Attached files

file filename
EX-99.25 - EXHIBIT 99.25 - MGIC INVESTMENT CORPex99_25.htm
EX-99 - EXHIBIT 99 - MGIC INVESTMENT CORPex99.htm
EX-31.1 - EXHIBIT 31.1 - MGIC INVESTMENT CORPex31_1.htm
EX-32 - EXHIBIT 32 - MGIC INVESTMENT CORPex32.htm
EX-31.2 - EXHIBIT 31.2 - MGIC INVESTMENT CORPex31_2.htm
EXCEL - IDEA: XBRL DOCUMENT - MGIC INVESTMENT CORPFinancial_Report.xls

FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2015
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 
NO 
 
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 
NO 

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   ☒    Accelerated filer   ☐    Non-accelerated filer   ☐   Smaller reporting company   ☐    (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
NO 

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
04/30/15
339,638,670


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.
 
2

PART I.
FINANCIAL INFORMATION
Item 1.
Financial Statements

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2015 and December 31, 2014
(Unaudited)

   
March 31,
2015
   
December 31,
2014
 
ASSETS
 
(In thousands)
 
Investment Portfolio (notes 7 and 8):
       
Securities, available-for-sale, at fair value:
       
Fixed maturities (amortized cost, 2015 - $4,567,873; 2014 - $4,602,514)
 
$
4,594,663
   
$
4,609,614
 
Equity securities
   
3,100
     
3,055
 
Total investment portfolio
   
4,597,763
     
4,612,669
 
Cash and cash equivalents
   
232,623
     
197,882
 
Restricted cash and cash equivalents (note 1)
   
-
     
17,212
 
Accrued investment income
   
32,114
     
30,518
 
Prepaid reinsurance premiums
   
50,119
     
47,623
 
Reinsurance recoverable on loss reserves
   
55,415
     
57,841
 
Reinsurance recoverable on paid losses
   
5,966
     
6,424
 
Premiums receivable
   
59,254
     
57,442
 
Home office and equipment, net
   
28,565
     
28,693
 
Deferred insurance policy acquisition costs
   
13,251
     
12,240
 
Profit commission receivable (note 4)
   
114,974
     
91,500
 
Other assets
   
92,688
     
106,390
 
Total assets
 
$
5,282,732
   
$
5,266,434
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Liabilities:
               
Loss reserves (note 12)
 
$
2,244,624
   
$
2,396,807
 
Premium deficiency reserve (note 13)
   
17,333
     
23,751
 
Unearned premiums
   
223,053
     
203,414
 
Senior notes (note 3)
   
61,930
     
61,918
 
Convertible senior notes (note 3)
   
845,000
     
845,000
 
Convertible junior debentures (note 3)
   
389,522
     
389,522
 
Other liabilities
   
315,710
     
309,119
 
Total liabilities
   
4,097,172
     
4,229,531
 
Contingencies (note 5)
               
Shareholders' equity (note 14):
               
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2015 - 340,079; 2014 - 340,047; shares outstanding 2015 - 339,639; 2014 - 338,560)
   
340,079
     
340,047
 
Paid-in capital
   
1,662,211
     
1,663,592
 
Treasury stock (shares at cost 2015 - 440; 2014 - 1,487)
   
(3,362
)
   
(32,937
)
Accumulated other comprehensive loss, net of tax (note 9)
   
(64,492
)
   
(81,341
)
Retained deficit
   
(748,876
)
   
(852,458
)
Total shareholders' equity
   
1,185,560
     
1,036,903
 
Total liabilities and shareholders' equity
 
$
5,282,732
   
$
5,266,434
 

See accompanying notes to consolidated financial statements.
 
3

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2015 and 2014
(Unaudited)

   
Three Months Ended March 31,
 
   
2015
   
2014
 
   
(In thousands, except per share data)
 
Revenues:
       
Premiums written:
       
Direct
 
$
265,412
   
$
244,189
 
Assumed
   
338
     
451
 
Ceded (note 4)
   
(31,294
)
   
(26,620
)
Net premiums written
   
234,456
     
218,020
 
Increase in unearned premiums, net
   
(17,168
)
   
(3,759
)
Net premiums earned
   
217,288
     
214,261
 
Investment income, net of expenses
   
24,120
     
20,156
 
Net realized investment gains (losses):
               
Total other-than-temporary impairment losses
   
-
     
-
 
Portion of losses recognized in comprehensive income, before taxes
   
-
     
-
 
Net impairment losses recognized in earnings
   
-
     
-
 
Other realized investment gains (losses)
   
26,327
     
(231
)
Net realized investment gains (losses)
   
26,327
     
(231
)
Other revenue
   
2,480
     
896
 
Total revenues
   
270,215
     
235,082
 
                 
Losses and expenses:
               
Losses incurred, net (note 12)
   
81,785
     
122,608
 
Change in premium deficiency reserve (note 13)
   
(6,418
)
   
(5,173
)
Amortization of deferred policy acquisition costs
   
1,757
     
1,419
 
Other underwriting and operating expenses, net
   
39,268
     
37,981
 
Interest expense
   
17,362
     
17,539
 
Total losses and expenses
   
133,754
     
174,374
 
                 
Income before tax
   
136,461
     
60,708
 
Provision for income taxes (note 11)
   
3,385
     
726
 
                 
Net income
 
$
133,076
   
$
59,982
 
                 
Income per share (note 6)
               
Basic
 
$
0.39
   
$
0.18
 
Diluted
 
$
0.32
   
$
0.15
 
                 
Weighted average common shares outstanding - basic (note 6)
   
339,107
     
338,213
 
Weighted average common shares outstanding - diluted (note 6)
   
468,141
     
413,180
 

See accompanying notes to consolidated financial statements.
 
4

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended March 31, 2015 and 2014
(Unaudited)
 
   
Three Months Ended March 31,
 
   
2015
   
2014
 
   
(In thousands, except per share data)
 
         
Net income
 
$
133,076
   
$
59,982
 
                 
Other comprehensive income, net of tax (note 9):
               
                 
Change in unrealized investment gains and losses (note 7)
   
19,563
     
39,598
 
                 
Benefit plan adjustments
   
(700
)
   
(1,486
)
                 
Foreign currency translation adjustment
   
(2,014
)
   
1,253
 
                 
Other comprehensive income, net of tax
   
16,849
     
39,365
 
                 
Comprehensive income
 
$
149,925
   
$
99,347
 

See accompanying notes to consolidated financial statements.
 
5

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three months ended March 31, 2015 and 2014
(Unaudited)

   
Common stock
   
Paid-in capital
   
Treasury stock
   
Accumulated other comprehensive income (loss)
   
Retained earnings (deficit)
   
Total shareholders' equity
 
                         
Balance, December 31, 2013
 
$
340,047
   
$
1,661,269
   
$
(64,435
)
 
$
(117,726
)
 
$
(1,074,617
)
 
$
744,538
 
                                                 
Net income
   
-
     
-
     
-
     
-
     
59,982
     
59,982
 
Change in unrealized investment gains and losses, net
   
-
     
-
     
-
     
39,598
     
-
     
39,598
 
Reissuance of treasury stock, net
   
-
     
(5,712
)
   
30,530
     
-
     
(29,791
)
   
(4,973
)
Equity compensation
   
-
     
1,803
     
-
     
-
     
-
     
1,803
 
Benefit plan adjustments, net
   
-
     
-
     
-
     
(1,486
)
   
-
     
(1,486
)
Unrealized foreign currency translation adjustment, net
   
-
     
-
     
-
     
1,253
     
-
     
1,253
 
Balance, March 31, 2014
 
$
340,047
   
$
1,657,360
   
$
(33,905
)
 
$
(78,361
)
 
$
(1,044,426
)
 
$
840,715
 

   
Common stock
   
Paid-in capital
   
Treasury stock
   
Accumulated other comprehensive income (loss)
   
Retained earnings (deficit)
   
Total shareholders' equity
 
                         
Balance, December 31, 2014
 
$
340,047
   
$
1,663,592
   
$
(32,937
)
 
$
(81,341
)
 
$
(852,458
)
 
$
1,036,903
 
                                                 
Net income
   
-
     
-
     
-
     
-
     
133,076
     
133,076
 
Change in unrealized investment gains and losses, net (note 7)
   
-
     
-
     
-
     
19,563
     
-
     
19,563
 
Net common stock issued under share-based compensation plans
   
32
     
38
     
-
     
-
     
-
     
70
 
Reissuance of treasury stock, net
   
-
     
(7,251
)
   
29,575
     
-
     
(29,494
)
   
(7,170
)
Tax benefit from share-based compensation
   
-
     
2,568
     
-
     
-
     
-
     
2,568
 
Equity compensation
   
-
     
3,264
     
-
     
-
     
-
     
3,264
 
Benefit plan adjustments, net
   
-
     
-
     
-
     
(700
)
   
-
     
(700
)
Unrealized foreign currency translation adjustment, net
   
-
     
-
     
-
     
(2,014
)
           
(2,014
)
Balance, March 31, 2015
 
$
340,079
   
$
1,662,211
   
$
(3,362
)
 
$
(64,492
)
 
$
(748,876
)
 
$
1,185,560
 

See accompanying notes to consolidated financial statements.
 
6

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2015 and 2014
(Unaudited)

   
Three Months Ended March 31,
 
   
2015
   
2014
 
   
(In thousands)
 
Cash flows from operating activities:
       
Net income
 
$
133,076
   
$
59,982
 
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation and amortization
   
11,311
     
14,889
 
Deferred tax benefit
   
(11
)
   
(86
)
Realized investment (gains) losses, net
   
(26,327
)
   
231
 
Loss on repurchases of senior notes
   
-
     
837
 
Excess tax benefits related to share-based compensation
   
(2,568
)
   
-
 
Other
   
13,436
     
(879
)
Change in certain assets and liabilities:
               
Accrued investment income
   
(1,596
)
   
(151
)
Prepaid insurance premium
   
(2,496
)
   
(1,828
)
Reinsurance recoverable on loss reserves
   
2,426
     
6,467
 
Reinsurance recoverable on paid losses
   
458
     
1,394
 
Premium receivable
   
(1,812
)
   
7,962
 
Deferred insurance policy acquisition costs
   
(1,011
)
   
(433
)
Profit commission receivable
   
(23,474
)
   
(22,212
)
Real estate
   
1,761
     
2,143
 
Loss reserves
   
(152,183
)
   
(226,842
)
Premium deficiency reserve
   
(6,418
)
   
(5,173
)
Unearned premiums
   
19,639
     
5,618
 
Return premium accrual
   
3,300
     
(300
)
Income taxes payable - current
   
2,813
     
494
 
Net cash used in operating activities
   
(29,676
)
   
(157,887
)
                 
Cash flows from investing activities:
               
Purchases of investments:
               
Fixed maturities
   
(940,867
)
   
(582,261
)
Equity securities
   
(18
)
   
(19
)
Proceeds from sales of fixed maturities
   
795,968
     
419,293
 
Proceeds from maturity of fixed maturities
   
192,463
     
295,188
 
Net increase in payable for securities
   
699
     
12,692
 
Net decrease (increase) in restricted cash
   
17,212
     
(4
)
Additions to property and equipment
   
(576
)
   
(2,971
)
Net cash provided by investing activities
   
64,881
     
141,918
 
                 
Cash flows from financing activities:
               
Repayment of long-term debt
   
-
     
(21,767
)
Net common stock issued under share-based compensation plans
   
70
     
-
 
Excess tax benefits related to share-based compensation
   
2,568
     
-
 
Net cash provided by (used in) financing activities
   
2,638
     
(21,767
)
                 
Effect of exchange rate changes on cash
   
(3,102
)
   
1,931
 
                 
Net increase (decrease) in cash and cash equivalents
   
34,741
     
(35,805
)
Cash and cash equivalents at beginning of period
   
197,882
     
332,692
 
Cash and cash equivalents at end of period
 
$
232,623
   
$
296,887
 

See accompanying notes to consolidated financial statements.
 
7

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2015
(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, 2014 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, 2015.

Capital - GSEs

Since 2008, substantially all of our insurance written has been for loans sold to Fannie Mae and Freddie Mac (the “GSEs”). In April 2015, the GSEs each released revised private mortgage insurer eligibility requirements (the “PMIERs”) that become effective December 31, 2015. The PMIERs include revised financial requirements for mortgage insurers (the “GSE Financial Requirements”) under which a mortgage insurer’s “Available Assets” (generally only the most liquid assets of an insurer) must meet or exceed “Minimum Required Assets” (which are based on an insurer’s book and are calculated from tables of factors with several risk dimensions and are subject to a floor amount).

We expect that MGIC will be in compliance with the PMIERs, including the GSE Financial Requirements, when they become effective.

We estimate that as of March 31, 2015, before considering the effects of reinsurance, MGIC has a shortfall in Available Assets of approximately $230 million. This shortfall estimate is based on our interpretation of the GSE Financial Requirements and assumes that the risk in force and assets of MGIC’s MIC subsidiary will be repatriated to MGIC. This shortfall estimate does not reflect the benefits from MGIC’s existing quota share reinsurance transaction or the anticipated restructure of that transaction; or the transfer of assets (including the $45 million discussed below) from regulated insurance affiliates of MGIC that, subject to regulatory authorization, could increase the assets of MGIC. We believe that these benefits will eliminate our shortfall in Available Assets and each is discussed below.
 
8

We did not expect to receive full credit under the PMIERs for our existing reinsurance transaction. However, we and the reinsurers have reached agreement to restructure the transaction in a manner that we believe will result in MGIC receiving full credit under the PMIERs. The effectiveness of the restructured transaction will be subject to approval by the GSEs and the Office of the Commissioner of Insurance of the State of Wisconsin (“OCI”). In addition, in April 2015, regulated insurance affiliates of MGIC transferred $45 million of assets to MGIC increasing the Available Assets of MGIC. Furthermore, if additional Available Assets are required, we believe that a portion of our holding company’s $494 million of cash and investments at March 31, 2015, may be available for future contribution to MGIC. In addition, we could seek non-dilutive debt capital to mitigate a shortfall.

As noted above, we expect to be in compliance with the PMIERs, including the GSE Financial Requirements, by their effective date. However, if we are not in compliance with the GSE Financial Requirements by then, we could submit to the GSEs for approval, a transition plan having milestones for actions to achieve compliance. If the plan were approved, the GSEs would monitor our progress and we could have until June 2017 to meet the GSE Financial Requirements (the “transition period”). During the transition period, MGIC would be considered to be in remediation (a status similar to the one under which it has been operating with the GSEs for over five years) and eligible to provide mortgage insurance on loans acquired by the GSEs.

Factors that may negatively impact MGIC’s ability to comply with the GSE Financial Requirements before their effective date include the following:

· The GSEs may not approve our restructured reinsurance transaction or they may not allow full credit under the GSE Financial Requirements for that transaction.
 
· We may not obtain regulatory authorization to transfer assets from MIC to MGIC to the extent we are assuming because regulators project higher losses than we project or require a level of capital be maintained in MIC higher than we are assuming.
 
· MGIC may not receive additional capital contributions from our holding company due to competing demands on the holding company resources, including for repayment of debt.
 
· Our future operating results may be negatively impacted by the matters discussed in the rest of these footnotes. Such matters could decrease our revenues, increase our losses or require the use of assets, thereby increasing our shortfall in Available Assets.
 
· 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 may seek.
 
There can be no assurance that the GSEs will not make the GSE Financial Requirements more onerous in the future; in this regard, the PMIERs provide that the tables of factors that determine Minimum Required Assets will be updated every two years and may be updated more frequently to reflect changes in macroeconomic conditions or loan performance. The GSEs will provide notice 180 days prior to the effective date of table updates. In addition, the GSEs may amend the PMIERs at any time. 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.
 
9

While on an overall basis, the amount of Available Assets we must hold in order to continue to insure GSE loans has increased under the PMIERs over what state regulation currently provides, reinsurance is one option we have to mitigate the effect of PMIERs on our returns. In this regard, see the first bullet point above.

See additional disclosure regarding statutory capital in Note 16 – “Statutory Capital.”

Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2014 amounts to conform to 2015 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, Inc. (“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. In the first quarter of 2015, the escrow funds were disbursed to us pursuant to the amended and restated settlement agreement and release entered into with CHL on March 2, 2015.  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 Pronouncements

Revenue from Contracts with Customers
 
In May 2014, the FASB issued guidance to clarify the principles for recognizing revenue. While insurance contracts are not within the scope of this updated guidance, our fee income related to contract underwriting and other fee-based services provided to lenders will be subject to this guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts. We are currently evaluating the impact of this update, but it is not expected to have a significant impact on our consolidated financial statements and disclosures.

The guidance is effective for fiscal years beginning after December 15, 2016. On April 1, 2015, the FASB issued a proposal to defer the effective date by one year and permit early adoption, but not before the original effective date of December 15, 2016.
 
10

Presentation of Debt Issuance Costs
 
In April 2015, the FASB amended existing guidance related to the presentation of debt issuance costs. The new standard requires the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge. It is effective for annual reporting periods beginning after December 15, 2015, but early adoption is permitted. The adoption of this guidance is not expected to have a significant impact on our consolidated financial statements.

Note 3 – Debt

Long-term debt as of March 31, 2015 and December 31, 2014 consists of the following obligations.

   
March 31,
2015
   
December 31, 2014
 
   
(In millions)
 
Senior Notes, interest at 5.375% per annum, due November 2015
 
$
61.9
   
$
61.9
 
Convertible Senior Notes, interest at 5% per annum, due May 2017 (1)
   
345.0
     
345.0
 
Convertible Senior Notes, interest at 2% per annum, due April 2020 (2) (3)
   
500.0
     
500.0
 
Convertible Junior Subordinated Debentures, interest 9% per annum, due April 2063 (4)
   
389.5
     
389.5
 
Total debt
   
1,296.4
     
1,296.4
 
Less current portion of debt
   
(61.9
)
   
(61.9
)
Total long-term debt
 
$
1,234.5
   
$
1,234.5
 

(1)
Convertible at any time prior to maturity at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount, representing an initial conversion price of approximately $13.44 per share.

(2)
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 2% Notes are convertible at an initial conversion rate, which is subject to adjustment, of 143.8332 shares per $1,000 principal amount, representing 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. For the quarter ending March 31, 2015, our common stock was greater than or equal to 130% of the applicable conversion price for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, March 31, 2015.

(3)
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 rate 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 each of at least 20 of the 30 consecutive trading days preceding notice of the redemption. .

(4)
Convertible at any time prior to maturity at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.0741 share per $1,000 principal amount, representing 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.

The Senior Notes, Convertible Senior Notes and Convertible Junior Subordinated Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. At March 31, 2015, we had approximately $494 million in cash and investments at our holding company. The net unrealized gains on our holding company investment portfolio were approximately $1.3 million at March 31, 2015. The modified duration of the holding company investment portfolio, excluding cash and cash equivalents, was 2.8 years at March 31, 2015.
 
11

Note 4 – Reinsurance

A summary of our quota share reinsurance agreements, excluding captive agreements, for the three months ended March 31, 2015 and 2014 appears below.

   
Three months ended March 31,
 
   
2015
   
2014
 
   
(In thousands)
 
         
Ceded premiums written, net of profit commission
 
$
27,136
   
$
21,486
 
                 
Ceded premiums earned, net of profit commission
   
24,613
     
19,627
 
                 
Ceded losses incurred
   
4,873
     
2,519
 
                 
Ceding commissions (1)
   
10,122
     
8,740
 

(1)
Ceding commissions are reported within Other underwriting and operating expenses, net on the consolidated statements of operations.


As of March 31, 2015 and December 31, 2014, we have accrued a profit commission receivable of $115.0 million and $91.5 million, respectively. 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. Recoverables under the agreement are supported by trust funds or letters of credit. Profit commissions are recorded as a reduction to our ceded premiums.

In the past, MGIC has obtained both captive and non-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 $39 million at March 31, 2015 which was supported by $168 million of trust assets, while at December 31, 2014, the reinsurance recoverable on loss reserves related to captive agreements was $45 million which was supported by $198 million of trust assets.
 
12

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 as “curtailments.” In 2014 and the first quarter of 2015, curtailments reduced our average claim paid by approximately 6.7% and 8.2%, 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. 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 and have not significantly mitigated our incurred losses since then.  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.

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. Certain settlements require GSE approval. 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 in effect prior to October 1, 2014, 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, and under our master policy effective October 1, 2014, such proceedings may be brought up to two years from the date of the notice of rescission. In a few jurisdictions there is a longer time to bring such proceedings.

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.
 
13

Since December 2009, we have been involved in legal proceedings with 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”). On March 2, 2015, the parties to the Agreement with CHL amended and restated the Agreement.
 
The Agreement with BANA covers loans purchased by the GSEs. That 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”). The original Agreement addressed rescission and denial rights; the amended and restated Agreement also addresses curtailment rights. That Agreement will be implemented only as and to the extent that it is consented to by or on behalf of the other investors. While there can be no assurance that the Agreement with CHL will be implemented, we have determined that its implementation is probable.

The estimated impact of the Agreements and other probable settlements have been recorded in our financial statements. The estimated impact that we recorded for probable settlements is our best estimate of our loss from these matters. We estimate that the maximum exposure above the best estimate provision we recorded is $441 million, of which about 72% is related to claims paying 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. 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 $29 million, although we believe we will ultimately resolve these matters for significantly less than this amount.
 
14

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. 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. Seven of those cases had been dismissed prior to February 2015 without any further opportunity to appeal. The remaining five cases were dismissed with prejudice in the first quarter of 2015 pursuant to stipulations of dismissal from the plaintiffs. 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.

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. Since August 2013, MGIC and several competitors have exchanged drafts of a proposed Consent Order with the MN Department, containing terms and conditions, including unspecified civil penalties, that would resolve the MN Department’s investigation. We received the latest draft of the Consent Order from the MN Department in March 2015. We continue to be 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.
 
15

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. State insurance regulatory authorities could take actions, including changes in capital requirements, that could have a material adverse effect on us. In addition, the CFPB may issue additional rules or regulations, which may materially affect our business.

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.

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. That motion for reconsideration was denied, however, in May 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 related contract underwriting remedy expense was approximately $4 million and $5 million for the years ended December 31, 2014 and 2013, respectively. There was no underwriting remedy expense incurred in the first quarter of 2015, but it may increase in the future.
 
16

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

Note 6 – Earnings per Share

Basic earnings per share (“EPS”) is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted EPS includes the components of basic EPS and also gives effect to dilutive common equivalent shares outstanding during the reporting period. We calculate diluted EPS using the treasury stock method for unvested restricted stock, and the if-converted method for convertible debt instruments. For unvested restricted stock, assumed proceeds under the treasury stock method would include unamortized compensation expense and windfall tax benefits or shortfalls. The determination of potentially issuable shares from our convertible debt instruments does not consider satisfaction of the conversion requirements and the shares are included in the determination of diluted EPS as of the beginning of the period, if dilutive. In addition, if dilutive, interest expense, net of tax, related to the convertible debt instrument is added back to earnings in calculating diluted EPS.
 
17

The following table reconciles the numerators and denominators used to calculate basic and diluted EPS.
 
   
Three months ended March 31,
 
   
2015
   
2014
 
   
(In thousands, except per share data)
 
Basic earnings per share:
       
         
Net income
 
$
133,076
   
$
59,982
 
                 
Weighted average common shares outstanding
   
339,107
     
338,213
 
                 
Basic income per share
 
$
0.39
   
$
0.18
 
                 
Diluted earnings per share:
               
                 
Net income
 
$
133,076
   
$
59,982
 
                 
Interest expense, net of tax:
               
2% Convertible Senior Notes due 2020
   
3,049
     
3,049
 
5% Convertible Senior Notes due 2017
   
4,692
     
-
 
9% Convertible Junior Subordinated Debentures due 2063
   
8,765
     
-
 
                 
Diluted income available to common shareholders
 
$
149,582
   
$
63,031
 
                 
Weighted average shares - basic
   
339,107
     
338,213
 
                 
Effect of dilutive securities:
               
Unvested restricted stock units
   
2,569
     
3,025
 
2% Convertible Senior Notes due 2020
   
71,942
     
71,942
 
5% Convertible Senior Notes due 2017
   
25,670
     
-
 
9% Convertible Junior Subordinated Debentures due 2063
   
28,853
     
-
 
                 
Weighted average shares - diluted
   
468,141
     
413,180
 
                 
Diluted income per share
 
$
0.32
   
$
0.15
 
                 
Antidilutive securities (in millions)
   
-
     
54.5
 
 
18

Note 7 – Investments

The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at March 31, 2015 and December 31, 2014 are shown below.
 
   
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses (1)
   
Fair Value
 
March 31, 2015
 
(In thousands)
 
                 
U.S. Treasury securities and obligations of U.S. government corporations and   agencies
 
$
312,233
   
$
2,629
   
$
(2,057
)
 
$
312,805
 
Obligations of U.S. states and political subdivisions
   
937,548
     
16,621
     
(1,466
)
   
952,703
 
Corporate debt securities
   
2,394,862
     
18,939
     
(5,785
)
   
2,408,016
 
Asset-backed securities
   
253,185
     
769
     
(35
)
   
253,919
 
Residential mortgage-backed securities
   
315,778
     
719
     
(7,466
)
   
309,031
 
Commercial mortgage-backed securities
   
259,934
     
1,804
     
(1,132
)
   
260,606
 
Collateralized loan obligations
   
61,341
     
-
     
(797
)
   
60,544
 
Debt securities issued by foreign sovereign governments
   
32,992
     
4,047
     
-
     
37,039
 
Total debt securities
   
4,567,873
     
45,528
     
(18,738
)
   
4,594,663
 
Equity securities
   
3,021
     
85
     
(6
)
   
3,100
 
                                 
Total investment portfolio
 
$
4,570,894
   
$
45,613
   
$
(18,744
)
 
$
4,597,763
 

   
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses (1)
   
Fair Value
 
December 31, 2014
 
(In thousands)
 
                 
U.S. Treasury securities and obligations of U.S. government corporations and    agencies
 
$
349,153
   
$
2,752
   
$
(5,130
)
 
$
346,775
 
Obligations of U.S. states and political subdivisions
   
844,942
     
12,961
     
(2,761
)
   
855,142
 
Corporate debt securities
   
2,418,991
     
16,325
     
(10,035
)
   
2,425,281
 
Asset-backed securities
   
286,260
     
535
     
(140
)
   
286,655
 
Residential mortgage-backed securities
   
329,983
     
254
     
(9,000
)
   
321,237
 
Commercial mortgage-backed securities
   
276,215
     
1,221
     
(2,158
)
   
275,278
 
Collateralized loan obligations
   
61,340
     
-
     
(1,264
)
   
60,076
 
Debt securities issued by foreign sovereign governments
   
35,630
     
3,540
     
-
     
39,170
 
Total debt securities
   
4,602,514
     
37,588
     
(30,488
)
   
4,609,614
 
Equity securities
   
3,003
     
61
     
(9
)
   
3,055
 
                                 
Total investment portfolio
 
$
4,605,517
   
$
37,649
   
$
(30,497
)
 
$
4,612,669
 
 
(1)
At March 31, 2015 and December 31, 2014, there were no other-than-temporary impairment losses recorded in other comprehensive income.
19

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 86% of the market value of our foreign investments with the remaining 10% invested in corporate securities and 4% in cash equivalents. Eighty-five percent of the Australian portfolio is rated AAA, by one or more of Moody’s, Standard & Poor’s and Fitch Ratings, and the remaining 15% is rated AA.

The amortized cost and fair values of debt securities at March 31, 2015, 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.

   
Amortized Cost
   
Fair Value
 
March 31, 2015
 
(In thousands)
 
         
Due in one year or less
 
$
301,142
   
$
301,873
 
Due after one year through five years
   
1,806,892
     
1,823,593
 
Due after five years through ten years
   
1,127,078
     
1,133,449
 
Due after ten years
   
442,523
     
451,648
 
                 
   
$
3,677,635
   
$
3,710,563
 
                 
Asset-backed securities
   
253,185
     
253,919
 
Residential mortgage-backed securities
   
315,778
     
309,031
 
Commercial mortgage-backed securities
   
259,934
     
260,606
 
Collateralized loan obligations
   
61,341
     
60,544
 
                 
Total at March 31, 2015
 
$
4,567,873
   
$
4,594,663
 
 
20

At March 31, 2015 and December 31, 2014, the investment portfolio had gross unrealized losses of $18.7 million and $30.5 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
 
March 31, 2015
 
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
 
$
93,555
   
$
362
   
$
26,435
   
$
1,695
   
$
119,990
   
$
2,057
 
Obligations of U.S. states and political   subdivisions
   
174,785
     
695
     
50,757
     
771
     
225,542
     
1,466
 
Corporate debt securities
   
621,952
     
4,169
     
113,002
     
1,616
     
734,954
     
5,785
 
Asset-backed securities
   
34,294
     
10
     
11,930
     
26
     
46,224
     
36
 
Residential mortgage-backed securities
   
34,574
     
168
     
229,563
     
7,298
     
264,137
     
7,466
 
Commercial mortgage-backed securities
   
61,443
     
304
     
71,895
     
828
     
133,338
     
1,132
 
Collateralized loan obligations
   
-
     
-
     
60,544
     
797
     
60,544
     
797
 
Equity securities
   
68
     
-
     
177
     
5
     
245
     
5
 
                                                 
Total investment portfolio
 
$
1,020,671
   
$
5,708
   
$
564,303
   
$
13,036
   
$
1,584,974
   
$
18,744
 

   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
December 31, 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
 
$
58,166
   
$
138
   
$
232,351
   
$
4,992
   
$
290,517
   
$
5,130
 
Obligations of U.S. states and political   subdivisions
   
166,408
     
1,066
     
114,465
     
1,695
     
280,873
     
2,761
 
Corporate debt securities
   
816,555
     
5,259
     
243,208
     
4,776
     
1,059,763
     
10,035
 
Asset-backed securities
   
54,491
     
80
     
11,895
     
60
     
66,386
     
140
 
Residential mortgage-backed securities
   
24,168
     
34
     
263,002
     
8,966
     
287,170
     
9,000
 
Commercial mortgage-backed securities
   
89,301
     
810
     
110,652
     
1,348
     
199,953
     
2,158
 
Collateralized loan obligations
   
-
     
-
     
60,076
     
1,264
     
60,076
     
1,264
 
Equity securities
   
167
     
1
     
235
     
8
     
402
     
9
 
                                                 
Total investment portfolio
 
$
1,209,256
   
$
7,388
   
$
1,035,884
   
$
23,109
   
$
2,245,140
   
$
30,497
 

The unrealized losses in all categories of our investments at March 31, 2015 and December 31, 2014 were primarily caused by the difference in interest rates at each respective period, compared to interest rates at the time of purchase. There were 278 and 423 securities in an unrealized loss position at March 31, 2015 and December 31, 2014, respectively. During each of the three months ended March 31, 2015 and 2014 there were no other-than-temporary impairments (“OTTI”) recognized.
 
21

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

   
Three Months Ended
March 31,
 
   
2015
   
2014
 
   
(In thousands)
 
         
Net realized investment gains (losses) and OTTI on investments:
       
Fixed maturities
 
$
26,324
   
$
(234
)
Equity securities
   
3
     
3
 
   
$
26,327
   
$
(231
)

   
Three Months Ended
March 31,
 
   
2015
   
2014
 
   
(In thousands)
 
         
Net realized investment gains (losses) and OTTI on investments:
       
Gains on sales
 
$
27,206
   
$
805
 
Losses on sales
   
(879
)
   
(1,036
)
   
$
26,327
   
$
(231
)

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 U.S. Treasury securities, equity securities, 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 obligations of U.S. government corporations and agencies and certain municipal and corporate bonds.

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 primarily 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. The fair value of real estate acquired is the lower of our acquisition cost or a percentage of the appraised value. The percentage applied to the appraised value is based upon our historical sales experience adjusted for current trends.
 
22

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.

Our financial assets that are classified as Level 3 securities are primarily state premium tax credit investments.  The state premium tax credit investments have an average maturity of less than 4 years, credit ratings of AA+ or higher, and their balance reflects their remaining scheduled payments discounted at an average annual rate of 7.2%.

Fair value measurements for assets measured at fair value included the following as of March 31, 2015 and December 31, 2014:

   
Total Fair
Value
   
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
March 31, 2015
 
(In thousands)
 
                 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
312,805
   
$
189,913
   
$
122,892
   
$
-
 
Obligations of U.S. states and political subdivisions
   
952,703
     
-
     
950,912
     
1,791
 
Corporate debt securities
   
2,408,016
     
-
     
2,408,016
     
-
 
Asset-backed securities
   
253,919
     
-
     
253,919
     
-
 
Residential mortgage-backed securities
   
309,031
     
-
     
309,031
     
-
 
Commercial mortgage-backed securities
   
260,606
     
-
     
260,606
     
-
 
Collateralized loan obligations
   
60,544
     
-
     
60,544
     
-
 
Debt securities issued by foreign sovereign governments
   
37,039
     
37,039
     
-
     
-
 
Total debt securities
   
4,594,663
     
226,952
     
4,365,920
     
1,791
 
Equity securities
   
3,100
     
2,779
     
-
     
321
 
Total investment portfolio
 
$
4,597,763
   
$
229,731
   
$
4,365,920
   
$
2,112
 
Real estate acquired (1)
 
$
10,897
   
$
-
   
$
-
   
$
10,897
 
 
23

   
Total Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
December 31, 2014
 
(In thousands)
 
                 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
346,775
   
$
188,824
   
$
157,951
   
$
-
 
Obligations of U.S. states and political subdivisions
   
855,142
     
-
     
853,296
     
1,846
 
Corporate debt securities
   
2,425,281
     
-
     
2,425,281
     
-
 
Asset-backed securities
   
286,655
     
-
     
286,655
     
-
 
Residential mortgage-backed securities
   
321,237
     
-
     
321,237
     
-
 
Commercial mortgage-backed securities
   
275,278
     
-
     
275,278
     
-
 
Collateralized loan obligations
   
60,076
     
-
     
60,076
     
-
 
Debt securities issued by foreign sovereign governments
   
39,170
     
39,170
     
-
     
-
 
Total debt securities
   
4,609,614
     
227,994
     
4,379,774
     
1,846
 
Equity securities
   
3,055
     
2,734
     
-
     
321
 
Total investment portfolio
 
$
4,612,669
   
$
230,728
   
$
4,379,774
   
$
2,167
 
Real estate acquired (1)
 
$
12,658
   
$
-
   
$
-
   
$
12,658
 

(1)
Real estate acquired through claim settlement, which is held for sale, is reported in Other assets on the consolidated balance sheets.

There were no transfers of securities between Level 1 and Level 2 during the first three months of 2015.
 
24

For assets measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the three months ended March 31, 2015 and 2014 is as follows:
 
   
Debt
Securities
   
Equity
Securities
   
Total
Investments
   
Real Estate
Acquired
 
                 
Balance at December 31, 2014
 
$
1,846
   
$
321
   
$
2,167
   
$
12,658
 
Total realized/unrealized gains (losses):
                               
Included in earnings and reported as losses incurred, net
   
-
     
-
     
-
     
(503
)
Purchases
   
7
     
-
     
7
     
10,797
 
Sales
   
(62
)
   
-
     
(62
)
   
(12,055
)
Transfers into Level 3
   
-
     
-
     
-
     
-
 
Transfers out of Level 3
   
-
     
-
     
-
     
-
 
Balance at March 31, 2015
 
$
1,791
   
$
321
   
$
2,112
   
$
10,897
 
                                 
Amount of total losses included in earnings for the three months ended March 31, 2015 attributable to the change in unrealized losses on assets still held at   March 31, 2015
 
$
-
   
$
-
   
$
-
   
$
-
 

   
Debt Securities
   
Equity Securities
   
Total Investments
   
Real Estate Acquired
 
                 
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
   
-
     
-
     
-
     
(1,160
)
Purchases
   
30
     
-
     
30
     
8,010
 
Sales
   
(75
)
   
-
     
(75
)
   
(8,993
)
Transfers into Level 3
   
-
     
-
     
-
     
-
 
Transfers out of Level 3
   
-
     
-
     
-
     
-
 
Balance at March 31, 2014
 
$
2,378
   
$
321
   
$
2,699
   
$
11,137
 
                                 
Amount of total losses included in earnings for the three months ended March 31, 2014 attributable to the change in unrealized losses on assets still held at March 31, 2014
 
$
-
   
$
-
   
$
-
   
$
-
 
                                                            
Authoritative guidance over disclosures about the fair value of financial instruments requires additional disclosure for financial instruments not measured at fair value. Certain financial instruments, including insurance contracts, are excluded from these fair value disclosure requirements. The carrying values of cash and cash equivalents (Level 1) and accrued investment income (Level 2) approximated their fair values.
                                                                   
Additional fair value disclosures related to our investment portfolio are included in Note 7 – “Investments.”
                                                           
We incur financial liabilities in the normal course of our business. The following tables present the carrying value and fair value of our financial liabilities disclosed, but not carried, at fair value at March 31, 2015 and December 31, 2014, and the level within the fair value hierarchy at which such liabilities are measured on a recurring basis.
 
25

March 31, 2015
 
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)
 
                     
Financial liabilities:
                   
Senior Notes
 
$
61,953
   
$
63,309
   
$
-
   
$
63,309
   
$
-
 
Convertible Senior Notes due 2017
   
345,000
     
382,622
     
-
     
382,622
     
-
 
Convertible Senior Notes due 2020
   
500,000
     
735,945
     
-
     
735,945
     
-
 
Convertible Junior Subordinated Debentures
   
389,522
     
497,221
     
-
     
497,221
     
-
 
Total Debt
 
$
1,296,475
   
$
1,679,097
   
$
-
   
$
1,679,097
   
$
-
 

December 31, 2014
 
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)
 
                     
Financial liabilities:
                   
Senior Notes
 
$
61,953
   
$
63,618
   
$
-
   
$
63,618
   
$
-
 
Convertible Senior Notes due 2017
   
345,000
     
387,997
     
-
     
387,997
     
-
 
Convertible Senior Notes due 2020
   
500,000
     
735,075
     
-
     
735,075
     
-
 
Convertible Junior Subordinated Debentures
   
389,522
     
500,201
     
-
     
500,201
     
-
 
Total Debt
 
$
1,296,475
   
$
1,686,891
   
$
-
   
$
1,686,891
   
$
-
 

The fair values of our Senior Notes, Convertible Senior Notes and Debentures were determined using available pricing for these debentures or similar instruments and are considered Level 2 securities.
 
26

Note 9 – Other Comprehensive Income

Our other comprehensive income for the three months ended March 31, 2015 and 2014 was as follows:

   
Three Months Ended March 31, 2015
 
   
Before tax
   
Tax effect
   
Valuation allowance
   
Net of tax
 
   
(In thousands)
 
Other comprehensive income (loss):
               
Change in unrealized gains and losses on investments
 
$
19,721
   
$
(6,876
)
 
$
6,718
   
$
19,563
 
Benefit plan adjustments
   
(700
)
   
245
     
(245
)
   
(700
)
Unrealized foreign currency translation adjustment
   
(3,102
)
   
1,088
     
-
     
(2,014
)
                                 
Other comprehensive income (loss)
 
$
15,919
   
$
(5,543
)
 
$
6,473
   
$
16,849
 
 
   
Three Months Ended March 31, 2014
 
   
Before tax
   
Tax effect
   
Valuation allowance
   
Net of tax
 
   
(In thousands)
 
Other comprehensive income (loss):
               
Change in unrealized gains and losses on investments
 
$
39,661
   
$
(13,871
)
 
$
13,808
   
$
39,598
 
Benefit plan adjustments
   
(1,486
)
   
520
     
(520
)
   
(1,486
)
Unrealized foreign currency translation adjustment
   
1,931
     
(678
)
   
-
     
1,253
 
                                 
Other comprehensive income (loss)
 
$
40,106
   
$
(14,029
)
 
$
13,288
   
$
39,365
 

See Note 11 – “Income Taxes” for a discussion of the valuation allowance.

Total accumulated other comprehensive income and changes in accumulated other comprehensive income, including amounts reclassified from other comprehensive income, are included in the table below.
 
27

   
Three Months Ended March 31, 2015
 
   
Unrealized gains and losses on available-for-sale securities
   
Defined benefit plans
   
Foreign currency translation
   
Total
 
   
(In thousands)
 
                 
Balance at December 31, 2014, before tax
 
$
7,148
   
$
(55,878
)
 
$
7,117
   
$
(41,613
)
                                 
Other comprehensive income (loss) before reclassifications
   
30,955
     
-
     
(3,102
)
 
$
27,853
 
                                 
Amounts reclassified from accumulated other comprehensive income (loss)
   
11,234
(1)
   
700
(2)
   
-
   
$
11,934
 
                                 
Net current period other comprehensive income (loss)
   
19,721
     
(700
)
   
(3,102
)
   
15,919
 
                                 
Balance at March 31, 2015, before tax
 
$
26,869
   
$
(56,578
)
 
$
4,015
   
$
(25,694
)
                                 
Tax effect (3)
   
(64,857
)
   
26,940
     
(881
)
   
(38,798
)
                                 
Balance at March 31, 2015, net of tax
 
$
(37,988
)
 
$
(29,638
)
 
$
3,134
   
$
(64,492
)

   
Three Months Ended March 31, 2014
 
   
Unrealized gains and losses on available-for-sale securities
   
Defined benefit plans
   
Foreign currency translation
   
Total
 
   
(In thousands)
 
                 
Balance at December 31, 2013, before tax
 
$
(84,634
)
 
$
(3,766
)
 
$
11,184
   
$
(77,216
)
                                 
Other comprehensive income (loss) before reclassifications
   
36,672
     
-
     
1,931
     
38,603
 
                                 
Less: Amounts reclassified from accumulated other comprehensive income (loss)
   
(2,989
)(1)
   
1,486
(2)
   
-
     
(1,503
)
                                 
Net current period other comprehensive income (loss)
   
39,661
     
(1,486
)
   
1,931
     
40,106
 
                                 
Balance at March 31, 2015, before tax
 
$
(44,973
)
 
$
(5,252
)
 
$
13,115
   
$
(37,110
)
                                 
Tax effect (3)
   
(64,119
)
   
26,940
     
(4,072
)
   
(41,251
)
                                 
Balance at March 31, 2014, net of tax
 
$
(109,092
)
 
$
21,688
   
$
9,043
   
$
(78,361
)
 
(1) During the three months ended March 31, 2015 and 2014, we realized net investment gains (losses) that at the end of the prior quarter had been classified in net unrealized gains (losses) of $11.2 million and ($3.0) million, respectively. As a result, these amounts were reclassified to the Consolidated Statement of Operations and included in Realized investment gains (losses).
(2) During the three months ended March 31, 2015 and 2014, other comprehensive income related to benefit plans of $0.7 million and $1.5 million was reclassified to the Consolidated Statement of Operations and included in Underwriting and other expenses, net.
(3) Tax effect does not approximate 35% due to amounts of tax benefits not provided in various periods due to our tax valuation allowance.
 
28

Total accumulated other comprehensive income at December 31, 2014 is included in the table below.

   
Unrealized gains and losses on available-for-sale securities
   
Defined benefit plans
   
Foreign currency translation
   
Total
 
   
(In thousands)
 
                 
Balance at December 31, 2014, before tax
 
$
7,148
   
$
(55,878
)
 
$
7,117
   
$
(41,613
)
                                 
Tax effect (1)
   
(64,699
)
   
26,940
     
(1,969
)
   
(39,728
)
                                 
Balance at December 31, 2014, net of tax
 
$
(57,551
)
 
$
(28,938
)
 
$
5,148
   
$
(81,341
)

(1)
Tax effect does not approximate 35% due to amounts of tax benefits not provided in various periods due to our tax valuation allowance.

Note 10 - Benefit Plans

The following table provides the components of net periodic benefit cost for the pension, supplemental executive retirement and other postretirement benefit plans:

   
Three Months Ended March 31,
 
   
Pension and Supplemental Executive Retirement Plans
   
Other Postretirement
Benefits
 
   
2015
   
2014
   
2015
   
2014
 
   
(In thousands)
 
                 
Service cost
 
$
2,448
   
$
2,080
   
$
202
   
$
177
 
Interest cost
   
3,908
     
4,009
     
178
     
183
 
Expected return on plan assets
   
(5,295
)
   
(5,258
)
   
(1,248
)
   
(1,161
)
Recognized net actuarial loss
   
1,209
     
291
     
(35
)
   
(73
)
Amortization of prior service cost
   
(211
)
   
(42
)
   
(1,662
)
   
(1,662
)
                                 
Net periodic benefit cost
 
$
2,059
   
$
1,080
   
$
(2,565
)
 
$
(2,536
)
 
29

We currently intend to make a contribution of $17 million to our qualified pension plan and supplemental executive retirement plan in 2015.

Note 11 – Income Taxes
 
Valuation Allowance
 
We review the need to maintain the deferred tax asset valuation allowance on a quarterly basis. We analyze several factors, among which are the severity and frequency of operating losses, our capacity for the carryback or carryforward of any losses, the existence and current level of taxable operating income, the expected occurrence of future income or loss, the expiration dates of the carryforwards, the cyclical nature of our operating results, and available tax planning strategies. Based on our analysis and the current level of cumulative operating losses, we continue to reduce our benefit from income tax through the recognition of a valuation allowance.

It is reasonably possible that the valuation allowance will be reversed in the foreseeable future. Specifically, if we continue to recognize meaningful levels of sustainable pre-tax income, it is likely that the valuation allowance will be reversed in 2015. In the period in which the valuation allowance is reversed, we would recognize a tax benefit which will increase our earnings for that period. In future years, after the valuation allowance has been reversed and until such time as our net operating loss carryforwards are exhausted or expired, our provision for income tax would substantially exceed the amount of cash tax payments.

The effect of the change in valuation allowance on the provision for income taxes was as follows:

   
Three months ended March 31,
 
   
2015
   
2014
 
   
(In thousands)
 
         
Provision for income tax
 
$
47,883
   
$
23,120
 
Change in valuation allowance
   
(44,498
)
   
(22,394
)
                 
Provision for income taxes
 
$
3,385
   
$
726
 

The change in the valuation allowance that was included in other comprehensive income for the three months ended March 31, 2015 and 2014 was a decrease of $6.5 million and $13.3 million, respectively. The total valuation allowance as of March 31, 2015 and December 31, 2014 was $851.3 million and $902.3 million, respectively.

We have approximately $2.3 billion of net operating loss carryforwards on a regular tax basis and $1.4 billion of net operating loss carryforwards for computing the alternative minimum tax as of March 31, 2015. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2033.

Tax Contingencies

As previously disclosed, the Internal Revenue Service (“IRS”) completed examinations of our federal income tax returns for the years 2000 through 2007 and issued proposed assessments for taxes, interest and penalties related to our treatment of the flow-through income and loss from an investment in a portfolio of residual interests of Real Estate Mortgage Investment Conduits (“REMICs”). The IRS indicated that it did not believe that, for various reasons, we had established sufficient tax basis in the REMIC residual interests to deduct the losses from taxable income. We appealed these assessments within the IRS and in August 2010, we reached a tentative settlement agreement with the IRS which was not finalized.
 
30

On September 10, 2014, we received Notices of Deficiency (commonly referred to as “90 day letters”) covering the 2000-2007 tax years. The Notices of Deficiency reflect taxes and penalties related to the REMIC matters of $197.5 million and at March 31, 2015, there would also be interest related to these matters of approximately $171.9 million. In 2007, we made a payment of $65.2 million to the United States Department of the Treasury which will reduce any amounts we would ultimately owe. The Notices of Deficiency also reflect additional amounts due of $261.4 million, which are primarily associated with the disallowance of the carryback of the 2009 net operating loss to the 2004-2007 tax years. We believe the IRS included the carryback adjustments as a precaution to keep open the statute of limitations on collection of the tax that was refunded when this loss was carried back, and not because the IRS actually intends to disallow the carryback permanently.

We filed a petition with the U.S. Tax Court contesting most of the IRS' proposed adjustments reflected in the Notices of Deficiency and the IRS has filed an answer to our petition which continues to assert their claim. Litigation to resolve our dispute with the IRS could be lengthy and costly in terms of legal fees and related expenses. We can provide no assurance regarding the outcome of any such litigation or whether a compromised settlement with the IRS will ultimately be reached and finalized. Depending on the outcome of this matter, additional state income taxes and state interest may become due when a final resolution is reached. As of March 31, 2015, those state taxes and interest would approximate $47.7 million. In addition, there could also be state tax penalties. Our total amount of unrecognized tax benefits as of March 31, 2015 is $106.4 million, which represents the tax benefits generated by the REMIC portfolio included in our tax returns that we have not taken benefit for in our financial statements, including any related interest. We continue to believe that our previously recorded tax provisions and liabilities are appropriate. However, we would need to make appropriate adjustments, which could be material, to our tax provision and liabilities if our view of the probability of success in this matter changes, and the ultimate resolution of this matter could have a material negative impact on our effective tax rate, results of operations, cash flows, available assets and statutory capital. In this regard, see Note 1 – “Nature of Business – Capital-GSEs.”

 In October 2014, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax returns for the years 2011 and 2012.  The result of the examination had no material effect on the financial statements.

The total amount of the unrecogn