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FORM 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to ______ 

Commission file number 1-10816

 

MGIC INVESTMENT CORPORATION

(Exact name of registrant as specified in its charter)

WISCONSIN		39-1486475
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

250 E. KILBOURN AVENUE		53202
MILWAUKEE, WISCONSIN		(Zip Code)
(Address of principal executive offices)

(414) 347-6480

(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   x

NO  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

YES   x

NO  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x	Accelerated filer o	Non-accelerated filer  o	Smaller reporting company  o
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

YES   o

NO  x

 

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

CLASS OF STOCK	PAR VALUE	DATE	NUMBER OF SHARES
Common stock	$1.00	07/31/14	338,559,545

 

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Forward Looking and Other Statements

All statements in this report that address events, developments or results that we expect or anticipate may occur in the future are “forward looking statements.” Forward looking statements consist of statements that relate to matters other than historical fact. In most cases, forward looking statements may be identified by words such as “believe,” “anticipate” or “expect,” or words of similar import. The risk factors referred to in “Forward Looking Statements and Risk Factors – Location of Risk Factors” in Management’s Discussion and Analysis of Financial Condition and Results of Operations below, may cause our actual results to differ materially from the results contemplated by forward looking statements that we may make. We are not undertaking any obligation to update any forward looking statements or other statements we may make in this document even though these statements may be affected by events or circumstances occurring after the forward looking statements or other statements were made. Therefore no reader of this document should rely on these statements being current as of any time other than the time at which this document was filed with the Securities and Exchange Commission.

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PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2014 and December 31, 2013

(Unaudited)

		June 30, 2014				December 31, 2013
ASSETS		(In thousands)
Investment portfolio (notes 7 and 8):
Securities, available-for-sale, at fair value:
Fixed maturities (amortized cost, 2014 - $4,611,685; 2013 - $4,948,543)		$	4,611,468			$	4,863,925
Equity securities			3,011				2,894
Total investment portfolio			4,614,479				4,866,819
Cash and cash equivalents			342,600				332,692
Restricted cash and cash equivalents (note 1)			17,203				17,440
Accrued investment income			29,030				31,660
Prepaid reinsurance premiums (note 4)			40,261				36,243
Reinsurance recoverable on loss reserves (note 4)			57,763				64,085
Reinsurance recoverable on paid losses (note 4)			7,517				10,425
Premium receivable			52,934				62,301
Home office and equipment, net			28,336				26,185
Deferred insurance policy acquisition costs			10,676				9,721
Other assets			178,345				143,819
Total assets		$	5,379,144			$	5,601,390
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves (note 12)		$	2,675,594			$	3,061,401
Premium deficiency reserve (note 13)			35,455				48,461
Unearned premiums			168,200				154,479
Senior notes (note 3)			61,894				82,773
Convertible senior notes (note 3)			845,000				845,000
Convertible junior debentures (note 3)			389,522				389,522
Other liabilities			271,864				275,216
Total liabilities			4,447,529				4,856,852
Contingencies (note 5)
Shareholders' equity (note 14):
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2014 and 2013 - 340,047; shares outstanding 2014 - 338,560; 2013 - 337,758)			340,047				340,047
Paid-in capital			1,658,661				1,661,269
Treasury stock (shares at cost 2014 - 1,487; 2013 - 2,289)			(32,937	)			(64,435	)
Accumulated other comprehensive loss, net of tax (note 9)			(35,253	)			(117,726	)
Accumulated deficit			(998,903	)			(1,074,617	)
Total shareholders' equity			931,615				744,538
Total liabilities and shareholders' equity		$	5,379,144			$	5,601,390

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Three and Six Months Ended June 30, 2014 and 2013

(Unaudited)

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
Revenues:		(In thousands, except per share data)
Premiums written:
Direct		$	241,249			$	247,481			$	485,438			$	502,028
Assumed			430				531				881				1,082
Ceded (note 4)			(28,294	)			(11,390	)			(54,914	)			(17,988	)
Net premiums written			213,385				236,622				431,405				485,122
(Increase) decrease in unearned premiums, net			(5,899	)			1,155				(9,658	)			(286	)
Net premiums earned			207,486				237,777				421,747				484,836
Investment income, net of expenses			21,180				20,883				41,336				39,211
Realized investment gains, net			522				2,485				291				3,744
Total other-than-temporary impairment losses			-				-				-				-
Portion of losses recognized in other comprehensive income, before taxes			-				-				-				-
Net impairment losses recognized in earnings			-				-				-				-
Other revenue			2,048				2,715				2,944				5,254
Total revenues			231,236				263,860				466,318				533,045
Losses and expenses:
Losses incurred, net (note 12)			141,141				196,274				263,749				462,482
Change in premium deficiency reserve (note 13)			(7,833	)			(11,283	)			(13,006	)			(12,933	)
Amortization of deferred policy acquisition costs			1,676				1,955				3,095				3,652
Other underwriting and operating expenses, net			32,238				45,607				70,219				93,922
Interest expense (note 3)			17,374				17,942				34,913				44,348
Total losses and expenses			184,596				250,495				358,970				591,471
Income (loss) before tax			46,640				13,365				107,348				(58,426	)
Provision for income taxes (note 11)			1,118				990				1,844				2,129
Net income (loss)		$	45,522			$	12,375			$	105,504			$	(60,555	)
Income (loss) per share (note 6):
Basic		$	0.13			$	0.04			$	0.31			$	(0.21	)
Diluted		$	0.12			$	0.04			$	0.27			$	(0.21	)
Weighted average common shares outstanding - basic (note 6)			338,626				337,868				338,419				285,336
Weighted average common shares outstanding - diluted (note 6)			413,481				339,341				413,374				285,336

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three and Six Months Ended June 30, 2014 and 2013

(Unaudited)

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands)
Net income (loss)		$	45,522			$	12,375			$	105,504			$	(60,555	)
Other comprehensive income (loss), net of tax (note 9):
Change in unrealized investment gains and losses (note 7)			44,501				(98,119	)			84,099				(108,073	)
Benefit plan adjustments			(1,980	)			-				(3,466	)			-
Foreign currency translation adjustment			587				(12,512	)			1,840				(12,196	)
Other comprehensive income (loss), net of tax			43,108				(110,631	)			82,473				(120,269	)
Comprehensive income (loss)		$	88,630			$	(98,256	)		$	187,977			$	(180,824	)

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

 CONSOLIDATED  STATEMENTS OF SHAREHOLDERS' EQUITY

 Six Months Ended June 30, 2013 and 2014

 (Unaudited)

 

		Common stock				Paid-in capital				Treasury stock				Accumulated other comprehensive income (loss)				Accumulated deficit
		(In thousands)
Balance, December 31, 2012		$	205,047			$	1,135,296			$	(104,959	)		$	(48,163	)		$	(990,281	)
Net loss																			(60,555	)
Change in unrealized investment gains and losses, net			-				-				-				(108,073	)			-
Common stock issuance (note 14)			135,000				528,392				-				-				-
Reissuance of treasury stock, net			-				(7,892	)			40,524				-				(34,487	)
Equity compensation			-				3,009				-				-				-
Unrealized foreign currency translation adjustment			-				-				-				(12,196	)			-
Balance, June 30, 2013		$	340,047			$	1,658,805			$	(64,435	)		$	(168,432	)		$	(1,085,323	)
Balance, December 31, 2013		$	340,047			$	1,661,269			$	(64,435	)		$	(117,726	)		$	(1,074,617	)
Net income																			105,504
Change in unrealized investment gains and losses, net (note 7)			-				-				-				84,099				-
Reissuance of treasury stock, net			-				(6,680	)			31,498				-				(29,790	)
Equity compensation			-				4,072				-				-				-
Benefit plan adjustments			-				-				-				(3,466	)			-
Unrealized foreign currency translation adjustment			-				-				-				1,840				-
Balance, June 30, 2014		$	340,047			$	1,658,661			$	(32,937	)		$	(35,253	)		$	(998,903	)

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months Ended June 30, 2014 and 2013

(Unaudited)

 

		Six Months Ended June 30,
		2014				2013
		(In thousands)
Cash flows from operating activities:
Net income (loss)		$	105,504			$	(60,555	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and other amortization			26,622				37,517
Deferred tax provision (benefit)			243				(21	)
Realized investment gains, excluding impairment losses			(291	)			(3,744	)
Loss on repurchases of senior notes			837				-
Other			(45,745	)			(31,862	)
Change in certain assets and liabilities:
Accrued investment income			2,630				(5,920	)
Prepaid reinsurance premium			(4,018	)			(3,465	)
Reinsurance recoverable on loss reserves			6,322				20,950
Reinsurance recoverable on paid losses			2,908				1,433
Premium receivable			9,367				5,250
Deferred insurance policy acquisition costs			(955	)			(1,133	)
Loss reserves			(385,807	)			(457,535	)
Premium deficiency reserve			(13,006	)			(12,933	)
Unearned premiums			13,721				3,578
Income taxes payable (current)			(689	)			(179	)
Net cash used in operating activities			(282,357	)			(508,619	)
Cash flows from investing activities:
Purchase of fixed maturities			(1,054,567	)			(2,182,211	)
Purchase of equity securities			(40	)			(51	)
Proceeds from sale of fixed maturities			718,938				483,171
Proceeds from maturity of fixed maturities			649,468				778,896
Net increase in payable for securities			(4	)			(97,868	)
Net change in restricted cash			237				(60,333	)
Net cash provided by (used in) investing activities			314,032				(1,078,396	)
Cash flows from financing activities:
Net proceeds from convertible senior notes			-				484,697
Common stock shares issued			-				663,392
Repurchases of long-term debt			(21,767	)			(17,235	)
Net cash (used in) provided by financing activities			(21,767	)			1,130,854
Net increase (decrease) in cash and cash equivalents			9,908				(456,161	)
Cash and cash equivalents at beginning of period			332,692				1,027,625
Cash and cash equivalents at end of period		$	342,600			$	571,464

See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2014

(Unaudited)

Note 1 – Nature of Business and Basis of Presentation

MGIC Investment Corporation is a holding company which, through Mortgage Guaranty Insurance Corporation ("MGIC"), MGIC Indemnity Corporation (“MIC”) and several other subsidiaries, is principally engaged in the mortgage insurance business.  We provide mortgage insurance to lenders throughout the United States and to government sponsored entities (“GSEs”) to protect against loss from defaults on low down payment residential mortgage loans.

The accompanying unaudited consolidated financial statements of MGIC Investment Corporation and its wholly-owned subsidiaries have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (“SEC”) for interim reporting and do not include all of the other information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2013 included in our Annual Report on Form 10-K. As used below, “we,” “our” and “us” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as the context requires.

In the opinion of management the accompanying financial statements include all adjustments, consisting primarily of normal recurring accruals, necessary to fairly state our financial position and results of operations for the periods indicated. The results of operations for the interim period may not be indicative of the results that may be expected for the year ending December 31, 2014.

 

Capital - GSEs

Since 2008, substantially all of our insurance written has been for loans sold to the GSEs, each of which has mortgage insurer eligibility requirements. The existing eligibility requirements include a minimum financial strength rating of Aa3/AA-. Because MGIC does not meet such financial strength rating requirements (its financial strength rating from Moody’s is Ba3 (with a stable outlook) and from Standard & Poor’s is BB (with a positive outlook)), MGIC is currently operating with each GSE as an eligible insurer under a remediation plan.

On July 10, 2014, the conservator of the GSEs, the Federal Housing Finance Agency (“FHFA”), released draft Private Mortgage Insurer Eligibility Requirements (“draft PMIERs”). The FHFA has requested public input on the draft PMIERs by September 8, 2014. The draft PMIERs include revised financial requirements for mortgage insurers (the “GSE Financial Requirements”) that require a mortgage insurer’s “Available Assets” (generally only the most liquid assets of an insurer) to meet or exceed “Minimum Required Assets” (which are calculated from tables of factors with several risk dimensions and are subject to a floor amount).

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We estimate that as of June 30, 2014, applying the rules of the draft PMIERs, MGIC would have a material shortfall in Available Assets.  This shortfall would be affected by operations throughout the transition period, which is expected to end December 31, 2016. The shortfall assumes the risk in force and capital of MIC are repatriated to MGIC, and full credit is given in the calculation of Minimum Required Assets for our existing reinsurance transaction.  However, we do not expect to receive full credit for our current reinsurance transaction. As a result, we have begun discussions with the reinsurance market to modify our existing reinsurance transaction so that any reduction in the credit would be minimized.

As of June 30, 2014, we had approximately $515 million of cash and investments at our holding company, a portion of which we believe may be available for future contribution to MGIC. Furthermore, there are regulated insurance affiliates of MGIC that have approximately $100 million of assets as of June 30, 2014. We expect that, subject to regulatory approval, we would be able to use a material portion of these assets to increase the Available Assets of MGIC.  Additionally, if the draft PMIERs are implemented as released, we would consider seeking additional reinsurance and/or non-dilutive debt capital to mitigate the shortfall. There can be no assurance that MGIC will be in compliance with the GSE Financial Requirements within the transition period. Factors that may impact MGIC’s compliance with the GSE Financial Requirements include the following:

 

·

Changes in the actual PMIERs adopted from the draft PMIERs may increase the amount of the MGIC’s Minimum Required Assets or reduce its Available Assets, with the result that the shortfall in Available Assets could increase;

·

We may not obtain regulatory approval to transfer assets from MGIC’s regulated insurance affiliates to the extent we are assuming because regulators project higher losses than we project or require a level of capital be maintained in these companies higher than we are assuming;

·

We may not be able to access the non-dilutive debt markets due to market conditions, concern about our creditworthiness, or other factors, in a manner sufficient to provide the funds we are assuming;

·

We may not be able to achieve modifications in our existing reinsurance arrangements necessary to minimize the reduction in the credit for reinsurance under the draft PMIERs; and

·

We may not be able to obtain additional reinsurance necessary to further reduce the Minimum Required Assets due to market capacity, pricing or other reasons.

 

Factors that could negatively affect MGIC’s compliance with the GSE Financial Requirements are discussed throughout the financial statement footnotes. Such matters could decrease our revenues, increase our losses or require the use of assets, thereby reducing our Available Assets and increasing our shortfall in Available Assets, or they could increase the Minimum Required Assets, also increasing our shortfall in Available Assets.

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There also can be no assurance that the GSEs would not make the GSE Financial Requirements more onerous in the future; in this regard, the draft PMIERs provide that the tables of factors that determine Minimum Required Assets may be updated to reflect changes in risk characteristics and the macroeconomic environment. If MGIC ceases to be eligible to insure loans purchased by one or both of the GSEs, it would significantly reduce the volume of our new business writings.

If we increase the amount of Available Assets we hold in order to continue to insure GSE loans, the amount of capital we hold may increase. If we increase the amount of capital we hold with respect to insured loans, our returns may decrease unless we increase premiums. An increase in premium rates may not be feasible for a number of reasons, including competition from other private mortgage insurers, the FHA or other credit enhancement products.

See disclosure regarding statutory capital in Note 15 – “Statutory Capital.”

Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2013 amounts to conform to 2014 presentation.

Restricted cash and cash equivalents

During the second quarter of 2013, approximately $60.3 million was placed in escrow in connection with the two agreements we entered into to resolve our dispute with Countrywide Home Loans (“CHL”) and its affiliate, Bank of America, N.A., as successor to Countrywide Home Loans Servicing LP (“BANA” and collectively with CHL, “Countrywide”) regarding rescissions. In the fourth quarter of 2013, approximately $42.9 million was released from escrow in connection with the BANA agreement. At June 30, 2014 and December 31, 2013, approximately $17.2 million and $17.4 million, respectively, remains in escrow in connection with the CHL agreement. See additional discussion of these settlement agreements in Note 5 – “Litigation and Contingencies.”

Subsequent events

We have considered subsequent events through the date of this filing.

Note 2 - New Accounting Guidance

In July 2013, the FASB issued an update to the accounting standard regarding income taxes. This update provides guidance concerning the balance sheet presentation of an unrecognized tax benefit when a net operating loss carryforward or a tax credit carryforward (the “Carryforwards”) is available. This accounting standard requires an entity to net its liability related to unrecognized tax benefits against the related deferred tax assets for the Carryforwards. A gross presentation will be required when the Carryforwards are not available under the tax law of the applicable jurisdiction or when the Carryforwards would not be used by the entity to settle any additional income taxes resulting from disallowance of the uncertain tax position. This update is effective for fiscal years and interim periods within such years beginning after December 15, 2013. We are currently in compliance with this new guidance.  It did not have a significant impact on our consolidated financial statements and disclosures.

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Note 3 – Debt

At June 30, 2014 and December 31, 2013 we had outstanding $62.0 million and $82.9 million, respectively, of 5.375% Senior Notes due in November 2015. In February 2014, we repurchased $20.9 million in par value of these notes at a cost slightly above par. Interest on these notes is payable semi-annually in arrears on May 1 and November 1 of each year. These Senior Notes are described in our Annual Report on Form 10-K for the year ended December 31, 2013. That description is qualified in its entirety by the terms of the notes, which are contained in the Indenture, dated as of October 15, 2000, between us and U.S. Bank, National Association, as trustee, and in an Officer's Certificate dated as of October 4, 2005, which specifies the interest rate, maturity date and other terms of the Senior Notes.

Scheduled interest payments on the Senior Notes were $1.7 million and $2.8 million for the six months ended June 30, 2014 and 2013, respectively. In the first quarter of 2014, we also paid $0.3 million in interest related to our repurchase discussed above.

At June 30, 2014 and December 31, 2013 we had outstanding $345 million principal amount of 5% Convertible Senior Notes due in May 2017. Interest on the 5% Notes is payable semi-annually in arrears on May 1 and November 1 of each year.

The 5% Notes are convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount at any time prior to the maturity date. This represents an initial conversion price of approximately $13.44 per share. These 5% Notes will be equal in right of payment to our other senior debt and will be senior in right of payment to our existing Convertible Junior Debentures, discussed below. Debt issuance costs are being amortized to interest expense over the contractual life of the 5% Notes. These 5% Notes are described in our Annual Report on Form 10-K for the year ended December 31, 2013. That description is qualified in its entirety by the terms of the notes, which are contained in the Supplemental Indenture, dated as of April 26, 2010, between us and U.S. Bank National Association, as trustee, and the Indenture dated as of October 15, 2000, between us and the trustee.

Interest payments on the 5% Notes were $8.6 million in each of the six months ended June 30, 2014 and 2013.

At June 30, 2014 and December 31, 2013, we had outstanding $500 million principal amount of 2% Convertible Senior Notes due in 2020 which we issued in March 2013. We received net proceeds of approximately $484.6 million after deducting underwriting discount and offering expenses. Interest on the 2% Notes is payable semi-annually in arrears on April 1 and October 1 of each year. The 2% Notes will mature on April 1, 2020, unless earlier repurchased by us or converted. Prior to January 1, 2020, the 2% Convertible Senior Notes are convertible only upon satisfaction of one or more conditions. One such condition is that during any calendar quarter commencing after March 31, 2014, the last reported sale price of our common stock for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter be greater than or equal to 130% of the applicable conversion price on each applicable trading day. The notes are convertible at an initial conversion rate, which is subject to adjustment, of 143.8332 shares per $1,000 principal amount. This represents an initial conversion price of approximately $6.95 per share. 130% of such conversion price is $9.03. On or after January 1, 2020, holders may convert their notes irrespective of satisfaction of the conditions. These 2% Notes will be equal in right of payment to our other senior debt and will be senior in right of payment to our existing Convertible Junior Debentures. Debt issuance costs are being amortized to interest expense over the contractual life of the 2% Notes. Prior to April 10, 2017, the notes will not be redeemable. On any business day on or after April 10, 2017 we may redeem for cash all or part of the notes, at our option, at a redemption price equal to 100% of the principal amount of the notes being redeemed, plus any accrued and unpaid interest, if the closing sale price of our common stock exceeds 130% of the then prevailing conversion price of the notes for at least 20 of the 30 trading days preceding notice of the redemption.

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These 2% Notes are described in our Annual Report on Form 10-K for the year ended December 31, 2013. That description is qualified in its entirety by the terms of the notes, which are contained in the Second Supplemental Indenture, dated March 12, 2013, between us and U.S. Bank National Association, as trustee, and the Indenture dated as of October 15, 2000, between us and the trustee.

Interest payments on the 2% Notes were $5.0 million for the six months ended June 30, 2014. There were no scheduled interest payments on the 2% Notes for the six months ended June 30, 2013.

At June 30, 2014 and December 31, 2013 we had outstanding $389.5 million principal amount of 9% Convertible Junior Subordinated Debentures due in 2063 (the “debentures”). The debentures rank junior to all of our existing and future senior indebtedness.

Interest on the debentures is payable semi-annually in arrears on April 1 and October 1 of each year. As long as no event of default with respect to the debentures has occurred and is continuing, we may defer interest, under an optional deferral provision, for one or more consecutive interest periods up to ten years without giving rise to an event of default. Deferred interest will accrue additional interest at the rate then applicable to the debentures. During an optional deferral period we may not pay or declare dividends on our common stock.

Interest on the debentures that would have been payable on the scheduled interest payment date of October 1, 2012 had been deferred. During the deferral period the deferred interest continued to accrue and compound semi-annually at an annual rate of 9%.

On April 1, 2013 we paid the deferred interest payment, including the compound interest. The interest payment, totaling approximately $18.3 million, was made from the net proceeds of our March 2013 common stock offering. We also paid the regular April 1, 2013 interest payment due on the debentures of approximately $17.5 million, and we remain current on all interest payments due. We continue to have the right to defer interest that is payable on subsequent scheduled interest payment dates. Any deferral of such interest would be on terms equivalent to those described above.

These debentures are described in our Annual Report on Form 10-K for the year ended December 31, 2013. That description is qualified in its entirety by the terms of the debentures, which are contained in the Indenture, dated as of March 28, 2008, between us and U.S. Bank National Association, as trustee.

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We may redeem the debentures in whole or in part from time to time, at our option, at a redemption price equal to 100% of the principal amount of the debentures being redeemed, plus any accrued and unpaid interest, if the closing sale price of our common stock exceeds 130% of the then prevailing conversion price of the debentures for at least 20 of the 30 trading days preceding notice of the redemption.

The debentures are currently convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.0741 common shares per $1,000 principal amount of debentures at any time prior to the maturity date. This represents an initial conversion price of approximately $13.50 per share. If a holder elects to convert their debentures, deferred interest owed on the debentures being converted is also converted into shares of our common stock. The conversion rate for any deferred interest is based on the average price that our shares traded at during a 5-day period immediately prior to the election to convert. In lieu of issuing shares of common stock upon conversion of the debentures, we may, at our option, make a cash payment to converting holders for all or some of the shares of our common stock otherwise issuable upon conversion.

Interest payments on the debentures were $17.5 million and $35.8 million for the six months ended June 30, 2014 and 2013, respectively.

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The par value and fair value of our debt at June 30, 2014 and December 31, 2013 appears in the table below.

		Par Value				Total Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
		(In thousands)
June 30, 2014
Liabilities:
Senior Notes		$	61,953			$	64,973			$	64,973			$	-			$	-
Convertible Senior Notes due 2017			345,000				403,650				403,650				-				-
Convertible Senior Notes due 2020			500,000				746,750				746,750				-				-
Convertible Junior Subordinated Debentures			389,522				482,033				-				482,033				-
Total Debt		$	1,296,475			$	1,697,406			$	1,215,373			$	482,033			$	-
December 31, 2013
Liabilities:
Senior Notes		$	82,883			$	85,991			$	85,991			$	-			$	-
Convertible Senior Notes due 2017			345,000				388,988				388,988				-				-
Convertible Senior Notes due 2020			500,000				685,625				685,625				-				-
Convertible Junior Subordinated Debentures			389,522				439,186				-				439,186				-
Total Debt		$	1,317,405			$	1,599,790			$	1,160,604			$	439,186			$	-

The fair value of our Senior Notes and Convertible Senior Notes was determined using publicly available trade information and those notes are considered Level 1 securities as described in Note 8 – “Fair Value Measurements.” The fair value of our debentures was determined using available pricing for these debentures or similar instruments and our debentures are considered Level 2 securities as described in Note 8 – “Fair Value Measurements.”

The Senior Notes, Convertible Senior Notes and Convertible Junior Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. At June 30, 2014, we had approximately $515 million in cash and investments at our holding company. The net unrealized losses on our holding company investment portfolio were approximately $2.8 million at June 30, 2014. The modified duration of the holding company investment portfolio, excluding cash and cash equivalents, was 3.4 years at June 30, 2014.

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Note 4 – Reinsurance

In April 2013, we entered into a quota share reinsurance agreement with a group of unaffiliated reinsurers that are not captive reinsurers. These reinsurers primarily have a rating of A or better by Moody’s Investors Service, Standard & Poor’s Rating Services or both. This reinsurance agreement applies to new insurance written between April 1, 2013 and December 31, 2015 (with certain exclusions) and covers incurred losses, with renewal premium through December 31, 2018, at which time the agreement terminates. Early termination of the agreement prior to December 31, 2018 is possible under specified scenarios. The structure of the reinsurance agreement is a 30% quota share, with a 20% ceding commission as well as a profit commission. In December 2013, we entered into an Addendum to the quota share reinsurance agreement that applies to certain insurance written before April 1, 2013 that has never been delinquent. The structure of the quota share reinsurance agreement remained the same, with the exception that the business written before April 1, 2013 is a 40% quota share. Under the Addendum, policies for which premium was received but unearned as of December 31, 2013 were ceded.

As of June 30, 2014 and December 31, 2013, we have accrued a profit commission receivable of $47.1 million and $2.4 million, respectively, which is included in “Other assets” on our consolidated balance sheet. This receivable could increase materially through the term of the agreement, but the ultimate amount of the commission will depend on the ultimate level of premiums earned and losses incurred under the agreement. Any profit commission would be paid to us upon termination of the reinsurance agreement.

The reinsurers are required to maintain trust funds or letters of credit to support recoverable balances for reinsurance, such as loss reserves, paid losses, prepaid reinsurance premiums and profit commissions.  As such forms of collateral are in place, we have not established an allowance against these balances.

In the past, MGIC had also obtained captive reinsurance. In a captive reinsurance arrangement, the reinsurer is affiliated with the lender for whom MGIC provides mortgage insurance. As part of our settlement with the Consumer Financial Protection Bureau (“CFPB”) discussed in Note 5 – “Litigation and Contingencies”, MGIC and three other mortgage insurers agreed that they would not enter into any new captive reinsurance agreement or reinsure any new loans under any existing captive reinsurance agreement for a period of ten years. In accordance with this settlement, all of our active captive arrangements have been placed into run-off.

Captive agreements were written on an annual book of business and the captives are required to maintain a separate trust account to support the combined reinsured risk on all annual books. MGIC is the sole beneficiary of the trust, and the trust account is made up of capital deposits by the lender captive, premium deposits by MGIC, and investment income earned.  These amounts are held in the trust account and are available to pay reinsured losses. The reinsurance recoverable on loss reserves related to captive agreements was $52 million at June 30, 2014 which was supported by $208 million of trust assets, while at December 31, 2013, the reinsurance recoverable on loss reserves related to captives was $64 million which was supported by $226 million of trust assets. At June 30, 2014 and December 31, 2013 there was an additional $20 million and $23 million, respectively, of trust assets in captive agreements where there was no related reinsurance recoverable on loss reserves. See Note 5 – “Litigation and Contingencies” for a discussion of requests or subpoenas for information regarding captive mortgage reinsurance arrangements.

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A summary of the effect of our reinsurance agreements on our results for the six months ended June 30, 2014 and 2013 appears below.

		Six Months Ended June 30,
		2014				2013
		(In thousands)
Ceded premiums written, net of profit commission		$	54,914			$	17,988
Ceded premiums earned, net of profit commission			50,898				14,521
Ceded losses incurred			14,871				17,234
Ceding commissions			18,680				2,197

Note 5 – Litigation and Contingencies

Before paying a claim, we review the loan and servicing files to determine the appropriateness of the claim amount. All of our insurance policies provide that we can reduce or deny a claim if the servicer did not comply with its obligations under our insurance policy, including the requirement to mitigate our loss by performing reasonable loss mitigation efforts or, for example, diligently pursuing a foreclosure or bankruptcy relief in a timely manner. We call such reduction of claims submitted to us “curtailments.” In 2013 and the first half of 2014, curtailments reduced our average claim paid by approximately 5.8% and 6.2%, respectively. In addition, the claims submitted to us sometimes include costs and expenses not covered by our insurance policies, such as hazard insurance premiums for periods after the claim date and losses resulting from property damage that has not been repaired. These other adjustments reduced claim amounts by less than the amount of curtailments. After we pay a claim, servicers and insureds sometimes object to our curtailments and other adjustments. We review these objections if they are sent to us within 90 days after the claim was paid.

When reviewing the loan file associated with a claim, we may determine that we have the right to rescind coverage on the loan. Prior to 2008, rescissions of coverage on loans were not a material portion of our claims resolved during a year. However, beginning in 2008, our rescissions of coverage on loans have materially mitigated our paid losses. In 2009 through 2011, rescissions mitigated our paid losses in the aggregate by approximately $3.0 billion; and in 2012, 2013 and the first half of 2014, rescissions mitigated our paid losses by approximately $265 million, $135 million and $50 million, respectively (in each case, the figure includes amounts that would have either resulted in a claim payment or been charged to a deductible under a bulk or pool policy, and may have been charged to a captive reinsurer). In recent quarters, approximately 5% of claims received in a quarter have been resolved by rescissions, down from the peak of approximately 28% in the first half of 2009.

We estimate rescissions mitigated our incurred losses by approximately $2.5 billion in 2009 and $0.2 billion in 2010. These figures include the benefit of claims not paid in the period as well as the impact of changes in our estimated expected rescission activity on our loss reserves in the period. In 2012, we estimate that our rescission benefit in loss reserves was reduced by $0.2 billion due to probable rescission settlement agreements. We estimate that other rescissions had no significant impact on our losses incurred in 2011 through the first half of 2014. Our loss reserving methodology incorporates our estimates of future rescissions and reversals of rescissions. Historically, reversals of rescissions have been immaterial. A variance between ultimate actual rescission and reversal rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses.

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If the insured disputes our right to rescind coverage, we generally engage in discussions in an attempt to settle the dispute. As part of those discussions, we may voluntarily suspend rescissions we believe may be part of a settlement. In 2011, Freddie Mac advised its servicers that they must obtain its prior approval for rescission settlements, Fannie Mae advised its servicers that they are prohibited from entering into such settlements and Fannie Mae notified us that we must obtain its prior approval to enter into certain settlements. Since those announcements, the GSEs have consented to our settlement agreements with two customers, one of which is Countrywide, as discussed below, and have rejected other settlement agreements. We have reached and implemented settlement agreements that do not require GSE approval, but they have not been material in the aggregate.

If we are unable to reach a settlement, the outcome of a dispute ultimately would be determined by legal proceedings. Under our policies, legal proceedings disputing our right to rescind coverage may be brought up to three years after the lender has obtained title to the property (typically through a foreclosure) or the property was sold in a sale that we approved, whichever is applicable, although in a few jurisdictions there is a longer time to bring such an action.

Until a liability associated with a settlement agreement or litigation becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes even though discussions and legal proceedings have been initiated and are ongoing. Under ASC 450-20, an estimated loss from such discussions and proceedings is accrued for only if we determine that the loss is probable and can be reasonably estimated.

Since December 2009, we have been involved in legal proceedings with Countrywide Home Loans, Inc. (“CHL”) and its affiliate, Bank of America, N.A., as successor to Countrywide Home Loans Servicing LP (“BANA” and collectively with CHL, “Countrywide”) in which Countrywide alleged that MGIC denied valid mortgage insurance claims. (In our SEC reports, we refer to insurance rescissions and denials of claims collectively as “rescissions” and variations of that term.) In addition to the claim amounts it alleged MGIC had improperly denied, Countrywide contended it was entitled to other damages of almost $700 million as well as exemplary damages. We sought a determination in those proceedings that we were entitled to rescind coverage on the applicable loans.

In April 2013, MGIC entered into separate settlement agreements with CHL and BANA, pursuant to which the parties will settle the Countrywide litigation as it relates to MGIC’s rescission practices (as amended, the “Agreements”). The Agreement with BANA covers loans purchased by the GSEs. The original Agreement was implemented beginning in November 2013 and we resolved all related suspended rescissions in November and December 2013 by paying the associated claim or processing the rescission. The pending arbitration proceedings concerning the loans covered by that agreement have been dismissed, the mutual releases between the parties regarding such loans have become effective and the litigation between the parties regarding such loans is to be dismissed.

The Agreement with CHL covers loans that were purchased by non-GSE investors, including securitization trusts (the “other investors”). That Agreement will be implemented only as and to the extent that it is consented to by or on behalf of the other investors, and any such implementation is expected to occur later in 2014. While there can be no assurance that the Agreement with CHL will be implemented, we have determined that its implementation is probable.

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We recorded the estimated impact of the Agreements and another probable settlement in our financial statements for the quarter ending December 31, 2012. We have also recorded the estimated impact of other probable settlements. The estimated impact that we recorded is our best estimate of our loss from these matters. We estimate that the maximum exposure above the best estimate provision we recorded is $510 million, of which about 45% is from rescission practices subject to the Agreement with CHL. If we are not able to implement the Agreement with CHL or the other settlements we consider probable, we intend to defend MGIC vigorously against any related legal proceedings.

The flow policies at issue with Countrywide are in the same form as the flow policies that we used with all of our customers during the period covered by the Agreements, and the bulk policies at issue vary from one another, but are generally similar to those used in the majority of our Wall Street bulk transactions.

We are involved in discussions and legal and consensual proceedings with customers with respect to our claims paying practices. These include a previously disclosed curtailment dispute with Countrywide that is in a mediation process. Although it is reasonably possible that when these discussions or proceedings are completed we will not prevail in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. We estimate the maximum exposure associated with these discussions and proceedings to be approximately $220 million, although we believe we will ultimately resolve these matters for significantly less than this amount.

The estimates of our maximum exposure referred to above do not include interest or consequential or exemplary damages.

Consumers continue to bring lawsuits against home mortgage lenders and settlement service providers. Mortgage insurers, including MGIC, have been involved in litigation alleging violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA. MGIC’s settlement of class action litigation against it under RESPA became final in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in December 2004, following denial of class certification in June 2004. Since December 2006, class action litigation has been brought against a number of large lenders alleging that their captive mortgage reinsurance arrangements violated RESPA. Beginning in December 2011, MGIC, together with various mortgage lenders and other mortgage insurers, has been named as a defendant in twelve lawsuits, alleged to be class actions, filed in various U.S. District Courts. Seven of those cases have previously been dismissed without any further opportunity to appeal. The complaints in all of the cases allege various causes of action related to the captive mortgage reinsurance arrangements of the mortgage lenders, including that the lenders’ captive reinsurers received excessive premiums in relation to the risk assumed by those captives, thereby violating RESPA. MGIC denies any wrongdoing and intends to vigorously defend itself against the allegations in the lawsuits. There can be no assurance that we will not be subject to further litigation under RESPA (or FCRA) or that the outcome of any such litigation, including the lawsuits mentioned above, would not have a material adverse effect on us.

In 2013, the U.S. District Court for the Southern District of Florida approved a settlement with the CFPB that resolved a federal investigation of MGIC’s participation in captive reinsurance arrangements in the mortgage insurance industry. The settlement concluded the investigation with respect to MGIC without the CFPB or the court making any findings of wrongdoing. As part of the settlement, MGIC agreed that it would not enter into any new captive reinsurance agreement or reinsure any new loans under any existing captive reinsurance agreement for a period of ten years. MGIC had voluntarily suspended most of its captive arrangements in 2008 in response to market conditions and GSE requests. In connection with the settlement, MGIC paid a civil penalty of $2.65 million and the court issued an injunction prohibiting MGIC from violating any provisions of RESPA.

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We received requests from the Minnesota Department of Commerce (the “MN Department”) beginning in February 2006 regarding captive mortgage reinsurance and certain other matters in response to which MGIC has provided information on several occasions, including as recently as May 2011. In August 2013, MGIC and several competitors received a draft Consent Order from the MN Department containing proposed conditions to resolve its investigation, including unspecified penalties. We are engaged in discussions with the MN Department regarding the draft Consent Order. We also received a request in June 2005 from the New York Department of Financial Services for information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation. Other insurance departments or other officials, including attorneys general, may also seek information about, investigate, or seek remedies regarding captive mortgage reinsurance.

Various regulators, including the CFPB, state insurance commissioners and state attorneys general may bring actions seeking various forms of relief in connection with violations of RESPA. The insurance law provisions of many states prohibit paying for the referral of insurance business and provide various mechanisms to enforce this prohibition. While we believe our practices are in conformity with applicable laws and regulations, it is not possible to predict the eventual scope, duration or outcome of any such reviews or investigations nor is it possible to predict their effect on us or the mortgage insurance industry.

We are subject to comprehensive, detailed regulation by state insurance departments. These regulations are principally designed for the protection of our insured policyholders, rather than for the benefit of investors. Although their scope varies, state insurance laws generally grant broad supervisory powers to agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business. Given the recent significant losses incurred by many insurers in the mortgage and financial guaranty industries, our insurance subsidiaries have been subject to heightened scrutiny by insurance regulators. State insurance regulatory authorities could take actions, including changes in capital requirements or termination of waivers of capital requirements, that could have a material adverse effect on us. In early 2013, the CFPB issued rules to implement laws requiring mortgage lenders to make ability-to-repay determinations prior to extending credit. We are uncertain whether the CFPB will issue any other rules or regulations that affect our business. Such rules and regulations could have a material adverse effect on us.

In December 2013, the U.S. Treasury Department’s Federal Insurance Office released a report that calls for federal standards and oversight for mortgage insurers to be developed and implemented. It is uncertain what form the standards and oversight will take and when they will become effective.

We understand several law firms have, among other things, issued press releases to the effect that they are investigating us, including whether the fiduciaries of our 401(k) plan breached their fiduciary duties regarding the plan’s investment in or holding of our common stock or whether we breached other legal or fiduciary obligations to our shareholders. We intend to defend vigorously any proceedings that may result from these investigations. With limited exceptions, our bylaws provide that our officers and 401(k) plan fiduciaries are entitled to indemnification from us for claims against them.

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A non-insurance subsidiary of our holding company is a shareholder of the corporation that operates the Mortgage Electronic Registration System (“MERS”). Our subsidiary, as a shareholder of MERS, has been named as a defendant (along with MERS and its other shareholders) in eight lawsuits asserting various causes of action arising from allegedly improper recording and foreclosure activities by MERS. Seven of these lawsuits have been dismissed without any further opportunity to appeal. The remaining lawsuit had also been dismissed by the U.S. District Court, however, the plaintiff in that lawsuit filed a motion for reconsideration by the U.S. District Court and to certify a related question of law to the Supreme Court of the State in which the U.S. District Court is located. In April 2014, that motion for reconsideration was denied, however, on May 30, 2014, the plaintiff appealed the denial. The damages sought in this remaining case are substantial. We deny any wrongdoing and intend to defend ourselves vigorously against the allegations in the lawsuit.

In addition to the matters described above, we are involved in other legal proceedings in the ordinary course of business. In our opinion, based on the facts known at this time, the ultimate resolution of these ordinary course legal proceedings will not have a material adverse effect on our financial position or results of operations.

Through a non-insurance subsidiary, we utilize our underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. As part of the contract underwriting activities, that subsidiary is responsible for the quality of the underwriting decisions in accordance with the terms of the contract underwriting agreements with customers. That subsidiary may be required to provide certain remedies to its customers if certain standards relating to the quality of our underwriting work are not met, and we have an established reserve for such future obligations. Claims for remedies may be made a number of years after the underwriting work was performed. Beginning in the second half of 2009, our subsidiary experienced an increase in claims for contract underwriting remedies, which continued throughout 2012. The underwriting remedy expense for 2013 and the first half of 2014 was approximately $5 million and $2 million, respectively, but may increase in the future.

See Note 11 – “Income Taxes” for a description of federal income tax contingencies.

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Note 6 – Earnings (Loss) per Share

Our basic EPS is based on the weighted average number of common shares outstanding, which excludes participating securities of 0.2 million for the six months ended June 30, 2013 because they were anti-dilutive due to our reported net loss. Participating securities of 0.1 million were included in our weighted average number of common shares outstanding for the three and six months ended June 30, 2014 and for the three months ended June 30, 2013. Typically, diluted EPS is based on the weighted average number of common shares outstanding plus common stock equivalents which include certain stock awards and the dilutive effect of our convertible debt. In accordance with accounting guidance, if we report a net loss from continuing operations then our diluted EPS is computed in the same manner as the basic EPS. In addition if any common stock equivalents are anti-dilutive they are excluded from the calculation. The following includes a reconciliation of the weighted average number of shares; however for the three months ended June 30, 2014 and 2013 common stock equivalents of 54.5 million and 126.5 million, respectively, and for the six months ended June 30, 2014 and 2013 common stock equivalents of 54.5 million and 100.3 million, respectively, were not included because they were anti-dilutive.

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(In thousands, except per share data)
Basic earnings per share:
Net income (loss)		$	45,522			$	12,375			$	105,504			$	(60,555	)
Weighted average common shares outstanding			338,626				337,868				338,419				285,336
Basic income (loss) per share		$	0.13			$	0.04			$	0.31			$	(0.21	)
Diluted earnings per share:
Net income (loss)		$	45,522			$	12,375			$	105,504			$	(60,555	)
Effect of dilutive securities:
2% Convertible Senior Notes			3,049				-				6,098				-
Net income (loss) plus assumed conversions		$	48,571			$	12,375			$	111,602			$	(60,555	)
Weighted-average shares - Basic			338,626				337,868				338,419				285,336
Common stock equivalents			74,855				1,473				74,955				-
Weighted-average shares - Diluted			413,481				339,341				413,374				285,336
Diluted income (loss) per share		$	0.12			$	0.04			$	0.27			$	(0.21	)

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Note 7 – Investments

The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at June 30, 2014 and December 31, 2013 are shown below.

June 30, 2014		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses (1)				Fair Value
		(In thousands)
U.S. Treasury securities and obligations of  U.S. government corporations and agencies		$	483,205			$	2,540			$	(10,927	)		$	474,818
Obligations of U.S. states and political subdivisions			840,266				11,709				(3,605	)			848,370
Corporate debt securities			2,185,994				16,842				(7,065	)			2,195,771
Asset-backed securities			367,306				1,554				(54	)			368,806
Residential mortgage-backed securities			359,908				170				(12,588	)			347,490
Commercial mortgage-backed securities			274,102				1,336				(1,917	)			273,521
Collateralized loan obligations			61,338				-				(875	)			60,463
Debt securities issued by foreign sovereign governments			39,566				2,707				(44	)			42,229
Total debt securities			4,611,685				36,858				(37,075	)			4,611,468
Equity securities			2,949				69				(7	)			3,011
Total investment portfolio		$	4,614,634			$	36,927			$	(37,082	)		$	4,614,479

December 31, 2013		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses (1)				Fair Value
		(In thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	663,642			$	1,469			$	(25,521	)		$	639,590
Obligations of U.S. states and political subdivisions			932,922				5,865				(17,420	)			921,367
Corporate debt securities			2,190,095				6,313				(24,993	)			2,171,415
Asset-backed securities			399,839				1,100				(453	)			400,486
Residential mortgage-backed securities			383,368				146				(24,977	)			358,537
Commercial mortgage-backed securities			277,920				131				(6,668	)			271,383
Collateralized loan obligations			61,337				-				(1,042	)			60,295
Debt securities issued by foreign sovereign governments			39,420				1,722				(290	)			40,852
Total debt securities			4,948,543				16,746				(101,364	)			4,863,925
Equity securities			2,908				9				(23	)			2,894
Total investment portfolio		$	4,951,451			$	16,755			$	(101,387	)		$	4,866,819

 

(1) At June 30, 2014 and December 31, 2013, there were no other-than-temporary impairment losses recorded in other comprehensive income.

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Our foreign investments primarily consist of the investment portfolio supporting our Australian domiciled subsidiary. This portfolio is comprised of Australian government and semi government securities, representing 84% of the market value of our foreign investments with the remaining 9% invested in corporate securities and 7% in cash equivalents. Seventy-eight percent of the Australian portfolio is rated AAA, by one or more of Moody’s, Standard & Poor’s and Fitch Ratings, and the remaining 22% is rated AA.

The amortized cost and fair values of debt securities at June 30, 2014, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Because most asset-backed and mortgage-backed securities and collateralized loan obligations provide for periodic payments throughout their lives, they are listed below in separate categories.

June 30, 2014		Amortized Cost				Fair Value
		(In thousands)
Due in one year or less		$	434,813			$	436,114
Due after one year through five years			1,877,498				1,892,200
Due after five years through ten years			783,152				783,800
Due after ten years			453,568				449,074
		$	3,549,031			$	3,561,188
Asset-backed securities			367,306				368,806
Residential mortgage-backed securities			359,908				347,490
Commercial mortgage-backed securities			274,102				273,521
Collateralized loan obligations			61,338				60,463
Total at June 30, 2014		$	4,611,685			$	4,611,468

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At June 30, 2014 and December 31, 2013, the investment portfolio had gross unrealized losses of $37.1 million and $101.4 million, respectively.  For those securities in an unrealized loss position, the length of time the securities were in such a position, as measured by their month-end fair values, is as follows:

 

		Less Than 12 Months								12 Months or Greater								Total
June 30, 2014		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
		(In thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	10,902			$	27			$	374,597			$	10,900			$	385,499			$	10,927
Obligations of U.S. states and political subdivisions			99,956				664				169,336				2,941				269,292				3,605
Corporate debt securities			397,503				964				277,677				6,101				675,180				7,065
Asset-backed securities			24,501				12				14,700				42				39,201				54
Residential mortgage-backed securities			-				-				328,343				12,588				328,343				12,588
Commercial mortgage-backed securities			61,372				456				104,802				1,461				166,174				1,917
Collateralized loan obligations			32,456				504				28,007				371				60,463				875
Debt securities issued by foreign sovereign governments			4,267				1				3,419				43				7,686				44
Equity securities			-				-				277				7				277				7
Total investment portfolio		$	630,957			$	2,628			$	1,301,158			$	34,454			$	1,932,115			$	37,082

		Less Than 12 Months								12 Months or Greater								Total
December 31, 2013		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
		(In thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	465,975			$	24,980			$	4,103			$	541			$	470,078			$	25,521
Obligations of U.S. states and political subdivisions			503,967				17,370				4,226				50				508,193				17,420
Corporate debt securities			1,238,211				20,371				81,593				4,622				1,319,804				24,993
Asset-backed securities			126,991				387				7,114				66				134,105				453
Residential mortgage-backed securities			91,534				3,886				265,827				21,091				357,361				24,977
Commercial mortgage-backed securities			192,440				6,239				43,095				429				235,535				6,668
Collateralized loan obligations			60,295				1,042				-				-				60,295				1,042
Debt securities issued by foreign sovereign governments			7,203				290				-				-				7,203				290
Equity securities			1,012				18				75				5				1,087				23
Total investment portfolio		$	2,687,628			$	74,583			$	406,033			$	26,804			$	3,093,661			$	101,387

The unrealized losses in all categories of our investments at June 30, 2014 and December 31, 2013 were primarily caused by the difference in interest rates at each respective period, compared to interest rates at the time of purchase.

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Under the current guidance a debt security impairment is deemed other than temporary if we either intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery or we do not expect to collect cash flows sufficient to recover the amortized cost basis of the security. During each of the three and six months ended June 30, 2014 and 2013 there were no other-than-temporary impairments (“OTTI”) recognized.

 

The net realized investment gains (losses) and OTTI on the investment portfolio are as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
	(In thousands)
Net realized investment gains (losses) and OTTI on investments:
Fixed maturities		$	360			$	1,891			$	126			$	3,148
Equity securities			162				594				165				596
		$	522			$	2,485			$	291			$	3,744

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
	(In thousands)
Net realized investment gains (losses) and OTTI on investments:
Gains on sales		$	1,307			$	3,027			$	2,112			$	4,961
Losses on sales			(785	)			(542	)			(1,821	)			(1,217	)
		$	522			$	2,485			$	291			$	3,744

Note 8 – Fair Value Measurements

In accordance with fair value guidance, we applied the following fair value hierarchy in order to measure fair value for assets and liabilities:

Level 1 – Quoted prices for identical instruments in active markets that we can access. Financial assets utilizing Level 1 inputs primarily include certain U.S. Treasury Securities and obligations of U.S. government corporations and agencies and Australian government and semi government securities.

 

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and inputs, other than quoted prices, that are observable in the marketplace for the financial instrument. The observable inputs are used in valuation models to calculate the fair value of the financial instruments. Financial assets utilizing Level 2 inputs primarily include certain municipal and corporate bonds.

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Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable. Level 3 inputs reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Financial assets utilizing Level 3 inputs include certain state premium tax credit investments. Our non-financial assets that are classified as Level 3 securities consist of real estate acquired through claim settlement that is fair valued at the lower of our acquisition cost or a percentage of appraised value. The percentage applied to appraised value is based upon our historical sales experience adjusted for current trends.

To determine the fair value of securities available-for-sale in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized by the independent pricing sources including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including data published in market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model.  Quality controls are performed by the independent pricing sources throughout this process, which include reviewing tolerance reports, trading information and data changes, and directional moves compared to market moves. This model combines all inputs to arrive at a value assigned to each security.  In addition, on a quarterly basis, we perform quality controls over values received from the pricing sources which include reviewing tolerance reports, trading information and data changes, and directional moves compared to market moves. We have not made any adjustments to the prices obtained from the independent pricing sources.

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Fair value measurements for assets measured at fair value included the following as of June 30, 2014 and December 31, 2013:

		Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
		(In thousands)
June 30, 2014
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	474,818			$	474,818			$	-			$	-
Obligations of U.S. states and political subdivisions			848,370				-				846,139				2,231
Corporate debt securities			2,195,771				-				2,195,771				-
Asset-backed securities			368,806				-				368,806				-
Residential mortgage-backed securities			347,490				-				347,490				-
Commercial mortgage-backed securities			273,521				-				273,521				-
Collateralized loan obligations			60,463				-				60,463				-
Debt securities issued by foreign sovereign governments			42,229				42,229				-				-
Total debt securities			4,611,468				517,047				4,029,190				2,231
Equity securities			3,011				2,690				-				321
Total investments		$	4,614,479			$	519,737			$	4,029,190			$	2,552
Real estate acquired (1)		$	10,804			$	-			$	-			$	10,804

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		Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
		(In thousands)
December 31, 2013
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	639,590			$	639,590			$	-			$	-
Obligations of U.S. states and political subdivisions			921,367				-				918,944				2,423
Corporate debt securities			2,171,415				-				2,171,415				-
Asset-backed securities			400,486				-				400,486				-
Residential mortgage-backed securities			358,537				-				358,537				-
Commercial mortgage-backed securities			271,383				-				271,383				-
Collateralized loan obligations			60,295				-				60,295				-
Debt securities issued by foreign sovereign governments			40,852				40,852				-				-
Total debt securities			4,863,925				680,442				4,181,060				2,423
Equity securities			2,894				2,573				-				321
Total investments		$	4,866,819			$	683,015			$	4,181,060			$	2,744
Real estate acquired (1)		$	13,280			$	-			$	-			$	13,280

 

There were no transfers of securities between Level 1 and Level 2 during the first six months of 2014 or 2013.

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For assets measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the three and six months ended June 30, 2014 and 2013 is as follows:

 

		Obligations of U.S. States and Political Subdivisions				Equity Securities				Total Investments				Real Estate Acquired
		(In thousands)
Balance at March 31, 2014		$	2,378			$	321			$	2,699			$	11,137
Total realized/unrealized gains (losses):
Included in earnings and reported as losses incurred, net			-				-				-				(1,157	)
Purchases			-				-				-				11,367
Sales			(147	)			-				(147	)			(10,543	)
Transfers into Level 3			-				-				-				-
Transfers out of Level 3			-				-				-				-
Balance at June 30, 2014		$	2,231			$	321			$	2,552			$	10,804
Amount of total losses included in earnings for the three months ended June 30, 2014 attributable to the change in unrealized losses on assets still held at June 30, 2014		$	-			$	-			$	-			$	-

		Obligations of U.S. States and Political Subdivisions				Equity Securities				Total Investments				Real Estate Acquired
		(In thousands)
Balance at December 31, 2013		$	2,423			$	321			$	2,744			$	13,280
Total realized/unrealized gains (losses):
Included in earnings and reported as losses incurred, net			-				-				-				(2,316	)
Purchases			30				-				30				19,377
Sales			(222	)			-				(222	)			(19,537	)
Transfers into Level 3			-				-				-				-
Transfers out of Level 3			-				-				-				-
Balance at June 30, 2014		$	2,231			$	321			$	2,552			$	10,804
Amount of total losses included in earnings for the six months ended June 30, 2014 attributable to the change in unrealized losses on assets still held at June 30, 2014		$	-			$	-			$	-			$	-