirement Plan (amended and restated as of May
20, 1999).
10.13(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
10.14(a) Form of Indemnification Agreement between the Registrant and its
officers and directors.
10.15(a) Per Mortgage Excess of Loss Reinsurance Treaty effective January 1,
1994 issued to PMI Mortgage Insurance Co. by Hannover.
10.16 The PMI Group, Inc. Retirement Plan (amended and restated as of
February 17, 2000).
10.17(j) The PMI Group, Inc., Additional Benefit Plan dated as of February 18,
1999
10.18(e) The Guarantee Agreement, dated February 4, 1997 between The PMI Group,
Inc. (As Guarantor) and The Bank of New York (As Trustee).
10.19(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.
10.20* The PMI Group, Inc., Employee Stock Purchase Plan (restated as of
August 16, 1999)
10.21(e) Form of Change of Control Employment Agreement
10.22(k) The PMI Group, Inc., Officer Deferred Compensation Plan. (amended and
restated as of September 16, 1999)
10.23 Excess of Loss Reinsurance Treaty effective August 20, 1999 issued by
PMI Mortgage Insurance Co. to reinsurers. 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 1999 Annual
Report to Shareholders.
21.1 Subsidiaries of the Registrant.
63
23.1 Independent Auditors' Consent.
27.1 Financial Data Schedule.
(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.
* Compensatory or benefit plan in which certain executive officers or
Directors of The PMI Group, Inc., or its subsidiaries are eligible to
participate.
64