International Operations. We completed the sale of PMI Australia on October 22, 2008 and the sale of PMI Asia on December 17, 2008. The results from PMI Australia and PMI Asia are reported as discontinued operations in our International Operations segment and in the consolidated statement of operations for all periods presented. Losses from the continuing operations of PMI Europe and PMI Canada in our International Operations segment were $87.0 million in 2008 and $35.3 million in 2007.
Financial Guaranty. Our Financial Guaranty segment includes our investment in RAM Holdings Ltd., whose wholly-owned subsidiary, RAM Reinsurance Company, Ltd., or RAM Re, is a financial guaranty reinsurer, and our investment in FGIC Corporation, whose wholly-owned subsidiary, Financial Guaranty Insurance Company (collectively, “FGIC”), is a financial guarantor. Effective December 31, 2008, our wholly-owned surety company, PMI Guaranty Co.’s (“PMI Guaranty”) remaining assets and liabilities were merged into PMI. The results of operations of PMI Guaranty are reported as discontinued operations in our Financial Guaranty segment and in the consolidated statement of operations for all periods presented. Continuing operations in our Financial Guaranty segment generated net losses of $124.0 million in 2008 and $734.8 million in 2007.
net realized investment gains (losses), including the impairment of FGIC and RAM Re and securities within our investment portfolio; and
Geographic Factors-Declining home prices, particularly in California and Florida, and weak economic conditions in California, as well as in Michigan, Indiana, Ohio, and Illinois (the “Auto States”), have negatively affected the development of PMI’s portfolio. PMI’s default rates in California and Florida continued to increase above PMI’s average default rate as of December 31, 2008. The default rate from California as of December 31, 2008 was 24.7 % compared to 10.9% and 3.6% as of December 31, 2007 and 2006, respectively. The default rate from Florida as of December 31, 2008 was 27.8% compared to 10.6% and 3.4% as of December 31, 2007 and 2006, respectively. As of December 31, 2008, risk in force from California and Florida insured loans represented 8.0% and 10.3% of PMI’s primary risk in force, respectively. The default rate of the Auto States as of December 31, 2008 was 15.1% compared to 10.6% and 8.1% as of December 31, 2007 and 2006, respectively. As of December 31, 2008, risk in force from the Auto States represented 13.5% of PMI’s primary risk in force.
During 2008, PMI commuted eight captive reinsurance agreements, with one partial commutation. We recorded cash payments of $32.6 million received from captive trust accounts as a result of captive commutations as a reduction of PMI’s total claims paid, which principally offset previously recorded reinsurance recoverables. Accordingly, there was no significant impact to our results of operations for the current period.
The results of U.S. Mortgage Insurance Operations include the operating results of PMI. CMG MI is accounted for under the equity method of accounting and its results are recorded as equity in earnings from unconsolidated subsidiaries. U.S. Mortgage Insurance Operations’ results are summarized in the table below.
Includes modified pool and other pool risk in force. As of September 30, 2008, we adjusted pool risk in force to reflect the effect of loan repayments on risk limits.
The following table presents PMI’s less-than-A quality, Alt-A, ARM, Above-97, interest only and payment option ARM loans as percentages of primary risk in force:
Income taxes-The effective tax rate of 3.9% for PMI Europe for 2008 was primarily driven by the Irish statutory tax rate of 12.5%. The tax rate of 7.2% for 2007 reflected certain U.S. tax expense derived from PMI Europe earnings that were allocated to the international business segment.
In the first quarter of 2008, we impaired our investment in FGIC, and reduced the carrying value of the investment from $103.6 million to zero. To the extent that our carrying value remains zero, we will not recognize in future periods our proportionate share of FGIC’s losses, if any. Equity in earnings from FGIC could be recognized in the future to the extent those earnings are deemed recoverable.
The results of our Corporate and Other segment include income and operating expenses related to contract underwriting and net investment income, interest expense and corporate overhead of The PMI Group, our holding company. Our Corporate and Other segment results are summarized as follows:
On October 7, 2008, Standard & Poor’s removed The PMI Group and its mortgage insurance subsidiaries, PMI Mortgage Insurance Co., PMI Insurance Co. and PMI Europe, from CreditWatch with Negative Implications. At the same time, Standard & Poor’s affirmed the ratings on all of these companies and revised the outlook to Negative.
Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed recoverable amounts, after considering investment income. In 2008, due to the novation of principally all of PMI Guaranty’s risk in force, we impaired the remaining deferred policy acquisition cost assets related to PMI Guaranty’s operations by $3.6 million reducing its value to zero and impaired $1.2 million of deferred policy acquisition cost assets relating to PMI Europe.
In connection with the preparation of our consolidated financial statements for the quarter ended March 31, 2008, we determined that our investment in FGIC was other-than-temporarily impaired and reduced the carrying value of our investment in FGIC from $103.6 million at December 31, 2007 to zero. To the extent that our carrying value remains zero, we will not recognize in future periods our proportionate share of FGIC’s losses, if any. Equity in earnings from FGIC could be recognized in the future to the extent those earnings are deemed recoverable.
Periodically, or as events dictate, the Company evaluates potential impairment of its investments in unconsolidated subsidiaries. Accounting Principles Board (“APB”) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (“APB No. 18”) provides criteria for determining potential impairment. In the event a loss in value of an investment is determined to be an other-than-temporary decline, an impairment charge would be recognized in the consolidated statement of operations. Evidence of a loss in value that could indicate impairment might include, but would not necessarily be limited to, the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. Realized capital gains or losses resulting from the sale of the Company’s ownership interests of unconsolidated subsidiaries are recognized as net realized investment gains or losses in the consolidated statement of operations.
Revenue Recognition-Mortgage guaranty insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide for payment of premiums on a monthly, annual or single basis. Upon renewal, the Company is not able to re-underwrite or re-price its policies. SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the earning of insurance premiums. Consistent with industry accounting practices, premiums written on a monthly basis are earned as coverage is provided. Monthly premiums accounted for 84.7%, 81.0% and 85.8% of gross premiums written from the Company’s mortgage insurance operations in 2008, 2007, and 2006, respectively. Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage. Primary mortgage
Net Investment Income-Net investment income consists of the following for the years ended December 31:
Realized investment (losses) gains-Net realized investment (losses) gains consist of the following for the years ended December 31:
Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.
PMI Europe’s credit default swap (“CDS”) contracts are valued using internal proprietary models because these instruments are unique, complex, and private and are often highly customized transactions, for which observable market quotes are not regularly available. Due to the lack of observable inputs required to value CDS contracts, they are considered to be Level 3 under the SFAS No. 157 fair value hierarchy. Valuation models and the related assumptions are continuously re-evaluated by management and refined, as appropriate.
The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2008. Level 3 instruments presented in the table, including credit default swaps, and certain fixed income and equity securities, were carried at fair value prior to the adoption of SFAS No. 157.
The components of income tax (benefit) expense from continuing operations for the years ended December 31, 2008, 2007 and 2006 are as follows: