PMI’s increases in primary NIW in 2003 and 2002 were driven by higher volumes of residential mortgage originations and refinance activities due to the historically low interest rate environment. As estimated by Mortgage Bankers Association of America, total U.S. residential mortgage originations were $3.4 trillion in 2003, $2.5 trillion in 2002 and $2.1 trillion in 2001.
The following table presents PMI’s less-than-A quality loans and non-traditional loans as percentages of its flow channel and bulk channel primary NIW and modified pool insurance written.
Nearly all of the modified pool insurance written classified as non-traditional received such classification as a result of the reduced documentation for the underlying loans and not as a result of any particular credit characteristic. The following table presents PMI’s less-than-A quality loans, non-traditional loans or both as percentages of primary risk in force.
The reported results of PMI Europe were favorably affected by the appreciation of the Euro in 2003. The average USD/Euro currency exchange rate was 1.1329 for 2003 and 0.9461 for 2002 and to 0.8961 for 2001.
In addition to Arizona, other states may limit or restrict PMI’s ability to pay shareholder dividends. For example, California and New York prohibit mortgage insurers from declaring dividends except from undivided profits remaining above the aggregate of their paid-in capital, paid-in surplus and contingency reserves. During 2003, with the approval of the Arizona Department of Insurance, PMI paid aggregate cash dividends of $100 million to The PMI Group. Under Arizona law, PMI would be able to pay dividends of approximately $51.9 million in 2004 without the prior permission of the Arizona Department of Insurance. During 2003, Residential Guaranty Co., one of our Arizona-domiciled insurance subsidiaries, paid approximately $8.4 million of dividends to The PMI Group, which it was able to do without prior permission from the Arizona Department of Insurance.
On a consolidated basis, our principal sources of funds are cash flows generated by our insurance subsidiaries, investment income derived from our investment portfolios and debt and equity financings by The PMI Group as described above. It is one of the goals of our cash management policy to ensure that we have sufficient funds on hand to pay these obligations when they are due. We believe that we have sufficient cash to meet these and other of our short- and medium-term obligations.
The $3.6 million, $85.2 million and $143.1 million reductions in 2003, 2002 and 2001 over prior years, respectively, were due to re-estimations of ultimate loss rates from those established at the original notice of default, updated through the period presented. These re-estimations of ultimate loss rates are the result of management’s periodic review of estimated claim amounts in light of actual claim amounts, loss development data or ultimate claim rates. The $3.6 million reduction in prior years’ reserves during 2003 was due primarily to (i) our reallocation of reserves predominantly between the accident years 2002 and 2001 and (ii) favorable PMI pool portfolio loss development trends. The $85.2 million and $143.1 million total reductions in prior years’ reserves during 2002 and 2001, respectively, were due primarily to more favorable loss trends than expected
The $15.4 million reduction in losses and LAE incurred relating to prior years in 2003 was primarily due to the reduction in PMI Australia’s loss reserves in the third quarter of 2003.
We are a holding company and conduct all of our business operations through our subsidiaries. Our principal sources of funds are dividends from our subsidiaries, investment income and funds that may be raised from time to time in the capital markets. Factors that may affect our ability to maintain and meet our capital and liquidity needs as well as to pay dividends to our shareholders include: the level and severity of claims experienced by our insurance subsidiaries; the performance of the financial markets; standards and factors used by various credit rating agencies; financial covenants in our credit agreements; and standards imposed by state insurance regulators relating to the payment of dividends by insurance companies.
Investigations by regulatory agencies into Fairbanks’ activities and private litigation involving Fairbanks could harm Fairbanks’ business and adversely affect our investment in Fairbanks.
If the FTC initiates an action against us relating to the activities of Fairbanks, our business could suffer.
The Company establishes loss reserves to recognize the liability of unpaid losses related to insured mortgages that are in default. These loss reserves are based upon our estimates of the claim rate and average claim amounts, as well as the estimated costs of settling claims. These estimates are regularly reviewed and updated using currently available information. Any adjustments due to positive or adverse developments, which may be material, resulting from these reviews would impact current reserve requirements. Our reserves may not be adequate to cover ultimate loss development on incurred defaults. Our consolidated financial condition, results of operations or cash flows could be seriously harmed if our reserve estimates are insufficient to cover the actual related claims paid and loss-related expenses incurred.
The fair value of stock-based compensation to employees is calculated using an option pricing model developed to estimate the fair value of freely tradable and fully transferable options without vesting restrictions, which differ from the Company’s stock option program. The model also requires considerable judgment, including assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated value.
SFAS No. 123 requires pro forma disclosure of net income and earnings per share using the fair value method. If the computed fair values of the awards had been amortized to expense over the vesting period of the awards, the Company’s consolidated net income, basic net income per share and diluted net income per share would have been reduced to the pro forma amounts indicated below:
Foreign Currency Translation-The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with SFAS No. 52, Foreign Currency Translation. Assets and liabilities denominated in non-U.S. dollar currencies are translated into U.S. dollar equivalents using either the year-end spot exchange rates or historical rates. Revenues and expenses are translated at weighted-average exchange rates. Gains and losses on currency re-measurement incurred by PMI Australia and PMI Europe represent the revaluation of assets and liabilities denominated in non-functional currencies into the functional currency, the Australian dollar and Euro, respectively. The effects of translating operations with a functional currency other than the reporting currency are reported as a component of accumulated other comprehensive income included in consolidated shareholders’ equity.
Deferred policy acquisition costs are affected by qualifying costs that are deferred in the period, and amortization of previously deferred costs in such period. In periods where there is growth in new business, the asset will generally increase because the amount of acquisition costs being deferred exceeds amortization expenses. Included in 2001 policy acquisition costs incurred and deferred was $4.5 million of deferred costs from the acquisition of PMI Indemnity Limited.
Leases-The Company leases certain office space and office equipment. Minimum rental payments under non-cancelable operating leases in the aggregate and the obligation recorded under capital leases for the five years subsequent to 2003 are as follows:
Included in the results of International Operations are the results of the Australian, European, and Hong Kong operations. The Company commenced operations in Europe in February 2001. The Company began to report its foreign subsidiaries on the same calendar month as U.S. Operations in 2001, therefore the Australian operating results for 2001 reflected thirteen months of activity. The Australian results for 2001 also include four months of PMI Indemnity Limited’s operations.
The following condensed financial statement information represents the Company’s proportionate share and has been presented on a combined basis for all equity investee and unconsolidated majority owned subsidiary accounted for under the equity method as of and for the years ended December 31, 2003 and 2002.