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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10 - Q

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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THE PMI GROUP, INC.
Index to Quarterly Report on Form 10-Q
March 31, 2003

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PART I – FINANCIAL INFORMATION

ITEM 1. INTERIM FINANCIAL STATEMENTS

THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

See accompanying notes to consolidated financial statements.

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THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying consolidated financial statements include the accounts of The PMI Group, Inc. (“The PMI Group”), a Delaware corporation; its direct and indirect wholly-owned subsidiaries, PMI Mortgage Insurance Co. (“PMI”), an Arizona corporation; American Pioneer Title Insurance Company (“APTIC”), a Florida corporation; PMI Mortgage Insurance Ltd and PMI Indemnity Limited (collectively, “PMI Australia”), Australian mortgage insurance companies; PMI Mortgage Insurance Company Limited (“PMI Europe”), an Irish insurance corporation; and other insurance, reinsurance and non-insurance subsidiaries. The PMI Group and its subsidiaries are collectively referred to as the “Company.” 

The Company has equity interests in CMG Mortgage Insurance Company (“CMG”), which conducts residential mortgage insurance business; Fairbanks Capital Holding Corp. (“Fairbanks”), a servicer of single-family residential mortgages; Truman Capital Founders, LLC (“Truman”), the general partner and majority-owner of an investment vehicle that focuses on the residential whole loan purchase market; and RAM Holdings Ltd. and RAM Holdings II Ltd. (collectively, “RAM Re”), financial guaranty reinsurance companies based in Bermuda.  The Company’s percentage ownership of equity securities of Fairbanks, CMG, RAM Re and Truman as of March 31, 2003 was 56.8%, 50.0%, 24.9% and 19.6%, respectively.  Because the Company has significant but not controlling interests in these entities, they are accounted for on the equity method of accounting in the Company’s consolidated financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”).  The results of Fairbanks and Truman are reported on a one-month lag basis, and RAM Re is reported on a quarter lag basis.  All material intercompany transactions and balances have been eliminated in consolidation.

The Company’s unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information and the requirements of Form 10-Q and Article 7 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation, have been included.  Interim results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.  The financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in The PMI Group, Inc.’s annual report on Form 10-K for the year ended December 31, 2002.

Cash and Cash Equivalents – The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.  As of December 31, 2002, the Company reclassified such investments previously reflected as short-term investments to cash equivalents.  Accordingly, the amounts of these investments classified as cash equivalents were approximately $121 million as of March 31, 2003 and $108 million as of March 31, 2002.

Investments  – The Company has designated its entire portfolio of fixed income and equity securities as available-for-sale.  These securities are recorded at fair value, based on quoted market prices, with unrealized gains and losses, net of deferred income taxes, accounted for as a component of accumulated other comprehensive income in shareholders’ equity.  The Company’s short-term investments have maturities of greater than three and less than 12 months when purchased and are classified as available-for-sale. The Company evaluates its investments regularly to determine whether there are declines in value and if such declines meet the definition of other-than-temporary impairment in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities.  The market value of a security below cost or amortized cost for two consecutive quarters is a potential indicator of an other-than-temporary impairment.  If the Company determines that a security has suffered an other-than-temporary impairment, the impairment loss is recognized, to the extent of the decline, as a realized investment loss in the current period’s earnings.

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Realized gains and losses on sales of investments are determined on a specific-identification basis.  Investment income consists primarily of interest and dividends.  Interest income is recognized on an accrual basis and dividend income is recorded on the date of declaration.

Investments in Unconsolidated Subsidiaries – Investments in unconsolidated subsidiaries with ownership interests of 20-50% are accounted for on the equity method of accounting, and investments of less than 20% ownership interest are generally accounted for on the cost method of accounting if the Company does not have significant influence over the entity.  The Company generally reports the equity earnings of its unconsolidated subsidiaries on either a one-month or one-quarter lag basis.  Fairbanks is accounted for on a one-month lag. The Company’s ownership interest in Fairbanks was 56.8% as of March 31, 2003.  The investment in Fairbanks was approximately $140 million at March 31, 2003, which included a goodwill component of approximately $35 million.  As a result of an agreement among the shareholders of Fairbanks limiting the Company’s ability to control the operations of Fairbanks, the Company reports its investment in Fairbanks using the equity method of accounting in accordance with EITF Issue No. 96-16, Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.  The cost basis of the investments in unconsolidated subsidiaries reflects the Company’s share of net unrealized gains and losses in the unconsolidated subsidiaries’ investment portfolio.

The Securities and Exchange Commission requires public companies to disclose condensed financial statement information in the footnotes for significant unconsolidated subsidiaries, individually or in the aggregate, if income before income taxes, extraordinary items and the cumulative effect of a change in accounting principle of the unconsolidated subsidiaries is in excess of 10% of such income of the Company, or if the Company’s proportionate share of unconsolidated subsidiaries’ total assets is in excess of 10% of total assets of the Company.  As of March 31, 2003, the income test and balance sheet test were exceeded for the unconsolidated subsidiaries in the aggregate.  Accordingly, a footnote has been provided for the Company’s proportionate share of balance sheet and statement of operations line items.  The condensed financial statements have been presented on a combined basis in the footnotes. 

Special Purpose Entities – Certain insurance transactions entered into by PMI Europe require the use of foreign special purpose entities (“SPEs”).  These SPEs are wholly-owned subsidiaries of the Company, and accordingly, are consolidated in the Company’s financial statements.  The Company is not affiliated with any SPEs that qualify for off-balance sheet treatment. 

Property and Equipment  – Property and equipment, including software, are carried at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to 39 years.  Leasehold improvements are recorded at cost and amortized over the lesser of the useful life of the assets or the remaining term of the related lease.

Under the provisions of Statement of Position (“SOP”) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes costs incurred during the application development stage related to software developed for internal use purposes and for which it has no substantive plan to market externally.  Capitalized costs are amortized on a straight-line basis over the estimated useful life of the asset at such time as the software is ready for its intended use, generally three to five years.  As a result, the Company capitalized costs associated with software developed for internal use of $5.3 million and $6.1 million for the three months ended March 31, 2003 and 2002, respectively. 

Policy Acquisition Costs  – The Company defers certain costs in its mortgage insurance operations relating to the acquisition of new insurance and amortizes these costs against related premium revenue in order to match costs and revenues.  These costs are primarily associated with the acquisition, underwriting and processing of new business, including contract underwriting and sales related activities.  To the extent the Company is compensated by customers for contract underwriting, those underwriting costs are not deferred.  Costs related to the issuance of mortgage insurance business are initially deferred and reported as deferred policy acquisition costs.  SFAS No. 60, Accounting and Reporting by Insurance Enterprises (“SFAS No. 60”), specifically excludes mortgage guaranty insurance from its guidance

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relating to the amortization of deferred policy acquisition costs.  Amortization of these costs for each underwriting year book of business is charged against revenue in proportion to estimated gross profits.  The estimates for each underwriting year are updated regularly to reflect actual experience and any changes to key assumptions such as persistency or loss development.

Losses and Loss Adjustment Expenses  – The reserves for mortgage guaranty insurance losses and loss adjustment expenses are the estimated claim settlement costs on notices of default that have been received by the Company, as well as loan defaults that have been incurred but have not been reported by the lenders.  SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to reserves for losses.  Consistent with industry accounting practices, the Company does not establish loss reserves for future claims on insured loans that are not currently in default.  The Company establishes loss reserves on a case-by-case basis when insured loans are identified as currently in default using estimated claim rates and average claim sizes for each report year, net of salvage recoverable.  The Company also reserves for defaults that have been incurred but have not been reported to the Company prior to the close of an accounting period, using estimated claim rates and claim sizes for the estimated number of defaults not reported.

Title policy claims reserves are established based on estimated amounts required to settle claims, including expenses for defending claims, for which notice has been received and an amount estimated to satisfy claims incurred but not reported.  Management believes that the title policy claim reserves are appropriately established in the aggregate and are adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred as of the balance sheet dates. 

Revenue Recognition  – Primary and pool insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide payment of premiums on a monthly, annual or single basis.  Upon renewal, the Company is not able to re-underwrite or re-price its policies.  SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the earning of insurance premiums.  Premiums written on a monthly basis are earned as coverage is provided.  Monthly premiums accounted for approximately 71% of gross premiums written from our mortgage insurance operations in the first quarter of 2003 compared with 76% in the first quarter of 2002.  Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage.  Primary mortgage insurance premiums written on policies covering more than one year are referred to as single premiums.  A portion of single premiums is recognized in earnings in the current period, and the remaining portion is deferred as unearned premiums and earned over the expected life of the policy, which ranges from seven to fifteen years.  Rates used to determine the earning of single premiums are estimates based on the expiration of risk.  Accordingly, the unearned premium reserve represents the portion of premiums written that is applicable to the estimated unexpired risk of insured policies. 

Title insurance premiums are recognized as revenue when an issued policy is received by APTIC.  Fee income of the non-insurance subsidiaries is earned as the services are provided including contract underwriting.  Contract underwriting revenue is recorded in other income.

Business Segments  –  The Company’s reportable operating segments include U.S. Mortgage Insurance Operations, International Mortgage Insurance Operations, Title Insurance and Other.  The Other segment includes the income, equity earnings and expenses of The PMI Group, contract underwriting services and an inactive broker-dealer.

Stock-Based Compensation  – The Company accounts for stock-based compensation to employees and directors using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and its related interpretations.  Under APB No. 25, compensation cost for stock-based awards is measured as the excess, if any, of the market price of the underlying stock on the grant date over the employees’ exercise price for the stock options.

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As all options have been granted with an exercise price equal to the fair value at the grant date, no compensation expense has been recognized for the Company’s stock option program.  SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), requires pro forma disclosure of net income and earnings per share using the fair value method, and provides that employers may continue to account for stock-based compensation under APB No. 25. 

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS  No. 148”).  SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002.  The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002.  Although the Company has not currently elected to expense the fair value of stock options granted, it continues to evaluate this alternative.  If the Company elects to expense the fair value of stock options under the guidelines of SFAS No. 148, the impact on its financial position and results of operations are expected to be consistent with SFAS No. 123 pro forma disclosure included in the financial statements.  The Company adopted the disclosure provisions of SFAS No. 148 effective in the first quarter of 2003.

The fair value of stock-based compensation to employees is calculated using the option pricing models that are developed to estimate the fair value of freely tradable and fully transferable options without vesting restrictions, which differ from the Company’s stock option program.  These models also require considerable judgment, including assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated value. 

The fair value of each stock option grant is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

SFAS No. 123 requires pro forma disclosure of net income and earnings per share using the fair value method.  If the computed fair values of the awards had been amortized to expense over the vesting period of the awards, the Company’s net income, basic net income per share and diluted net income per share would have been reduced to the pro forma amounts indicated below:

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Income Tax  –  The Company accounts for income taxes using the liability method in accordance with SFAS No. 109, Accounting for Income Taxes.  The liability method measures the expected future tax consequences of temporary differences at the enacted tax rates applicable for the period in which the deferred asset or liability is expected to be realized or settled.  Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable or deductible amounts in future years.

Earnings Per Share  –  Basic earnings per share, or EPS, excludes dilution and is based on net income available to common shareholders and the actual weighted-average of the common stock shares that are outstanding during the period.  Diluted EPS is based on net income available to common shareholders and the weighted-average of common stock shares outstanding on a fully diluted basis during the period.  The weighted-average of the common stock shares on a fully diluted basis reflects the potential increase of common stock shares if outstanding securities were converted into common stock, or if contracts to issue common stock, including stock options issued by the Company that have a dilutive impact, were exercised.  Net income available to common shareholders is the same for computing basic and diluted EPS.  The convertible debt outstanding has not been included in the calculation of diluted shares outstanding as it is anti-dilutive for the periods presented.

The following is a reconciliation of the weighted-average of the common stock shares used to calculate basic EPS to the weighted-average of the common stock shares used to calculate diluted EPS for the quarters ended March 31, 2003 and 2002.

Stock Split –In June 2002, the Company effected a two-for-one stock split in the form of a stock dividend.  All common share and per share data have been adjusted to reflect the stock split. 

Reclassifications– Certain items in the prior corresponding period’s consolidated financial statements have been reclassified to conform to the current period’s presentation.

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In January 2003, FASB issued Financial Interpretation Number (“FIN”) 46, Consolidation of Variable Interest Entities, which provides guidance on identifying and assessing interests in variable interest entities to determine if  consolidation of that entity is required.  FIN 46 requires consolidation of existing unconsolidated variable interest entities if the entities do not effectively disperse risk among the parties involved.  The Company will be required to adopt this interpretation for existing entities in the third quarter of 2003.  The Company is currently evaluating the impact, if any, of the adoption of this pronouncement.

Fair Values and Gross Unrealized Gains and Losses on Investments –The cost or amortized cost, estimated fair value, and gross unrealized gains and losses on investments are shown in the table below:

During the first quarter of 2003, the Company determined that the decline in the market value of certain equity securities met the definition of other-than-temporary impairment and recognized a realized loss of $0.1 million in the first quarter of 2003 compared to $3.2 million in the first quarter of 2002.

In March 2002, the Company entered into an agreement with a customer to provide mortgage insurance coverage for a three-year period on a pool of loans; the Company received funds to cover future claim payments on these loans.  The transaction does not transfer insurance risk.  Accordingly, the contract is being accounted for under the guidelines of SOP No. 98-7, Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk.  As of March 31, 2003, $12.4 million of deposits received under this agreement were included in cash and cash equivalents, and can only be utilized to pay claims related thereto.

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The following table summarizes deferred policy acquisition cost activity for the first three months of 2003 and 2002.

Deferred policy acquisition costs are affected by qualifying costs incurred and deferred, and amortization of previously deferred costs in the applicable period.  In periods where there is growth in new business, the asset will generally increase because the amount of acquisition costs being deferred exceeds amortization expenses. 

The reconciliation of net income to comprehensive income for the first three months of 2003 and 2002 are shown in the table below:

Transactions between segments are not significant.  The following tables present information for reported segment income or loss and segment assets as of and for the periods indicated.

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