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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, 1998
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 Identification No.)
executive offices)
(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 26, 1999
was $1,297,762,997 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 26, 1999: 30,093,055.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the fiscal year ended
December 31, 1998 are incorporated by reference into Items 6 through 8 of Part
II. Portions of the Proxy Statement for registrant's 1999 Annual Meeting of
Stockholders to be held on May 20, 1999 are incorporated by reference into Items
10 through 13 of Part III. The Exhibit Index is located on page 54.
TABLE OF CONTENTS
PART I.......................................................................................... 3
Cautionary Statement
Item 1. Business............................................................................... 3
A. General.................................................................................... 3
B. Products................................................................................... 4
C. Industry Overview.......................................................................... 6
D. Competition and Market Share............................................................... 7
E. Customers.................................................................................. 10
F. Business Composition....................................................................... 10
G. Sales, Product Development and Underwriting Personnel...................................... 12
H. Underwriting Practices..................................................................... 13
I. Affordable Housing......................................................................... 16
J. Defaults and Claims....................................................................... 16
K. Reinsurance................................................................................ 24
L. Claims-Paying Ability Ratings.............................................................. 25
M. Investment Portfolio....................................................................... 26
N. Other Businesses........................................................................... 26
O. Regulation................................................................................. 28
P. Employees.................................................................................. 32
Q. Statements and Risk Factors Concerning the Company's Operations and Future Results......... 32
Item 2. Properties............................................................................. 39
Item 3. Legal Proceedings...................................................................... 39
Item 4. Submission of Matters to a Vote of Security Holders.................................... 39
PART II......................................................................................... 41
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.............. 41
Common Stock.................................................................................. 41
Preferred Stock............................................................................... 41
Payment of Dividends and Policy............................................................... 41
Item 6. Selected Financial Data................................................................ 42
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 42
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................ 42
Item 8. Financial Statements and Supplementary Data............................................ 42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 42
PART III........................................................................................ 42
Item 10. Directors and Executive Officers of the Registrant.................................... 42
Item 11. Executive Compensation................................................................ 42
Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 43
Item 13. Certain Relationships and Related Transactions........................................ 43
PART IV......................................................................................... 43
1
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 43
INDEX TO EXHIBITS............................................................................... 54
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. Such forward-looking statements include the
following: (i) the statement that 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 insurance mortgage market; (ii) the statement that management anticipates
that contract underwriting will continue to generate a significant percentage of
PMI's NIW and that customer demand for contract underwriting services will
increase; (iii) the statement that management also believes the number of
contract underwriters deployed by the Company will decrease as mortgage
origination volumes decline; and (iv) the statement that although management
expects that California should continue to account for the majority of total
claims paid, management anticipates that with continued improvement in the
California economy, increased benefits of loss mitigation and improved default
reinstatement rates, California claims paid as a percentage of total claims paid
should continue to decline for the foreseeable future. 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. "Statements and Risk Factors Concerning the Company's
Operations and Future Results" (Risk Factors "RF# 1-14") 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
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, and PMI Mortgage Guaranty Co. ("PMG"), an
Arizona corporation. TPG also conducts non-residential mortgage insurance
business through its wholly-owned subsidiaries American Pioneer Title Insurance
Company ("APTIC"), a Florida corporation, TPG Segregated Portfolio Company
("TSPC"), a Cayman Islands corporation, and PMI Capital I, a Delaware trust. 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. ("SEC"), a Delaware
3
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
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. CMG is accounted for on the equity method in the Company's
consolidated financial statements. TPG is also a principal investor in RAM
Reinsurance Company Ltd. ("RAM Re"), a financial guaranty reinsurance company
based in Bermuda.
TPG, through PMI and CMG, is one of the leading residential mortgage insurers in
the United States. In addition to 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 and was acquired
by Allstate Insurance Company ("Allstate") in 1973. In April 1995, Allstate
sold approximately seventy percent of the common stock of TPG in an initial
public offering (the "IPO"). In April 1998, Allstate exchanged most of its
holdings of TPG common stock to redeem its Exchangeable Notes due on April 15,
1998. The Notes were sold to the public concurrently with the IPO. Currently,
Allstate has no significant holdings of TPG common stock. At December 31, 1998,
the Company's total assets were $1.8 billion and its shareholders' equity was
$1.1 billion.
B. Products
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 20% or less 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"). At December 31, 1998, 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 25% coverage, and 95s and 97s have 30% coverage. Fannie Mae and
Freddie Mac are collectively referred to as government-sponsored enterprises
("GSEs"). The GSEs recently announced programs which provide for reduced
mortgage insurance coverage requirements. (See "D. Competition and Market
Share", below and RF3). The coverage percentage insured by PMI is determined
by the lender, usually to comply with Fannie Mae and Freddie Mac 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.
Primary Insurance
PMI provides primary insurance coverage, insuring 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 claim amount. In lieu of paying the coverage
percentage of the claim amount, PMI has the option of: (i) paying the entire
claim amount 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
4
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, 1998. The average coverage percentage for PMI was 24.9% of
NIW for the year ended December 31, 1998. 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, TIC and PMG to provide reinsurance of such deep coverage to PMI and CMG.
(See "K. Reinsurance", below.). At December 31, 1998, PMI's average coverage
percentage on insurance in force was 23.9%. 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. 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. (See RF4). 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.
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 97.5% of
NIW in 1998. Beginning in April 1999, PMI will offer 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 which require the payment of an
additional fee for a further reduction in mortgage insurance coverage. See "D.
Competition and Market Share", below and RF3.
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). 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 1.7% of NIW in 1998.
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 0.8% of NIW in 1998.
Pool Insurance
During the fourth quarter of 1997, PMI began offering a pool insurance product
to state housing finance authorities GSEs as part of PMI's value added strategy.
New risk written for this product was $450.3 million for the year ended December
31, 1998 and was not significant for 1997. 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 geographic diversification and lower LTVs risk in force
under pool
5
insurance programs with PMI's customers represented approximately two percent of
the $19.3 billion total primary risk in force at December 31, 1998. See RF10.
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
"RF2 and RF8".
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.
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 RF5
Effective January 1, 1999 Fannie Mae and Freddie Mac announced increases in the
maximum principal balance of loans eligible for purchase by Fannie Mae and
Freddie Mac to $240,000. 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 RF2 and RF3.
6
Since 1992, Fannie Mae and Freddie Mac have been subject to oversight
legislation for GSEs 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.
TPG believes that the GSEs' announced goals for 1998 were that at least 42% of
the units financed by each GSE be low- and moderate-income housing, and that
approximately 25% 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%). 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.
Freddie Mac's and Fannie Mae's automated underwriting services, Loan
Prospector/SM/ and Desktop Underwriter/TM/, respectively, can be used by
mortgage originators to determine whether Freddie Mac or Fannie Mae will
purchase a loan prior to closing. Through these systems, lenders are able to
obtain 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 is 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 RF4, below.
D. Competition and Market Share
The U.S. private mortgage insurance industry consists of nine active mortgage
insurers, including Mortgage Guaranty Insurance Corporation ("MGIC"), GE
Capital Mortgage Insurance Corporation ("GEMICO"), an affiliate of GE Capital
Corporation, and United Guaranty Residential Insurance Company ("UGC"), an
affiliate of American International Group, Inc. PMI, including CMG, is the third
largest private mortgage insurer in the United States based on new primary
insurance written in 1998 and direct primary insurance in force at December 31,
1998. (Source: Inside Mortgage Finance.) In 1998, MGIC possessed the largest
share of the private mortgage insurance market, with approximately 23.1% of NIW,
and GEMICO, PMI and UGC had market shares of approximately 16.4%, 16.2% and
12.7%, respectively. (Source: Inside Mortgage Finance.) PMI's 1998 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 RF2.
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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,
------------------------------------------------------------
1998 1997 1996 1995 1994
--------- ---------- ---------- ---------- ----------
Mortgage Guaranty Insurance Corp. 23.1 % 26.4 % 25.5 % 27.4 % 25.7 %
GE Capital Mortgage Insurance Corp. 16.4 16.5 18.5 20.1 27.6
PMI Mortgage Insurance Co. (1) 16.2 13.8 14.7 13.5 13.8
United Guaranty Corp. 12.7 12.8 12.7 12.9 13.3
Commonwealth Mortgage Assurance Co. 11.3 11.3 9.7 9.6 7.8
Republic Mortgage Insurance Co. 9.7 10.3 11.2 9.7 8.7
Amerin Guaranty Corp. 8.1 6.5 6.0 5.3 1.9
Triad Guaranty Insurance Corp. 2.5 2.4 1.7 1.5 1.2
--------- ---------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========= ========== ========== ========== ==========
Source: Inside Mortgage Finance
(1) Includes CMG.
The following table indicates the market share by private mortgage insurer for
each quarter in 1998:
Private Mortgage Insurance Industry Market Share
1998 by Quarter
-----------------------------------------------------------
4Q 1998 3Q 1998 2Q 1998 1Q 1998
------------- ------------- ------------- -----------
Mortgage Guaranty Insurance Corp. 22.2 % 23.2 % 23.1 % 24.1 %
PMI Mortgage Insurance Co. (1) 16.4 16.6 16.3 15.0
GE Capital Mortgage Insurance Corp. 15.4 17.1 17.1 16.2
United Guaranty Corp. 13.3 12.3 12.4 12.4
Commonwealth Mortgage Assurance Co. 11.5 11.3 10.7 11.7
Republic Mortgage Insurance Co. 9.7 9.8 9.8 9.7
Amerin Guaranty Corp. 8.7 7.3 8.2 8.3
Triad Guaranty Insurance Corp. 2.8 2.4 2.4 2.6
------------- ------------- ------------- -----------
Total 100.0 % 100.0 % 100.0 % 100.0 %
============= ============= ============= ===========
Source: Inside Mortgage Finance
(1) Includes CMG.
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 which accounted for 43.7%, 45.6%, and 44.8% for 1998, 1997
and 1996, respectively, of all loans insured or guaranteed(2). Effective January
1, 1999, the Department of Housing and Urban Development announced an increase
in the maximum individual loan amount that FHA can insure to $208,800 from
8
$197,620. The maximum individual loan amount that the VA can insure is $203,150.
(See RF2). 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, signed into law on October 21, 1998
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 RF2.
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,
------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
FHA/VA 43.7 % 45.6 % 44.8 % 38.5 % 51.8 %
Private Mortgage Insurance 56.3 54.4 55.2 61.5 48.2
---------- ---------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
========== ========== ========== ========== ==========
Fannie Mae and Freddie Mac announced an increase in the maximum single-family
principal balance loan limit eligible for their purchase from $227,150 to
$240,000 effective in 1999. 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,
and RF3.
Freddie Mac and Fannie Mae both recently announced programs where reduced
mortgage insurance coverage will be made available for lenders that deliver
loans approved by the GSE's automated underwriting services, Loan
Prospector/SM/ and Desktop Underwriter/TM/, 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 home buyer to have MI at these
levels, such loans would require a payment at closing or a higher note rate.
See RF3.
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
9
national banks, savings institutions, or bank holding companies could become
significant competitors of the Company in the future. See "O. Regulation", and
RF2.
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% 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 competes with mortgage insurance as an
alternative for lenders selling loans in the secondary mortgage market. The
Federal Deposit Insurance Corporation and other banking regulators recently
approved rules to be effective April 1, 1999 that would require national banks
to hold almost twice as much risk-based capital to cover possible defaults on
the 80/10/10 products when the lender holds the first and second mortgage.
State-chartered banks already are subject to the higher capital requirement.
(See RF2). 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.
TPG also issues performance notes to certain lenders or their affiliates, which
notes pay a base rate of interest plus, if appropriate, a performance addition.
PMI is 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"
and RF4.
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, 1998, 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, 1998, total mortgage originations according to
Inside Mortgage Finance were estimated to be $1.5 trillion compared to $849.7
billion for the year ended December 31, 1997.
E. Customers
PMI insures mortgage loans funded by mortgage originators. Mortgage originators
include mortgage bankers, savings institutions, commercial banks and other
mortgage lenders. See RF1.
For the year ended December 31, 1998, 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.
F. 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
10
with another mortgage insurance company. However, the GSE's have restrictions on
changing mortgage insurance provider. 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 1994 to
1998. The relatively low interest rates during this period resulted in an
increasing percentage of mortgages insured by PMI at a fixed rate of interest,
representing 89.7% of direct primary risk in force at December 31, 1998, up from
74.4% at year-end 1994. 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 28.8% for
the year ended December 31, 1997 to 34.4%, for the year ended December 31, 1998.
During the period between 1997 and 1998, PMI's amount of direct primary risk in
force increased by 6.6% from $18.1 billion at December 31, 1997 to $19.3 billion
at December 31, 1998. The direct primary risk in force increased by 4.4% for
period between 1996 and 1997 from $17.3 billion, to $18.1 billion, at December
31, 1996 and 1997, respectively.
Recently 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. If the
reduction in required levels of mortgage insurance were to become widely
accepted by mortgage lenders and their customers, however, such reduction
could have a materially adverse impact on the Company's financial condition
and results of operations. See "D. Competition and Market Share", above and
RF3.
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, 1998, 46.3% 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, 1998, 3.3% of PMI's risk in force consisted of 97s which 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 pool insurance product. 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
pool risk written was $450.3 million for the year ended December 31, 1998.
Management is uncertain about the amount of new pool risk that will be written
in 1999, but believes total new pool risk written in 1999 will be less than the
amount of pool risk written in 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 such products, and the
associated investment income, may ultimately prove to be inadequate to
compensate for future losses from such products. See RF10.
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:
11
Direct Risk in Force
As of December 31,
-----------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ----------- ----------- ----------- ------------
Direct Risk in Force (In millions) $ 19,324 $ 18,092 $ 17,336 $ 15,130 $ 13,243
============ =========== =========== =========== ============
Lender Concentration:
Top 10 Lenders (by original applicant) 30.0 % 27.8 % 26.0 % 22.5 % 20.4 %
============ =========== =========== =========== ============
LTV:
97s 3.3 % 1.8 % 1.1 % 0.4 % 0.0 %
95s 46.3 46.2 43.6 40.2 35.7
90s and below 50.4 52.0 55.3 59.4 64.3
------------ ----------- ----------- ----------- ------------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============ =========== =========== =========== ============
Average Coverage Percentage 23.9 % 24.3 % 22.4 % 21.2 % 20.1 %
============ =========== =========== =========== ============
Loan Type:
Fixed 89.7 % 83.3 % 80.6 % 76.8 % 74.4 %
ARM 9.2 15.2 17.7 21.3 23.9
ARM (scheduled/potential
negative amortization) 1.1 1.5 1.7 1.9 1.7
------------ ----------- ----------- ----------- ------------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============ =========== =========== =========== ============
Mortgage Term:
15 years and under 5.3 % 6.3 % 9.4 % 8.6 % 10.3 %
Over 15 years 94.7 93.7 90.6 91.4 89.7
------------ ----------- ----------- ----------- ------------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============ =========== =========== =========== ============
Property Type:
Single-family detached 87.1 % 86.3 % 86.7 % 86.7 % 86.3 %
Condominium 6.4 6.8 6.9 7.1 7.5
Other (1) 6.5 6.9 6.4 6.2 6.2
------------ ----------- ----------- ----------- ------------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============ =========== =========== =========== ============
Occupancy Status:
Primary residence 98.6 % 99.0 % 99.2 % 99.3 % 99.4 %
Second home 1.0 0.8 0.6 0.5 0.3
Non-owner occupied 0.4 0.2 0.2 0.2 0.3
------------ ----------- ----------- ----------- ------------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============ =========== =========== =========== ============
Loan Amount:
$100,000 or less 26.4 % 27.3 % 28.3 % 28.8 % 29.9 %
Over $100,000 and up to $250,000 66.1 65.6 64.8 64.3 63.5
Over $250,000 7.5 7.1 6.9 6.9 6.6
------------ ----------- ----------- ----------- ------------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============ =========== =========== =========== ============
(1) Includes two-to-four unit dwellings, townhouses, row houses and
cooperatives.
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, 1998, PMI had 34 sales and
underwriting service field and satellite offices located in 22 states. PMI's
sales force receives compensation
12
comprised of a base salary with incentive compensation tied to performance
objectives. PMI's Product Development and Pricing Department has primary
responsibility for advertising, sales materials, and the creation of new
products and services. PMI's product development and underwriting management
personnel 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 and
automated mortgage scoring 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 - Role of Technology" 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. New policies processed at the CPC represented 38.3% of
PMI's NIW in 1998 compared with 0.4% in 1997. During 1998, applications
processed at the CPC represented 47.0% of all applications compared with 1.2%
in 1997.
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 35.0%
of PMI's NIW in 1998 compared with 21.6% in 1997. Management anticipates that
contract underwriting will continue to generate a significant percentage of
PMI's NIW and that customer demand for contract underwriting services will
increase. Management also believes the number of contract underwriters deployed
by the Company will decrease as mortgage origination volumes decline. See RF7.
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.
. 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 limited 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.
13
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 RF12
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 submitted under this program.
The amount of business written under the Quick Application Program was 4.4% of
PMI's NIW in 1998. PMI's Certificate Priority Center ("CPC"), in Dallas Texas,
was designed to centralize the processing of data input for PMI's insurance
certificates and to enhance operational productivity and efficiency, customer
service and expense management. See "H. 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 1998, 62.2% of applications received were approved by the automated
underwriting systems. In 1997, 70.6% 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 1997 at approximately 8.0% for the
year ended December 31, 1998. 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 52.7% and 50.3% of PMI's
14
NIW in 1998 and 1997, respectively, and represented 37.3% of PMI's total risk in
force at December 31, 1998. PMI believes the percentage of risk in force written
under the PDQ Program will increase further in the future as the program is
expanded to include additional qualified lenders. 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 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.
Role of Technology
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.
In 1987, PMI completed development of pmiAURA/SM/ in conjunction with Allstate.
The system was initially developed utilizing five years of performance
information from approximately 300,000 borrower profiles. The system 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. PMI
has updated the pmiAURA/SM/ database with performance data of over 2 million
loans, and has added economic and demographic information to the database in
order to enhance pmiAURA/SM/ predictive power. During 1997, the 4th generation
of pmiAURA/SM/ was released which enabled the pmiAURA/SM/ system to generate
three types of scores: a loan risk score that 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 generation
includes a revised credit score indicator. PMI intends to further update the
model from time to time.
In 1991, the pmiTERRA/SM/ system was installed to complement 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.
15
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.
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. During 1998, pmiAURA/SM/, was approved by all four Wall
Street rating agencies as an effective tool for establishing levels of credit
support needed on securities backed by non-conforming, conventional loans.
I. Affordable Housing
PMI insures residential mortgages identified by its customers as loans secured
by properties owned and occupied by low- and moderate-income borrowers, or by
borrowers who reside in areas targeted for community reinvestment or
redevelopment ("affordable housing" loans). The percentage of affordable housing
loans designated as such by lenders was 6.5% of new risk written in 1998, as
compared to 9.10% in 1997. Management believes that affordable housing loans
have higher risks than its other insured business. As a result, PMI has
instituted various programs seeking to mitigate the higher risk characteristics
of such loans.
J. Defaults and Claims
Defaults
PMI's default rate has decreased to 2.31% at December 31, 1998 from the December
31, 1997 rate of 2.38%. This decrease was primarily due to an improvement in the
national economy, and particularly California, and to an increase in policies in
force. See RF12 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 1998 by PMI insureds was approximately within 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
16
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.
Historical Default Rates
Total Insured Loans in Force
Year Ended December 31,
-------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ---------- ----------- ---------- -----------
Number of Insured Loans in Force 714,210 698,831 700,084 657,800 612,806
Number of Loans in Default 16,528 16,638 15,326 13,022 11,550
Default Rate 2.31 % 2.38 % 2.19 % 1.98 % 1.88 %
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,
1998.
Default Rates by Region(1)
As of Period End,
------------------------------------------------------------------------------------------------
1998 1997
--------------------------------- ---------------------------------
Region 4th Q 3rd Q 2nd Q 1st Q 4th Q 3rd Q 2nd Q 1st Q 1996 1995 1994
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Pacific(2) 2.69 % 2.67 % 2.72 % 3.03 % 3.14 % 3.17 % 3.12 % 3.28 % 3.22 % 3.34 % 2.99 %
New England(3) 1.79 1.68 1.64 1.81 1.81 1.79 1.82 1.87 1.80 1.93 1.98
Northeast(4) 2.91 2.77 2.68 2.88 2.79 2.67 2.57 2.56 2.52 2.22 2.11
South
Central(5) 1.92 1.78 1.73 1.87 1.98 1.87 1.71 1.68 1.67 1.51 1.76
Mid-Atlantic(6) 2.37 2.23 2.22 2.40 2.35 2.29 2.17 2.15 2.03 1.65 1.60
Great Lakes(7) 1.98 1.94 1.88 1.88 1.86 1.75 1.56 1.63 1.82 1.21 1.28
Southeast(8) 2.39 2.16 2.10 2.35 2.31 2.13 2.05 1.99 1.93 1.53 1.41
North
Central(9) 1.96 1.91 1.78 1.95 1.95 1.75 1.67 1.65 1.61 1.31 1.03
Plains(10) 1.73 1.63 1.45 1.53 1.56 1.56 1.40 1.25 1.21 0.89 0.68
Total Portfolio 2.31 2.20 2.16 2.36 2.38 2.29 2.20 2.22 2.19 1.98 1.88
(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.
17
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,
-------------------- -------------------------------------------------------------
1998 1998 1997 1996 1995 1994
---------------- -------- -------- -------- -------- --------
California 17.6 % 3.15 % 3.73 % 3.81 % 4.08 % 3.72 %
Florida 7.3 3.08 2.93 2.40 1.92 1.86
Texas 7.2 2.18 2.25 2.04 1.85 2.29
New York 4.9 2.98 2.94 2.59 2.30 2.00
Washington 4.8 1.58 1.66 1.58 1.21 0.96
Illinois 4.2 2.35 2.56 2.14 1.84 0.60
Virginia 4.1 1.55 1.67 1.54 1.18 1.20
Pennsylvania 4.1 2.64 2.38 2.13 1.91 1.72
Georgia 4.0 2.01 1.87 2.59 2.26 2.14
Massachusetts 3.9 1.67 1.67 1.73 1.91 2.04
Total Portfolio 100.0 % 2.31 % 2.38 % 2.19 % 1.98 % 1.88 %
(1) Top ten states as determined by total risk in force as of December 31, 1998.
Default rates are shown by states based on location of the underlying
property.
Default rates on PMI's California policies decreased to 3.15% (representing
3,067 loans in default) at December 31, 1998, from 3.73% (representing 3,991
loans in default) at December 31, 1997. 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 48% and 64% of the total
dollar amount of claims paid for the year ended December 31, 1998 and 1997,
respectively. Although management expects that California should continue to
account for the majority of total claims paid, management anticipates that with
continued improvement in the California economy, increased benefits of loss
mitigation and improved default reinstatement rates, California claims paid as a
percentage of total claims paid should continue to decline for the foreseeable
future. See RF11
The following table sets forth the dispersion of PMI's primary insurance in
force and risk in force as of December 31, 1998, by year of policy origination
since PMI began operations in 1972.
18
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 - 1991 $ 4,226,669 5% $ 879,684 5%
1992 5,066,645 6% 989,627 5%
1993 10,485,549 13% 2,100,152 11%
1994 6,831,009 8% 1,459,165 8%
1995 6,872,617 9% 1,802,821 9%
1996 9,940,144 12% 2,632,644 14%
1997 11,485,537 14% 3,020,328 16%
1998 25,773,912 33% 6,439,414 32%
--------------------- ----------- ------------------- -----------
Total Portfolio $ 80,682,082 100% $ 19,323,835 100%
===================== =========== =================== ===========
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
42.3% of PMI's insurance in force at December 31, 1998. This substantial volume
of PMI's business is in its expected peak claim period. Despite increasing
coverage percentages and increasing mortgage principal amounts, direct primary
claims paid by PMI in 1998 decreased to approximately $118.4 million compared
with $147.1 million in 1997.
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, 1998, by year of policy origination and average coupon
rate.
19
Insurance in Force by Policy Year
and Average Coupon Rate
As of December 31, 1998
-----------------------------------------------------
Policy Average Percent
Year Rate (1) IIF of Total
------- ---------- --------------- ----------
1998 7.16 % $ 25,773,912 32.0 %
1997 7.80 11,485,537 14.2
1996 7.86 9,940,144 12.3
1995 8.03 6,872,617 8.5
1994 7.82 6,831,009 8.5
1993 7.50 10,485,549 13.0
1992 8.16 5,066,645 6.3
1972 - 1991 9.10 4,226,669 5.2
--------------- ----------
Total $ 80,682,082 100.0 %
=============== ==========
(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 of its claim payment. Generally, however, PMI settles by
paying the coverage percentage multiplied by the claim amount. In 1998 and 1997,
PMI settled 22.1% and 12.3%, respectively, of the primary claims processed for
payment on the basis of a prearranged sale. In each of 1998 and 1997, PMI
20
exercised the option to acquire the property on less than 4% of the primary
claims processed for payment. At December 31, 1998, PMI owned $8.6 million of
REO valued at the lower of cost or estimated realizable value.
The ratio of the claim paid to the original risk in force relating to such loan
is referred to as claim severity 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
95.8% in the period from 1994 to 1998.
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 a
personal computer-based automated claim-for-loss worksheet program, developed in
1987, 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; in 1998 PMI introduced
an enhanced version of pmiPC-CONNECT/SM/ named pmiWEB-CONNECT/SM/ which 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.
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 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.
21
Years Percentage of Cumulative
Since Losses Paid to Cumulative Premiums Written
Policy
Issue Policy Issue Year
---------------------------------------------------------------------------
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989
---------------------------------------------------------------------------
(in percents)
1 0.4 0.3 0.8 0.3 0.2 - 0.1 - - -
2 9.2 18.7 30.3 11.8 8.0 4.4 1.5 0.4 0.1 0.3
3 27.0 68.5 86.5 37.0 41.2 18.8 5.2 2.0 2.0 3.6
4 48.6 106.0 132.9 80.3 82.2 35.4 8.8 5.1 6.1 10.9
5 64.8 134.1 177.6 128.5 113.4 47.7 12.2 9.7 11.7 22.0
6 74.5 160.0 230.0 165.0 126.2 56.7 15.7 13.1 18.6 32.4
7 85.6 184.0 251.1 176.7 133.5 60.9 18.6 17.6 23.1 40.3
8 98.3 196.9 265.4 183.8 138.5 63.1 21.4 20.7 26.2 45.6
9 107.7 203.3 265.7 187.0 141.2 65.1 24.1 23.0 29.1 49.9
10 111.3 205.3 264.3 189.0 141.9 65.3 25.8 25.1 31.9 51.6
11 112.9 207.0 263.7 190.7 142.9 65.9 27.4 26.7 33.6
12 114.2 208.8 264.5 191.3 142.5 65.8 28.5 27.8
13 114.7 209.0 263.2 191.1 142.1 65.8 28.9
14 115.1 209.8 262.1 190.6 141.8 65.9
15 115.2 209.6 261.5 190.2 141.5
16 115.4 209.3 260.8 189.8
17 115.5 208.9 260.3
18 115.6 208.6
19 115.5
--------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998
--------------------------------------------------------------------
(in percents)
1 - - - - - 0.1 - 0.1 -
2 0.7 0.8 1.2 1.0 1.0 2.8 3.5 2.3
3 7.2 6.7 6.9 5.5 6.5 11.4 8.5
4 17.9 16.8 16.3 13.4 14.6 15.5
5 31.7 28.8 28.3 19.2 18.1
6 41.7 39.8 37.1 21.2
7 50.4 48.3 40.3
8 56.6 51.4
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.
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.
22
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 RF12). 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, 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 RF12.
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:
23
1998 1997 1996
-------------- -------------- --------------
($ in thousands)
Balance, January 1 $ 202,387 $ 199,774 $ 192,087
Less reinsurance recoverable 6,067 5,287 17,899
-------------- -------------- --------------
Net balance, January 1 196,320 194,487 174,188
-------------- -------------- --------------
Losses and loss adjustment expenses
(principally in respect of defaults occurring in)
Current year 146,884 158,147 161,740
Prior years (11,168) (5,890) (9,331)
-------------- -------------- --------------
Total losses and loss adjustment expenses 135,716 152,257 152,409
-------------- -------------- --------------
Losses and loss adjustment expense payments
(principally in respect of defaults occurring in)
Current year 12,503 27,700 23,353
Prior years 111,056 122,724 108,757
-------------- -------------- --------------
Total payments 123,559 150,424 132,110
-------------- -------------- --------------
Net balance, December 31 208,477 196,320 194,487
Plus reinsurance recoverable 6,782 6,067 5,287
-------------- -------------- --------------
Balance, December 31 $ 215,259 $ 202,387 $ 199,774
============== ============== ==============
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 recoverables) decreased by $11.2 million, $5.9 million, and
$9.3 million in 1998, 1997 and 1996, respectively, due primarily to lower-than-
anticipated 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.
Forestview
In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage
Insurance Company ("Forestview") whereby Forestview agreed to reinsure all
liabilities (net of amounts collected from third party reinsurers and
indemnitors) in connection with PMI's mortgage pool insurance business in
exchange for premiums received. In 1994, Forestview also agreed that as soon as
practicable after November 1, 1994, Forestview and PMI would seek regulatory
approval for the Reinsurance Treaty to be deemed to be an assumption agreement
and that, upon receipt of the requisite approvals, Forestview would assume such
liabilities. Forestview's claims-paying ability is currently rated "AA" by
Fitch IBCA. Forestview's previous claims-paying ability rating of "AA"
(Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P") in
1997. These ratings are subject to revisions or withdrawal at any time by the
assigning rating organization. Management is uncertain at this time what impact
the withdrawal of the claims-paying ability rating will have on the parties'
ability to timely consummate the assumption transaction. Pursuant to this
agreement, PMI ceded $9.0 million of pool premiums to
24
Forestview and Forestview reimbursed PMI for pool claims on the covered policies
in the amount of $26.8 million in 1998. The failure of Forestview to meet its
contractual commitments would materially and adversely affect the Company's
financial condition and results of operations. See RF14.
Capital Mortgage
In March 1994, PMI entered into a quota share reinsurance agreement with Capital
Mortgage Reinsurance Company ("Capital Mortgage") (claims-paying ability
rating of "AA+" at December 31, 1998 from S&P) whereby PMI ceded to Capital
Mortgage 5% of PMI's liability under its primary insurance policies written in
1993 through 1997 (and 5% of the related premiums). This agreement, which was
canceled effective December 31, 1997, provides for a ceding commission to be
paid by Capital Mortgage to PMI relating to premiums ceded. Capital Mortgage
remains liable on a runoff basis for nine years (subject to either party's right
to commute the agreement at six years) and receives renewal premiums on the
ceded portion of the primary insurance in force at the time of cancellation of
the agreement. See Part II, Item 8, Financial Statements Note 6--"Reinsurance."
Reinsurance Subsidiaries; RGC, RIC, PMG and TIC
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, PMG and TIC 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 RF2 and RF8
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 intends to reinsure the remaining risk though its affiliates,
including RGC, PMG and other subsidiaries being formed. See "B. Products",
above; "O. Regulation" and RF2, RF7, and RF8
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 Investors
Service, 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"). 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 RF3 and RF5
25
M. Investment Portfolio
Cash flow from the Company's investment portfolio represented approximately
48.0% of its total cash flow from operations during 1998. 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, 1998, based on
market value, approximately 96.6% of the Company's total investment portfolio
was invested in securities rated "A" or better, with 61.1% rated "AAA" and
25.3% rated "AA," in each case by at least one nationally recognized securities
rating organization.
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. During 1998, approximately 96% of the Company's investment
portfolio was managed internally.
At December 31, 1998, the consolidated market value of the Company's investment
portfolio was approximately $1.5 billion. At December 31, 1998, municipal
securities represented 77.9% of the market value of the total investment
portfolio. Securities due in less than one year, within one to five years, after
ten years, and other represented 0.5%, 4.8%, 11.6%, 78.8% and 4.3%,
respectively, of such total market value. The Company's net pre-tax investment
income (excluding capital gains) was $84.7 million for the year ended December
31, 1998, which represented a pre-tax yield of 6.06% for the year, a decline
from 6.14% for 1997. This decrease was the result of a decline in the average
interest rate on investments in 1998 as compared to 1997. Net realized capital
gains on the investment portfolio were $24.6 million and $19.6 million for 1998
and 1997, respectively. See Part II, Item 8, Financial Statements Note 3--
"Investments."
N. Other Businesses
TPG seeks to supplement its core mortgage insurance business and enhance its
customer relationships through ancillary businesses and may, from time to time,
invest in joint ventures or acquire related businesses in whole or in part or
diversify into other lines of business utilizing the Company's credit
enhancement and/or mortgage default analysis skills. TPG, through certain
subsidiaries, provides title insurance and various services and products for the
home mortgage finance industry, such as contract underwriting and the licensing
of its proprietary underwriting and real estate valuation systems.
Total revenues recognized for the year ended December 31, 1998 from TPG's
businesses other than PMI constituted approximately 17.4% of the Company's
consolidated revenues, compared with approximately 13.8% and 12.7%,
respectively, in 1997 and 1996.
Ram Re
During the first quarter of 1998, TPG became 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 1998. Three executives
of the Company serve as directors of Ram Re.
American Pioneer Title Insurance Co.
26
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 39 states and the District of Columbia. Although
APTIC is currently writing business in 30 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 1998, APTIC is ranked fifth among the 28
active title insurers conducting business in the State of Florida. For the year
ended December 31, 1998, 77.3% 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 93.8% and 94.1% of APTIC's
premiums earned for the years ended December 31, 1998 and 1997, respectively.
CMG Mortgage Insurance Company
CMG offers mortgage guaranty insurance for loans originated by credit unions.
CMG is operated as a joint venture between PMI and CUNA Mutual Investment
Corporation ("CMIC"), with PMI having a 45% ownership interest from September
1994 to September 1998. Beginning October 1998 PMI's ownership increased to 50%.
PMI and CMIC provide services to the venture, with CMIC providing primarily
sales and marketing services and PMI providing primarily 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.
As of December 31, 1998, 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, 1998 CMG had $4.2 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.
PMI Mortgage Services Co.
MSC, established in 1993, provides a variety of technical products and mortgage
underwriting services through a staff of underwriters in 34 field offices. The
Customer Technology Division of MSC provides technical products and services to
PMI's customers. This department licenses use of 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
27
customers. Contract underwriting on-site is generally more expensive for the
Company than underwriting a loan in-house and is becoming an increasingly
popular method among mortgage lenders for processing loan applications.
Contract underwriting processed loans represented 35.0% of PMI's NIW for the
year ended December 31, 1998 compared to 21.6% for the year ended December 31,
1997. Management anticipates that contract underwriting will continue to
generate a significant percentage of PMI's NIW and that customer demand for
contract underwriting services will increase. Management also believes the
number of contract underwriters deployed by the Company will decrease as
mortgage origination volumes decline. See RF7.
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 noninsurance 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.
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.
Because TPG is an insurance holding company and PMI, PMG, RGC and RIC are
Arizona insurance companies, 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
28
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 nonmanagement 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 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, 1998, PMI had
statutory policyholders' surplus of $165.4 million and statutory contingency
reserve of $1,028.4 million. See Part II, Item 8, Financial Statements Note 14--
"Statutory Accounting."
Dividends. PMI's ability to pay dividends is limited under 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 $16.5 million in 1999 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.
29
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 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 insured's
claim amount. Coverage in excess of 25% (i.e., deep coverage) 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"), which is 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, 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 notification laws include:
California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New York,
Texas and Washington. (See RF10)
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
30
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, the Community
Reinvestment Act and the Fair Housing Act. And Fannie Mae and Freddie Mac are
subject to 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.
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 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 RF3
Fannie Mae and Freddie Mac announced an increase in the maximum single-family
principal balance loan limit eligible for their purchase from $227,150 to
$240,000 effective in 1999. 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 percent down payment
(a 95 percent LTV), from 30 percent to 25 percent of the mortgage loan covered
by MI; (iii) reduction in required MI coverage, for loans with a 10 percent down
payment (a 90 percent LTV loan), from 25 percent to 17 percent 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 percent LTV loan will require 18 percent of the mortgage loan have
mortgage insurance coverage. Similarly, a 90 percent LTV loan will require 12
percent of the mortgage loan have mortgage insurance. In order for the home
buyer to have MI at these levels, such loans would require a payment at closing
or a higher note rate. (See RF3).
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. (See RF3)
31
National Association of Insurance Commissioners. 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, 1998, TPG, including its subsidiaries had 1,016 full and part-
time employees; 733 persons perform services primarily for PMI not including
contract underwriter's, 13 perform services primarily for MSC, 14 perform
services primarily for CMG and an additional 256 persons are employed by APTIC.
TPG's employees are not unionized and TPG considers its employee relations to be
good. In addition, MSC had 627 contract workers at December 31, 1998.
Q. STATEMENTS AND RISK FACTORS CONCERNING THE COMPANY'S OPERATIONS AND FUTURE
RESULTS
General Conditions (RF1)
Several factors such as economic recessions, declining housing values, higher
unemployment rates, deteriorating borrower credit, rising interest rates,
increases in refinance activity caused by declining interest rates, changes in
legislation affecting the mortgage insurance industry, or combinations of such
factors might affect the mortgage insurance industry and demand for housing in
general and could materially and adversely affect the Company's financial
condition and results of operations. Such economic events could materially and
adversely impact the demand for mortgage insurance, cause claims on policies
issued by PMI to increase, and/or cause a similar adverse increase in PMI's loss
experience.
Other factors that may influence the amount of NIW by PMI include: mortgage
insurance industry volumes of new business; the impact of competitive
underwriting criteria and product offerings and services, including mortgage
pool insurance and contract underwriting services; the ability to recruit and
maintain a sufficient number of qualified underwriters; the effect of risk-
sharing structured transactions; changes in the performance of the financial
markets; PMI's claims-paying ability rating; general economic conditions that
affect the demand for or acceptance of the Company's products; changes in
government housing policy; changes in government regulations or interpretations
regarding the Real Estate Settlement Procedures Act and customer consolidation.
PMI's financial condition and results of operations may materially and adversely
be impacted by changes in legislation which affects the ability of Fannie Mae or
Freddie Mac to offer a substitute for mortgage insurance, including self-
insurance and alternative forms of credit support, or for the FHA or the VA to
increase statutory lending limits or other expansion of eligibility for the FHA
and VA. (See RF2). PMI's financial condition and results of operations may
materially and adversely be impacted by changes in legislation, statutory
charters and regulations governing banks and savings institutions to form
reinsurance subsidiaries or permit the offering of other products which do not
require mortgage insurance. In addition, PMI's financial condition and results
of operations may materially and adversely be impacted by a reduction in the
amount of mortgage insurance coverage required by Fannie Mae and Freddie Mac.
(See RF3)
The costs of Year 2000 remediation, the dates on which the Company estimates
that it will complete such remediation and possible risks associated with the
Year 2000 issue are based upon the Company's current estimates and are subject
to various uncertainties that could cause the actual results to differ
materially from the Company's expectations. Such uncertainties include, among
others, the success of the Company in identifying systems that are not Year 2000
compliant, the nature and amount of programming required to remediate each
affected system, the
32
nature and adequacy of testing performed by the Company, the availability of
qualified personnel, consultants and other resources, and the success of the
Year 2000 remediation efforts of others. If the Company's recently completed
remediation of its mission critical mortgage insurance origination and
application processing process is faulty or fails for any reason to be Year 2000
compliant, this circumstance could adversely impact its business operations and
could have a material adverse affect on the Company's financial condition,
liquidity and results of operations. See Management Discussion and Analysis -
Year 2000 Issues.
Market Share and Competition (RF2)
The Company's financial condition and results of operations could be materially
and adversely affected 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 impact of competitive underwriting criteria and product
offerings, including mortgage pool insurance and contract underwriting, has a
direct impact on the Company's market share. Further, several of the Company's
competitors have greater direct or indirect capital reserves that provide them
with potentially greater flexibility than the Company in addressing competitive
issues.
PMI competes directly with federal and state governmental and quasi-governmental
agencies, principally the FHA and, to a lesser degree, the VA. 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. Mortgage lenders, other than banks, thrifts or their
affiliates, are forming reinsurance affiliates that are typically regulated
solely by the insurance authority of their state of domicile. Management
believes that such reinsurance affiliates will increase competition in the
mortgage insurance industry and may materially and adversely impact PMI's market
share.
PMI offers various risk-sharing structured transactions, including a captive
reinsurance program as part of its strategic relationships with its customers.
PMI's customers have indicated an increasing demand for such products. PMI's
captive reinsurance program allows a reinsurance company, generally an affiliate
of the lender, to assume mortgage insurance default losses either on a quota
share basis, or at a specified entry point up to a maximum aggregate exposure,
up to an agreed upon amount of total coverage. An increasing percentage of PMI's
NIW is being generated by customers which have captive reinsurance programs, and
it is expected that this will continue and increase. Based on the current
structure, such products have the potential of reducing the Company's business
revenue as more premiums are ceded to customer captives. There can be no
assurance that PMI's risk-sharing structured transactions will continue to be
accepted by its customers. The inability of the Company to provide acceptable
risk-sharing structured transactions to its customers would likely have an
adverse effect on the competitive position of PMI and consequently could
materially and adversely affect the Company's financial condition, liquidity 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 competes with mortgage insurance as an
alternative for lenders selling loans in the secondary mortgage market. The
Federal Deposit Insurance Corporation and other banking regulators recently
approved rules to be effective April 1, 1999 that would require national banks
to hold almost twice as much risk-based capital to cover possible defaults on
the 80/10/10 products when the lender holds the first and second mortgage.
State-chartered banks already are subject to the higher capital requirement. If
the 80/10/10 product becomes a widely accepted alternative to mortgage
insurance, it could have a material and adverse impact on the Company's
financial condition and results of operations.
33
Legislation and regulatory changes affecting the FHA have affected demand for
private mortgage insurance. Effective January 1, 1999, the Department of Housing
and Urban Development announced an increase in the maximum individual loan
amount that FHA can insure to $208,800 from $197,620. The maximum individual
loan amount that the VA can insure is $203,150. The Omnibus Spending Bill of
1999, signed into law on October 21, 1998, among other items, streamlined the
FHA downpayment 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.
Although management believes that it is too early to ascertain the impact of the
increase in the maximum individual loan amount the FHA can insure, any increase
in the maximum loan amount would likely have an adverse effect on the
competitive position of PMI and, consequently, could materially and adversely
affect the Company's financial condition and results of operations.
Fannie Mae and Freddie Mac (RF3)
The GSEs are permitted by statute 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. 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 percent down payment
(a 95 percent LTV), from 30 percent to 25 percent of the mortgage loan covered
by MI; (iii) reduction in required MI coverage, for loans with a 10 percent down
payment (a 90 percent LTV loan), from 25 percent to 17 percent 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 percent LTV loan will require 18 percent of the mortgage loan have
mortgage insurance coverage. Similarly, a 90 percent LTV loan will require 12
percent of the mortgage loan have mortgage insurance. In order for the home
buyer to have MI at these levels, such loans would require a payment at closing
or a higher note rate.
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 operation. If the reduction in required
levels of mortgage insurance were to become widely accepted by mortgage lenders
and their customers, however, such reduction could have a materially adverse
impact on the Company's financial condition and results of operation.
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. Currently, Freddie Mac can purchase loans with
downpayments of less than 20%, only if the loans are insured or use other
limited methods to protect against default.
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'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
34
satisfactory payment record, 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. (See RF4 for a discussion of recent Federal legislation
providing for guidelines for automatic mortgage insurance cancellation)
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. Because loan originators prefer to
make loans that may be marketed in the secondary market to Fannie Mae and/or
Freddie Mac they are motivated to purchase mortgage insurance from insurers
deemed eligible by the GSEs. Although management believes that it is too early
to ascertain the impact of the increase in the maximum individual loan amount
the GSEs can insure, management believes any increase in the maximum loan amount
would likely increase the number of loans eligible for mortgage insurance and
may have the effect of increasing the size of the mortgage insurance market, and
have a positive effect on the competitive position of PMI and consequently could
materially affect the Company's financial condition and results of operations.
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. 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. Failure to maintain such a rating would
effectively cause PMI to be ineligible to provide mortgage insurance. A loss of
PMI's existing eligibility status, either due to a failure to maintain a 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. (See RF2)
Insurance in Force (RF4)
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 of six to eight 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. 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. As a result, the Company's financial
condition and results of operation could be materially and adversely affected by
greater than anticipated policy cancellations or lower than projected
persistency resulting in declines in insurance in force.
Upon request by an insured, PMI must cancel the mortgage insurance for a
mortgage loan. In addition, The Home Owners Protection Act of 1998 (the "Act"),
which is 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, 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 notification laws
include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New
York, Texas and Washington. Management is uncertain about the impact of the 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 operation
for the foreseeable future. (See RF10)
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans. PMI and other mortgage insurance
companies generally experience 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
35
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. A decrease
in persistency, resulting from policy cancellations of older books of business
affected by refinancings (which are affected, among other things, by decreases
in interest rates) may materially and adversely impact the level or rate of
growth of insurance in force or risk in force and consequently have similar
impacts on the Company's financial condition and results of operations.
Rating Agencies (RF5)
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.
Rating agencies generally assess capital charges on pool insurance policies
based on price and structure. One published methodology for assessing the
capital requirement for pool insurance is based on the real estate depression
which occurred in oil producing states during the mid-1980's. Management
believes the current capital charge that could be levied on pool insurance risk
by one rating agency is approximately $1.00 of capital for each $1.40 of pool
insurance risk. In comparison, primary mortgage insurance regulators
specifically limit the amount of insurance risk that may be written by PMI
according to a number of financial tests, including limiting risk, to a multiple
of 25 times PMI's statutory capital (which includes the contingency reserve).
The rating agencies could change their view as to the capital charges that are
assessed on pool insurance products at any time. (See RF10)
Management believes that a significant reduction in PMI's claims-paying ratings
could have a material, adverse effect on the Company's financial condition and
results of operations. (See RF6)
Liquidity (RF6)
In the mortgage guaranty insurance industry, liquidity refers to the ability of
an enterprise to generate adequate amounts of cash from its normal operations,
including premiums received and investment income, in order to meet its
financial commitments, which are principally obligations under the insurance
policies it has written. Liquidity requirements are significantly influenced by
the level and severity of claims.
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 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 the performance of the financial markets negatively
affecting the Company's ability to secure sources of capital, or changes in the
standards used by credit rating agencies which adversely impact PMI's claims-
paying ability rating, or changes in the insurance laws of Arizona, Florida or
Wisconsin that restrict the ability of PMI, APTIC or CMG to pay dividends at
currently permissible levels, could adversely affect the Company's ability to
maintain capital resources to meet its business needs, and thereby have a
material, adverse affect on the Company's financial condition, liquidity and
results of operations.
Contract Underwriting Services; New Products (RF7)
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. 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
36
are in addition to those contained in PMI's master primary insurance policies.
Due to the increasing demand of contract underwriting services, the limited
number of underwriting personnel available, 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 remedy obligations for underwriting services, could
materially and adversely affect its market share and materially and adversely
affect 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 be
materially and adversely affected if PMI or the Company experiences delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products, including any
mortgage pool type products, or programs will be as profitable as the Company's
existing products and programs.
New York Department of Insurance (RF8)
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, it could materially and
adversely affect the Company's financial condition and results of operations.
Risk-to-Capital Ratio (RF9)
The State of Arizona, and other regulators specifically limit the amount of
insurance risk that may be written by PMI, by a variety of financial factors.
Other factors affecting PMI's risk-to-capital ratio include: (i) regulatory
review and oversight by the State of Arizona, PMI's state of domicile for
insurance regulatory purposes; (ii) 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; (iii) TPG's credit agreements; and (iv) 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 materially and
adversely affect the Company's financial condition and results of operations.
Changes in Composition of Insurance Risk Written; Pool Insurance (RF10)
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, 1998, 46.3% 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, 1998, 3.3% of PMI's risk in force consisted of 97s which 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. 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 which did not
require primary insurance, in each case up to a stated aggregate loss limit. New
pool risk written was $450 million for the year ended December 31, 1998.
Management is uncertain about the amount of new pool risk which will be written
in 1999, but believes total new 1999 pool risk will be less than in 1998.
Although PMI charges higher premium rates for loans that have higher
37
risk characteristics, including ARMs, 95s, 97s and pool insurance products, 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. Such losses could materially and adversely affect the Company's
financial condition and results of operations. (See RF5)
Potential Increase in Claims (RF11)
Mortgage insurance coverage 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. (See
RF5)
Loss Reserves (RF12)
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 Concentration (RF13)
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 17.6%, 7.3% and 7.2% of its risk in force concentrated and where the default
rate on all PMI policies in force is 3.15%, 3.08% and 2.18% compared with 2.31%
nationwide as of December 31, 1998.
Continuing Relationships with Allstate and Affiliate (RF14)
In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage
Insurance Company ("Forestview") whereby Forestview agreed to reinsure all
liabilities (net of amounts collected from third party reinsurers and
indemnitors) in connection with PMI's mortgage pool insurance business in
exchange for premiums received. In 1994, Forestview also agreed that as soon as
practicable after November 1, 1994, Forestview and PMI would seek regulatory
approval for the Reinsurance Treaty to be deemed to be an assumption agreement
and that, upon receipt of the requisite approvals, Forestview would assume such
liabilities. Forestview's claims-paying ability is currently rated "AA" by
Fitch IBCA. Forestview's previous claims-paying ability rating of "AA"
(Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P") in
1997. These ratings are subject to revisions or withdrawal at any time by the
assigning rating organization. Management is uncertain at this time what impact
the withdrawal of the claims-paying ability rating will have on the parties'
ability to timely consummate the assumption transaction. Pursuant to this
agreement, PMI ceded $9.0 million of pool premiums to Forestview and Forestview
reimbursed PMI for pool claims on the covered policies in the amount of $26.8
million in 1998. The failure of Forestview to meet its contractual commitments
would materially and adversely affect the Company's financial condition and
results of operations.
On October 28, 1994, TPG entered into a Runoff Support Agreement (the "Runoff
Support Agreement") with Allstate Insurance Company ("Allstate") 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. Alternatively,
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),
38
Allstate would receive subordinated debt or preferred stock of PMI or TPG in
return. No payment obligation arose under the Runoff Support Agreement.
Item 2. Properties
TPG leases its home office in San Francisco, California, which consists of
approximately 99,928 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 17,563 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
Various 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 1998 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, 1998, including age as of March 31, 1999, and business experience
for at least the past five years.
W. ROGER HAUGHTON, 51, 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 and Actuarial
Services departments. In March 1999, Mr. Haughton concluded his two-year term as
President of the Mortgage Insurance Companies of America ("MICA"), the industry
trade association, a position he has held since March 1997. He also has a long
history of active volunteerism with various affordable housing organizations,
including Habitat for Humanity, and serves on 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, 49, 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.
39
CLAUDE J. SEAMAN, 52, 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., 54, 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, 44, 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.
THOMAS C. BROWN, 50, has been Executive Vice President, Field Operations of TPG
and PMI since September 1998. Prior thereto he was Senior Vice President of
National Accounts of TPG and PMI since joining TPG in June 1997. Prior to
joining TPG, he was president and chief executive officer of Centerbank Mortgage
Company, positions he held since 1989.
VICTOR J. BACIGALUPI, 55, has been 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 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.
40
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 PMA. As of December 31, 1998 there were 30,278,601 shares issued
and outstanding. As of February 26, 1999 there were 30,093,055 shares issued
and outstanding held by approximately 38 stockholders of record and
approximately 8,000 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, 1998 and 1997:
1998 1997
---------------------------------- ------------------------------
High Low Close High Low Close
---------- ----------- ----------- -------- ----------- ---------
First quarter 83 7/8 63 3/4 80 3/4 56 7/8 50 50 1/8
Second quarter 85 1/2 68 7/16 73 15/32 63 47 3/4 62 3/8
Third quarter 75 1/4 41 1/2 45 3/4 63 13/16 56 1/2 57 5/16
Fourth quarter 59 7/8 33 49 3/8 74 56 1/2 72 5/16
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 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
41
Agreement. (See Part I. "O. Regulation" and Part II, Item 8, Financial
Statement Note 13--"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 fourth quarter of 1998.
Item 6. Selected Financial Data
The information required by this Item is incorporated by reference from portions
of The PMI Group, Inc. 1998 Annual Report to Stockholders under the heading
"Five 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. 1998 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, 1998, the average duration of the Company's fixed income
investment portfolio was 5.3 years, and the Company had no 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. 1998 Annual Report to Stockholders as part of Exhibit
13.1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information concerning 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
42
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.
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 January 19, 1999, TPG filed a report on Form 8-K to announce that
Fannie Mae issued a press release announcing the expansion of available
mortgage insurance options reducing the amount of mortgage insurance
required on loans purchased by Fannie Mae; and
(ii) On January 22, 1999, TPG filed a report on Form 8-K to announce its
fourth quarter earnings and financial results for the period ended
December 31, 1998, and to announce additional statements made on
January 20, 1999 during the fourth quarter earnings conference call
with analysts.
43
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,
1998, 1997 and 1996 N/A 26
Consolidated Balance Sheets as of December 31, 1998 and 1997 N/A 27
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1998, 1997 and 1996 N/A 28
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996 N/A 29
Notes to Consolidated Financial Statements N/A 30-47
Report of Independent Auditors N/A 48
Financial Statement Schedules
-----------------------------
Report of Independent Auditors on Financial Statement Schedules as of and 36 N/A
for the specified years in the three-year period ended December 31, 1998:
Schedule I-Summary of investments other than in related parties 37 N/A
Schedule II-Condensed financial information of Registrant 38-41 N/A
Schedule III-Supplementary insurance information 42 N/A
Schedule IV-reinsurance 43 N/A
44
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 30th day of March, 1999.
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 30, 1999 by the following persons on behalf of
the registrant and in the capacities indicated.
/s/ W. Roger Haughton Chairman of the Board and March 30, 1999
- ---------------------------- Chief Executive Officer
W. Roger Haughton
/s/ John M. Lorenzen, Jr. Executive Vice President, March 30, 1999
- ---------------------------- Chief Financial Officer,
John M. Lorenzen, Jr. and Assistant Secretary
(Principal Financial Officer)
/s/ William A. Seymore Vice President, Controller March 30, 1999
- ---------------------------- (Controller and Principal
William A. Seymore Accounting Officer)
/s/ James C. Castle Director March 30, 1999
- ----------------------------
James C. Castle
/s/ Donald C. Clark Director March 30, 1999
- ----------------------------
Donald C. Clark
/s/ Wayne E. Hedien Director March 30, 1999
- ----------------------------
Wayne E. Hedien
/s/ John D. Roach Director March 30, 1999
- ----------------------------
John D. Roach
/s/ Kenneth T. Rosen Director March 30, 1999
- ----------------------------
Kenneth T. Rosen
/s/ Richard L. Thomas Director March 30, 1999
- ----------------------------
Richard L. Thomas
/s/ Mary Lee Widener Director March 30, 1999
- ----------------------------
Mary Lee Widener
/s/ Ronald H. Zech Director March 30, 1999
- ----------------------------
Ronald H. Zech
45
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, 1998 and 1997, and for each of the three
years in the period ended December 31, 1998, and have issued our report thereon
dated January 20, 1999; such consolidated financial statements and report are
included in your 1998 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, 1999
46
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1998
Amount at which
Amortized Market Shown in the
Type of Investment Cost Value Balance Sheet
---------------- --------------- ---------------
(In thousands)
Fixed maturities:
Bonds:
United States government and
government agencies and authorities $ 53,918 $ 55,978 $ 55,978
States, municipalities and political subdivisions 1,110,665 1,193,738 1,193,738
All other corporate 104,042 107,153 107,153
---------------- --------------- ---------------
Total fixed maturities 1,268,625 $ 1,356,869 1,356,869
---------------- =============== ---------------
Equity securities:
Common stocks:
Banks, trust and insurance companies 158 $ 156 156
Industrial, miscellaneous and all other 33,971 58,629 58,629
Non-redeemable preferred stocks 17,240 17,706 17,706
---------------- --------------- ---------------
Total equity securities 51,369 $ 76,491 76,491
---------------- =============== ---------------
Short-term investments 38,414 38,414
---------------- ---------------
Total investments, other than related party $ 1,358,408 $ 1,471,774
================ ===============
47
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
PARENT COMPANY ONLY
December 31, 1998 and 1997
1998 1997
---------------- -----------------
ASSETS (Dollars in thousands)
Investment portfolio, available for sale, at market value:
Fixed income securities (cost - $50,578 and $96,316) $ 51,904 $ 97,605
Short-term investments 3,722 36,177
---------------- -----------------
Total investment portfolio 55,626 133,782
---------------- -----------------
Cash 473 437
Investment in subsidiaries, at equity in net assets 1,238,209 1,120,809
Other assets 12,491 12,317
---------------- -----------------
Total assets $ 1,306,799 $ 1,267,345
================ =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Long-term debt $ 99,476 $ 99,409
Accounts payable - affiliates 1,678 1,113
Other liabilities 5,997 3,544
---------------- -----------------
Total liabilities 107,151 104,066
---------------- -----------------
Commitments and contingent liabilities (Note A) - -
Junior subordinated deferrable interest debenture
held solely by subsidiary trust 102,133 102,099
Shareholders' equity:
Preferred stock-$.01 par value; 5,000,000 shares authorized - -
Common stock -- $.01 par value; 125,000,000 shares authorized,
35,196,002 and 35,147,247 shares issued 352 351
Additional paid-in capital 265,040 262,448
Accumulated other comprehensive income 74,462 71,936
Retained earnings 1,060,724 876,588
---------------- -----------------
1,400,578 1,211,323
Less treasury stock (4,917,401 and 2,684,000 shares at cost) 303,063 150,143
---------------- -----------------
Total shareholders' equity 1,097,515 1,061,180
---------------- -----------------
Total liabilities and shareholders' equity $ 1,306,799 $ 1,267,345
================ =================
See accompanying supplementary notes to Parent company condensed financial
statements.
48
THE PMI GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
PARENT COMPANY ONLY
Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996
-------------- -------------- --------------
(In thousands)
Revenue:
Equity in undistributed net income of subsidiaries $ 90,696 $ 101,488 $ 110,758
Subsidiary dividends 103,200 78,863 47,660
Investment income, net 9,600 8,990 2,532
Capital gains (losses), net 1,045 (2,405) 113
-------------- -------------- --------------
Total revenue 204,541 186,936 161,063
-------------- -------------- --------------
Expenses:
Operating expenses 722 642 437
Interest expense 15,592 14,618 907
-------------- -------------- --------------
Total expenses 16,314 15,260 1,344
-------------- -------------- --------------
Income before tax 188,227 171,676 159,719
Income tax expense (benefit) (2,133) (3,633) 1,801
-------------- -------------- --------------
Net income $ 190,360 $ 175,309 $ 157,918
============== ============== ==============
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
PARENT COMPANY ONLY
Years Ended December 31, 1998, 1997 and 1996 (in thousands)
1998 1997 1996
-------------- -------------- --------------
Net income $ 190,360 $ 175,309 $ 157,918
------------ ------------ -----------
Other comprehensive income net of tax:
Unrealized gain on investments:
Unrealized holding gains (losses) arising during period 3,205 19,664 (5,979)
Less: reclassification adjustment for (gains) losses included
in net income (679) 1,563 (73)
------------ ------------ -----------
Other comprehensive income (loss), net of tax 2,526 21,227 (6,052)
------------ ------------ -----------
Comprehensive income $ 192,886 $ 196,536 $ 151,866
============ ============ ===========
See accompanying supplementary notes to Parent company condensed financial
statements.
49
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
PARENT COMPANY ONLY
Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996
--------------- ---------------- ---------------
(In thousands)
Cash flows from operating activities:
Net income $ 190,360 $ 175,309 $ 157,918
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization 1,063 848 185
Equity in net income of subsidiaries (193,896) (180,351) (158,418)
Capital (gains) losses, net (1,045) 2,405 (113)
Increase (decrease) in payable to affiliates 565 (4,246) 1,127
Other 2,282 (10,437) (551)
--------------- ---------------- ---------------
Net cash provided by (used in) operating activities (671) (16,472) 148
--------------- ---------------- ---------------
Cash flows from investing activities:
Dividends from subsidiaries 103,200 78,863 26,300
Investment in affiliates (4,000) (13,093) (14,683)
Purchases of fixed income securities (1,000) (92,350) (77,037)
Purchases of equity securities (20,173) - -
Investment collections of fixed income securities 6,271 5,000 20,848
Proceeds from sales of fixed income securities 40,522 46,667 -
Proceeds from sales of equity securities 93 - -
Net (increase) decrease in short-term investments 32,455 13,200 (19,147)
--------------- ---------------- ---------------
Net cash provided by (used in) investing activities 157,368 38,287 (63,719)
--------------- ---------------- ---------------
Cash flows from financing activities:
Issuance of junior subordinated debentures - 102,093 -
Issuance of long-term debt - - 99,337
Dividends paid to shareholders (6,333) (6,733) (7,002)
Proceeds from exercise of stock options 2,592 3,181 1,135
Purchase of The PMI Group, Inc. common stock (152,920) (120,002) (30,057)
--------------- ---------------- ---------------
Net cash provided by (used in) financing activities (156,661) (21,461) 63,413
--------------- ---------------- ---------------
Net increase (decrease) in cash 36 354 (158)
Cash at beginning of year 437 83 241
--------------- ---------------- ---------------
Cash at end of year $ 473 $ 437 $ 83
=============== ================ ===============
See accompanying supplementary notes to Parent company condensed financial
statements.
50
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 10, 11 and 12 related to long-term
obligations, commitments and contingent liabilities and the junior subordinated
debenture) appearing on pages 30-47 of The PMI Group, Inc. 1998 Annual Report to
Shareholders.
Note B
During 1998, 1997 and 1996, TPG received $103.2 million, $78.9 million, and
$26.3 million , respectively, of ordinary and extraordinary cash dividends from
subsidiaries. In addition, during 1996 TPG received $21.4 million of non-cash
dividends from a subsidiary.
51
THE PMI GROUP, INC AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
As of and for the Years Ended December 31, 1998, 1997 and 1996
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)
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 (2) - - - - 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 (2) - - - - 8,872 - - 17,708 -
------------ ------------ ------------- ------------- ----------- ------------- ------------ ------------ -------------
Total $ 37,864 $ 202,387 $ 94,150 $ 453,948 $ 83,136 $ 152,257 $ 43,395 $ 111,745 $ 432,052
============ ============ ============= ============= =========== ============= ============ ============ =============
1996:
MI (1) $ 31,633 $ 190,425 $ 116,951 $ 359,527 $ 63,689 $ 150,642 $ 46,192 $ 18,183 $ 349,809
Title - 9,349 - 53,211 1,162 1,767 - 48,012 53,211
Other (2) - - - - 2,591 - - 13,615 -
------------ ------------ ------------- ------------- ----------- ------------- ------------ ------------ -------------
Total $ 31,633 $ 199,774 $ 116,951 $ 412,738 $ 67,442 $ 152,409 $ 46,192 $ 79,810 $ 403,020
============ ============ ============= ============= =========== ============= ============ ============ =============
(1) Represents Mortgage Insurance Operations
(2) Represents ancillary services and parent company investment income.
The 1997 and 1996 amounts have been restated to conform to the SFAS 131
presentation of segments.
52
THE PMI GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
Years Ended December 31, 1998, 1997 and 1996
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)
1998:
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:
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%
=============== =============== =============== =============== ============
1996:
Mortgage Guaranty $ 372,439 $ 13,546 $ 634 $ 359,527 0.2%
Title 53,392 181 - 53,211 0.0%
--------------- --------------- --------------- --------------- ------------
Total $ 425,831 $ 13,727 $ 634 $ 412,738 0.2%
=============== =============== =============== =============== ============
53
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.
10.1* PMI Mortgage Insurance Co. Bonus Incentive Plan dated as of February 18, 1999
10.2* The PMI Group, Inc. Equity Incentive Plan. (amended & restated as of February 18, 1999
10.3(f)* The PMI Group, Inc. Stock Plan for Non-Employee Directors. (amended & restated as of July 23, 1998).
10.4(f) The PMI Group, Inc. Directors Deferred Compensation Plan. (amended & restated as of July 23, 1998).
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.
10.8(b) Runoff Support Agreement dated October 28, 1994 between Allstate Insurance Company, the
Registrant and PMI Mortgage Insurance Co.
10.9(a) Mortgage Pool Guaranty Insurance Reinsurance Treaty effective February 14, 1994 ceded by PMI
Mortgage Insurance Co. to Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.).
10.10(a) First Amendment Agreement made as of October 27, 1994 between PMI Mortgage Insurance Co. and
Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.).
10.11(a) Mortgage Guaranty Insurance Reinsurance Treaty effective December 31, 1991 ceded by PMI
Mortgage Insurance Co. to Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.).
10.12(a) Termination Agreement made as of October 27, 1994 between PMI Mortgage Insurance Co. and
Forestview Mortgage Insurance Co. (formerly PMI Insurance Co.).
54
Exhibit
Number Description of Exhibits
- ------------ ------------------------------------------------------------------------------------------------------
10.13(b) Form of Services Agreement between the Registrant, PMI Mortgage Insurance Co., and Forestview
Mortgage Insurance Co.
10.14(b) Form of Tax Sharing Agreement among the Registrant, the Registrant's subsidiaries, The Allstate
Corporation, Allstate Insurance Company and Sears, Roebuck and Co.
10.15(a) Mortgage Insurance Variable Quota Share Reinsurance Treaty effective January 1, 1991 issued to PMI
Mortgage Insurance Co. by Hannover Ruckversicherungs-Aktiengesellschaft ("Hannover").
10.16(a) First Amendment to Mortgage Insurance Variable Quota Share Reinsurance Treaty made as of
January 1, 1992 between Hannover and PMI Mortgage Insurance Co.
10.17(f) Supplemental Employee Retirement Plan (amended and restated as of February 12, 1998).
10.18(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
10.19(a) Form of Indemnification Agreement between the Registrant and its officers and directors.
10.20(a) Per Mortgage Excess of Loss Reinsurance Treaty effective January 1, 1994 issued to PMI Mortgage
Insurance Co. by Hannover.
10.21(c) The PMI Group, Inc. Retirement Plan.
10.22(e) The Guarantee Agreement, dated February 4, 1997 between The PMI Group, Inc. (As Guarantor)
and The Bank of New York (As Trustee).
10.23(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.
10.24(h)* The PMI Group, Inc., Employee Stock Purchase Plan
10.25(e) Form of Change of Control Employment Agreement.
10.26 The PMI Group, Inc., Officer Deferred Compensation Plan.
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
1998 Annual Report to Shareholders.
21.1 Subsidiaries of the Registrant.
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").
55
(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.
* Compensatory or benefit plan in which certain executive officers or Directors
of The PMI Group, Inc., or its subsidiaries are eligible to participate.
56