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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10 - Q

For the quarterly period ended March 31, 2004

OR

For the transition period from              to             

Commission file number 1-13664

THE PMI GROUP, INC.

(Exact name of registrant as specified in its charter)

(925) 658-7878

(Registrant’s telephone number, including area code)

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  þ    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  þ    No  ¨

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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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

NOTE 1. BASIS OF PRESENTATION

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 reported as discontinued operations in the consolidated financial statements and for which the sale was closed on March 19, 2004; PMI Mortgage Insurance Ltd and PMI Indemnity Limited, the Australian mortgage insurance companies, and their holding company, PMI Mortgage Insurance Australia (Holdings) Pty Limited (collectively, “PMI Australia”); PMI Mortgage Insurance Company Limited and its holding company TPG Reinsurance Co. Ltd, the Irish insurance corporations (collectively, “PMI Europe”); and other insurance, reinsurance and non-insurance subsidiaries. The PMI Group and its subsidiaries are collectively referred to as the “Company.” All material intercompany transactions and balances have been eliminated in the consolidated financial statements.

On December 18, 2003, the Company completed its acquisition of a 42% ownership interest in FGIC Corporation, the holding company of Financial Guaranty Insurance Company (“FGIC”), from General Electric Capital Corporation. The Company has an equity ownership interest in Fairbanks Capital Holding Corp. (“Fairbanks”), a servicer of single-family residential mortgages; CMG Mortgage Insurance Company (“CMG”), which conducts residential mortgage insurance business; and through the holding companies, RAM Holdings Ltd. and RAM Holdings II Ltd., RAM Reinsurance Company, Ltd. (“RAM Re”), a financial guaranty reinsurance company based in Bermuda. In addition, the Company has various ownership interests in limited partnerships.

The Company’s unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and disclosure requirements for interim financial information and the requirements of Form 10-Q and Articles 7 and 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated 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, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. The consolidated 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, 2003.

NOTE 2. SUMMARY OF CERTAIN SIGNIFICANT ACCOUNTING POLICIES

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

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 consolidated shareholders’ equity. The Company evaluates its investments regularly to determine whether there are declines in value and whether 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 fair value of a security below cost or amortized cost for consecutive quarters is a potential indicator of an other-than-temporary impairment. When the Company determines 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 consolidated net income.

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The Company’s short-term investments that have maturities of greater than three and less than 12 months when purchased and are carried at fair value. 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 and preferred stock dividends are recognized on an accrual basis. Dividend income on common stock is recognized on the date of declaration. Net investment income represents interest and dividend income, net of expenses.

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.

Investments in Unconsolidated Subsidiaries – Investments in the Company’s unconsolidated subsidiaries include both equity investees and an unconsolidated majority-owned subsidiary. Investments in equity investees with ownership interests of 20-50% are generally 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. Limited partnerships with ownership interests greater than 3% but less than 50%, are generally accounted for using the equity method of accounting. The Company reports the equity earnings of FGIC Corporation, Fairbanks and CMG on a current month basis, and of RAM Re and the Company’s interests in its limited partnerships on a one-quarter lag basis. Effective January 1, 2004, the Company recorded a reduction of $4.8 million, net of tax, to retained earnings due to a change in reporting of Fairbanks from a one-month lag basis to a current month basis. This reduction represents our proportionate share of Fairbanks’ results for the month of December 2003. The reported value of the investments in the Company’s unconsolidated subsidiaries includes the Company’s share of net unrealized gains and losses in the unconsolidated subsidiaries’ investment portfolios.

Although the Company’s ownership percentage of Fairbanks exceeds 50%, the Company reports its investment in Fairbanks using the equity method of accounting due to an agreement among the shareholders of Fairbanks limiting the Company’s ability to control the operations of Fairbanks. This treatment is in accordance with guidance provided by Emerging Issues Task Force Issue (“EITF”) 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.

Periodically or as events dictate, the Company evaluates potential impairment of its investments in unconsolidated subsidiaries. Accounting Principles Board (“APB”) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, provides criteria for determining potential impairment. In the event a loss in value of an investment is determined to be an other-than-temporary decline, an impairment charge would be recognized in the consolidated statements of operations. Evidence of a loss in value that could indicate impairment might include, but would not necessarily be limited to, the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. Realized gains or losses resulting from the sale of the Company’s ownership interests in unconsolidated subsidiaries are recognized in net realized investment gains or losses in the consolidated statement of operations.

The Securities and Exchange Commission (“SEC”) requires public registrants to disclose condensed financial statement information in the consolidated footnotes for significant equity investees and unconsolidated majority-owned subsidiaries, individually or in the aggregate, if (i) the Company’s investments in and advances to the unconsolidated subsidiaries are in excess of 10% of the total consolidated assets of the Company, (ii) the Company’s proportionate share of unconsolidated subsidiaries’ total assets is in excess of 10% of total consolidated assets of the Company, or (iii) income from continuing operations 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. Furthermore, if certain of the above tests exceed 20% by any unconsolidated subsidiary; separate financial statements of that unconsolidated subsidiary are required to be included in the registrants’ SEC filings. Equity investees are not subject to the 20% threshold for proportionate share of unconsolidated subsidiaries total asset tests, and accordingly, separate financial statements of FGIC Corporation are not included in this Form 10-Q. As of March 31, 2004, the Company’s equity investees and unconsolidated majority-owned subsidiary exceeded certain 10% tests in the aggregate and, accordingly, condensed financial statements on a combined basis are provided in Note 13.

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Deferred 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 are initially deferred and reported as deferred policy acquisition costs. SFAS No. 60, Accounting and Reporting for Insurance Enterprises, specifically excludes mortgage guaranty insurance from its guidance relating to the amortization of deferred policy acquisition costs. Consistent with industry accounting practice, amortization of these costs for each underwriting year portfolio of business is charged against revenue in proportion to estimated gross profits. Estimated gross profits are composed of earned premiums, interest income and losses and loss adjustment expenses. The estimates for each underwriting year are monitored regularly to reflect actual experience and any changes to persistency or loss development. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed recoverable amounts, after considering investment income.

Property, Equipment and Software – 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. The Company’s accumulated depreciation and amortization was $99.0 million and $92.9 million as of March 31, 2004 and December 31, 2003, respectively.

Under the provisions of Statement of Position (“SOP”) No. 98-1, Accounting for the Cost 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, which is generally three to seven years. The Company capitalized costs associated with software developed for internal use of $7.0 million and $5.3 million for the three months ended March 31, 2004 and 2003, respectively.

Related Party Receivables – These receivables include non-trade receivables from unconsolidated subsidiaries. The most significant portion of the balance as of March 31, 2004 was comprised of approximately $23 million of subordinated participation interests in Fairbanks debt, which was part of a debt restructuring completed in the second quarter of 2003. The participation bears interest at LIBOR plus 2.5% and is payable monthly. All interest payments related to this receivable are current. The principal may begin to be repaid in June 2004, with the balance due and payable in September 2004. In addition, the Company has approximately $3 million of advances to Fairbanks related to other matters as of March 31, 2004.

Derivatives – Until the quarter ended June 30, 2003, the Company’s use of derivative financial instruments was generally limited to reducing its exposure to interest rate risk and currency exchange risk by utilizing interest rate swap and currency forward agreements that are accounted for as hedges. However, in April 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 149, Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 requires certain credit default swaps entered into by PMI Europe beginning on July 1, 2003 to be accounted for as derivatives and reported on the consolidated balance sheet at fair value, and subsequent changes in fair value are recorded in consolidated net income. In addition, as required by EITF No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities, for certain derivative contracts entered into by PMI Europe where the fair value cannot be determined by reference to quoted market prices, current market transactions for similar contracts, or based on a valuation technique incorporating observable market data or inputs, initial fair value related to the derivative contracts are deferred and recognized in consolidated net income in proportion to the expiration of the associated insured risk. Gains or losses are recognized in consolidated net income at inception for all other derivative contracts where the fair value can be determined in such a manner.

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As of March 31, 2004, PMI Europe had entered into three transactions that were classified as derivatives in accordance with SFAS No. 149. However, initial fair value gains were deferred in accordance with EITF No. 02-3. As of March 31, 2004, $4.7 million of deferred gains related to the initial fair value of these derivative contracts was included in other liabilities and $0.2 million (pre-tax) of accretion from the deferred gains was reported in other income for the first quarter of 2004. Subsequent changes in the value, exclusive of accretion, of derivative contracts resulted in a $1.2 million gain pre-tax in the first quarter of 2004, which was also included in other income.

Special Purpose Entities – Certain insurance transactions entered into by PMI and PMI Europe require the use of foreign special purpose wholly-owned subsidiaries that are consolidated in the Company’s consolidated financial statements.

Revenue Recognition – Mortgage guarantee 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 guarantee 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 68% of gross premiums written from the Company’s mortgage insurance operations in the first quarter of 2004 compared with 71% in the first quarter of 2003. 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 revenue on single premiums is recognized in premiums earned in the current period, and the remaining portion is deferred as unearned premiums and earned over the expected life of the policy, a range of seven to 15 years. Unearned premiums represent the portion of premiums written that is applicable to the estimated unexpired risk of insured loans. Rates used to determine the earnings of single premiums are estimates based on actuarial analysis of the expiration of risk. The earning pattern calculation is an estimation process and, accordingly, we review our premium earning cycle regularly and any adjustments to the estimates are reflected in the current period’s consolidated operating results.

Losses and Loss Adjustment Expenses – The reserves for mortgage insurance losses and loss adjustment expenses (“LAE”) 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 amounts for each report year, net of salvage recoverable. The Company also establishes loss 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 amounts applied to the estimated number of defaults not reported. The reserve levels as of the balance sheet date represent management’s best estimate of existing losses incurred. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Such adjustments to the extent of increasing or decreasing loss reserves, are recognized in current period results of operations.

Income Taxes – 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 effects 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 settle. 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 future increases or decreases in taxes owed on a cash basis compared to amounts already recognized as tax expense in the consolidated statement of operations. The Company’s effective tax rate was 24.2% in the first quarter of 2004 compared to the federal statutory rate of 35%, due to the proportion of income derived from PMI Australia and equity in earnings from FGIC, which have lower effective tax rates combined with our municipal bond investment income.

Benefit Plans – The Company provides pension benefit plans to all employees under The PMI Group Inc. Retirement Plan, and to certain employees of the Company under The PMI Group Inc. Supplemental Employee Retirement Plan. In addition, the Company provides certain health care and life insurance benefits for retired employees under another post-employment benefit plan. Net periodic benefit costs for these benefit plans were $3.4 million and 3.6 million during the first quarter of 2004 and the first quarter of 2003, respectively.

Comprehensive Income – Comprehensive income includes net income, foreign currency translation gains or losses, changes in unrealized gains and losses in investments net of deferred taxes, and the reclassification of realized gains and losses previously reported in comprehensive income. For the purposes of interim reporting, the Company reports the components of comprehensive income in its notes to the consolidated financial statements.

Business Segments– During the fourth quarter of 2003, the Company changed its reportable segments to reflect the change in management’s views on operating segments primarily as a result of the investment in FGIC and the then-pending sale of APTIC, which has been accounted for as discontinued operations. The Company’s reportable operating segments are U.S. Mortgage Insurance Operations, International Operations, Financial Guaranty and Other. U.S. Mortgage Insurance Operations includes the results of PMI Mortgage Insurance Co., affiliated U.S. reinsurance companies and equity in earnings of CMG. International Operations includes the

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results of PMI Australia, PMI Europe and the results of operations for Hong Kong. Financial Guaranty includes the equity in earnings of FGIC and RAM Re. Other includes the income and expenses of the holding company, equity in earnings or losses of Fairbanks and limited partnerships, contract underwriting operations and dormant insurance companies. Segment information for the prior corresponding period has been reclassified accordingly.

Stock-Based Compensation – The Company accounts for stock-based compensation to employees and directors using the intrinsic value method prescribed in APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretations. Under APB Opinion 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. As all options have been granted with an exercise price equal to the fair value at the date of the grants, no compensation expense has been recognized for the Company’s stock option program. SFAS No. 123, Accounting for Stock-Based Compensation, requires the pro forma disclosure of net income and earnings per share using the fair value method, and provides that the employers may continue to account for the stock-based compensation under APB Opinion No. 25. SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, amends SFAS No. 123 and requires prominent disclosures in both the annual and interim consolidated financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results of operations.

The fair value of stock-based compensation to employees is calculated using an option pricing model 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. The model also requires 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:

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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 consolidated net income, basic net income per share and diluted net income per share would have been reduced to the pro forma amounts indicated below:

Earnings Per Share and Dividends—Basic earnings per share (“EPS”) excludes dilution and is based on consolidated net income available to common stockholders and the actual weighted-average of the common stock shares that are outstanding during the period. Diluted EPS is based on consolidated net income available to common stockholders and the weighted-average of dilutive common stock shares outstanding during the period. The weighted-average dilutive common stock shares reflect 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. Consolidated net income available to common stockholders is the same for computing basic and diluted EPS. The convertible debt and equity units outstanding have not been included in the calculation of diluted shares outstanding as they are presently antidilutive or not convertible due to conversion triggers that were not met 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 common stock shares used to calculate diluted EPS for the three months ended March 31, 2004 and 2003:

As of March 31, 2004, the Company declared dividends to common stockholders of $3.6 million, or $0.0375 per share. These dividends were accrued as of March 31, 2004.

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

NOTE 3. NEW ACCOUNTING STANDARDS

In February 2004, FASB issued EITF No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The issue relates to determining the meaning of other-than-temporary impairment and its application to investments classified as available-for-sale or held-to-maturity under SFAS No. 115, and investments accounted for under the cost method. At its March 2004 Meeting, the EITF concluded that equity method investments will not be within the scope of this issue. This issue is

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effective for fiscal years ending after December 15, 2003. It requires disclosures of quantitative information related to aging of unrealized losses for investments as well as qualitative discussion regarding considerations in reaching conclusions that impairments are not other-than-temporary. These disclosures have been presented in the footnotes and critical accounting policies. In March 2004, the remaining issues related to the application of the other-than-temporary impairment model were finalized by the EITF and are effective for the quarter ending June 30, 2003. It is not expected to significantly impact the Company’s consolidated results of operations or financial position.

NOTE 4. INVESTMENTS

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.

Unrealized Investment Losses – The following table shows the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2004.

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Unrealized losses in fixed income securities as of March 31, 2004 were primarily due to interest rate fluctuations during the first quarter of 2004 and do not qualify for other-than-temporary impairment as the Company has the intent and ability to hold until recovery or maturity. The remaining unrealized losses do not meet the criteria established in the Company’s policy for determining other-than-temporary impairment and as such are not considered impaired.

During the first quarter of 2004, the Company determined there was no decline in the market value of investments that met the definition of other-than-temporary impairment. The Company recognized an impairment loss of $0.1 million in the first quarter of 2003.

Net Investment Income – Net investment income consists of the following for the three months ended March 31, 2004 and March 31, 2003:

NOTE 5. RESTRICTED CASH

In 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 Risk. As of March 31, 2004, $7.8 million of deposits received under this agreement were included in cash and cash equivalents and can only be utilized to pay claims related to the agreement.

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NOTE 6. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES

Investments in unconsolidated subsidiaries consist of the following as of March 31, 2004 and December 31, 2003.

Equity in earnings from unconsolidated subsidiaries consisted of the following for the three months ended March 31, 2004 and 2003.

On December 18, 2003, the Company completed its investment in FGIC through the acquisition of a 42% ownership interest in FGIC. The investment is accounted for using the equity method of accounting in accordance with APB Opinion No. 18. The Company is the strategic investor in a group of investors, and funded $611 million in cash of the $1.6 billion total purchase price for the investment in FGIC. Our investment in FGIC, as of March 31, 2004, was $644.6 million which included $611 million cash for the investment, capitalized acquisition costs related to the transaction, equity in earnings and the Company’s proportion of unrealized gains in FGIC’s investment portfolio.

As of March 31, 2004, the Company’s carrying value of Fairbanks, including cumulative equity earnings, was $110.7 million. In addition, the Company holds receivables of $26.0 million from Fairbanks which is included in related party receivables. Included in the investment in Fairbanks is a component of goodwill of approximately $36 million. The Company evaluated its total investment in Fairbanks, including related party receivables as of March 31, 2004, and determined that there was no other-than-temporary decline in the carrying value. Accordingly, the Company has not recognized an impairment charge with respect to its total investment in Fairbanks. The Company will continue to evaluate this investment for potential impairment.

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During the first quarter of 2004, we recorded a reduction of $4.8 million, net of tax, to retained earnings due to a change in reporting of Fairbanks from a one-month lag basis to a current month basis. This reduction represents our proportionate share of Fairbanks’ results for the month of December 2003. The following table sets forth the reconciliation of change in our investment balance in Fairbanks:

In September 2003, the Company sold its ownership interest in Truman Capital Founders, LLC and Truman Capital Advisors, LLC. A loss in Other expense in the first quarter of 2003 was due to the $2.6 loss from certain private equity limited partnership investments.

NOTE 7. DEFERRED POLICY ACQUISITION COSTS

The following table summarizes deferred policy acquisition cost activity as of and for the three months ended March 31, 2004 and 2003:

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

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NOTE 8. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

The Company establishes reserves for losses LAE to recognize the estimated liability for potential losses and related loss expenses in connection with borrower default on their mortgage payments. The establishment of loss reserves is subject to inherent uncertainty and requires significant judgment by management. The following table provides a reconciliation of the beginning and ending consolidated reserves for losses and LAE for the three months ended March 31, 2004 and 2003:

The increase in loss reserves at March 31, 2004 over March 31, 2003 was due primarily to increases in the loss reserve balances in U.S. Mortgage Insurance Operations as well as PMI Europe’s acquisition of the U.K. lenders’ mortgage insurance portfolio from Royal & Sun Alliance (“R&SA”). The loss reserve increase in U.S. Mortgage Insurance Operations was the result of expected higher proportions of delinquencies developing into claims as well as higher mortgage insurance coverage levels on pending delinquencies. This has led to higher average claim amounts. U.S. Mortgage Insurance Operations’ primary insurance default inventory was 34,762 at March 31, 2004 compared to 35,803 at March 31, 2003. The default rate was 4.26% at March 31, 2004 compared to 4.19% at March 31, 2003. Generally, it takes approximately 12 to 36 months from the receipt of a default notice to result in a claim payment. Accordingly, most losses paid relate to default notices received in prior years.

PMI Europe increased its loss reserves in the first quarter of 2004 compared to the first quarter of 2003 primarily due to a $7.9 million loss reserve balance acquired in connection with its acquisition of the U.K. lenders’ mortgage insurance portfolio from R&SA.

The $7.2 million and $12.1 million reductions in total incurred in prior years related to the first quarter of 2004 and 2003, respectively, were due to re-estimations of ultimate loss rates from those established at the original notice of default, updated through the period presented. These re-estimations of ultimate loss rates are the result of management’s periodic review of estimated claim amounts in light of actual claim amounts, loss development data or ultimate claim rates. The $7.2 million and $12.1 million decreases were primarily due to re-estimates of ultimate claim rates of defaults occurring in prior years in our Australian operations. These reductions in loss rates were primarily attributable to the strong economy and housing market in Australia and New Zealand.

NOTE 9. COMMITMENTS AND CONTINGENCIES

Income Taxes – During 2002 and 2003, the Company received notices of assessment from the California Franchise Tax Board (“FTB”) for 1997 through 2000 in amounts totaling $13.9 million. Such amounts do not include the federal tax benefits from the payment of such assessment or interest that might be included on amounts, if any, ultimately paid to the FTB. The assessments are the result of a memorandum issued by the FTB in April 2002. The memorandum, which is based partly on the California Court of Appeals decision in

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Ceridian v. Franchise Tax Board, provides for the disallowance of the deduction for dividends received by holding companies from their insurance company subsidiaries, in determining California taxable income of the holding company for tax years ending on or after December 1, 1997. As of March 31, 2004, the Company has reserved $4.7 million related to this contingency. While the Company is protesting this assessment, there can be no assurance as to the ultimate outcome of these protests.

Guarantees to Related Party – In the fourth quarter of 2003, Fairbanks reached a settlement, subject to final court approval, of civil charges with the FTC and the HUD. The terms of the settlement require changes in Fairbanks’ operations and the creation of a $40 million fund for the benefit of consumers allegedly harmed by Fairbanks. The Company has guaranteed approximately two-thirds of Fairbanks’ obligations under a $30.7 million letter of credit, which may be drawn upon by FTC as security for a portion of the $40 million redress fund as required by the settlement.

Various other legal actions and regulatory reviews are currently pending that involve the Company and specific aspects of its conduct of business. In the opinion of management, the ultimate liability in one or more of these actions is not expected to have a material effect on the consolidated financial condition, results of operations or cash flows of the Company. The Company determined that the liability related to the fair value of the guarantees provided to a related party, in accordance with FASB Interpretation (“FIN”) No. 45 was not material.

NOTE 10. COMPREHENSIVE INCOME

The components of comprehensive income for the three months ended March 31, 2004 and 2003 are shown in the table below.