realization of such tax benefits is more likely than not to occur. To the extent our current estimate of future tax benefits to be realized changes, our tax expenses could be affected positively or negatively.
The $24.8 million realized investment loss in 2007 was driven by the other-than-temporary impairment of our investment in RAM Re of $38.5 million. This loss was partially offset by a $12.7 million settlement gain related to the favorable resolution of certain indemnification associated with the sale of our investment in SPS in 2005. The settlement gain reflects the extinguishment of our residual liability associated with SPS. The decline in other income in 2007 was due to unrealized mark-to-market losses of $16.9 million on PMI Europe’s CDS derivative contracts as a result of the significant widening of market spreads. PMI Europe is party to seventeen transactions classified as derivatives.
As of December 31, 2007, 52.2% of PMI’s primary insurance in force and 52.3% of primary risk in force were subject to captive reinsurance agreements compared to 52.9% and 53.2% as of December 31, 2006, and 53.4% and 54.4% as of December 31, 2005. The GSEs recently announced that, effective June 1, 2008, they will prohibit approved mortgage insurers such as PMI from ceding new risk with gross risk or gross premium cedes greater than 25% to captive reinsurers.
The decrease in PMI’s primary default rate as of December 31, 2006 compared to December 31, 2005 was primarily due to a decline in the number of primary loans in default, offset by a decrease in the number of primary insurance policies in force. The decrease in flow loans in default was primarily due to high cure rates associated with approximately 3,500 loans in default from hurricane impacted areas in 2005. Higher concentrations of Alt-A and Above-97s contributed to the increase in structured loans in default as of December 31, 2006 compared to December 31, 2005.
Other underwriting and operating expenses generally consist of all costs that are not attributable to the acquisition of new business and are recorded as expenses when incurred. Other underwriting and operating expenses decreased in 2007 compared to 2006 primarily as a result of lower employee compensation expenses and pension costs as a result of an amendment to our retirement plan. See Item 8. Financial Statements and Supplementary Data-Note 15. Benefit Plans. Other underwriting and operating expenses in 2006 were reduced by a $7.5 million re-allocation of certain costs from U.S. Mortgage Insurance Operations to our Corporate and Other segment as a result of a refinement of our allocation of operating costs between segments.
PMI incurs underwriting expenses related to contract underwriting services for mortgage loans without mortgage insurance coverage. These costs are allocated to PMI Mortgage Services Co., or MSC, which is reported in our Corporate and Other segment, thereby reducing PMI’s underwriting and operating expenses. Contract underwriting expenses allocated to MSC were $13.1 million in 2007 compared to $12.7 million in 2006 and $18.7 million in 2005.
The average USD/AUD currency exchange rates were 0.8389 in 2007, 0.7535 in 2006, and 0.7621 in 2005. Changes in the average USD/AUD currency exchange rates positively impacted PMI Australia’s net income in 2007 by $8.1 million, and the change in the average USD/AUD currency exchange rates from 2005 to 2006 negatively impacted PMI Australia’s net income by $1.0 million in 2006. Net income from PMI Australia in 2007, 2006 and 2005 includes pre-tax foreign currency put option costs of $1.2 million, $1.2 million, and $1.6 million, respectively.
Losses and LAE-PMI Europe’s losses and LAE includes claim payments and changes in reserves during the applicable period with respect to mortgage insurance in force and credit default swaps accounted for as insurance. Claim payments (excluding payments for CDS accounted as derivatives) totaled $5.1 million in 2007 compared to $1.9 million in 2006, and $1.0 million in 2005. We increased PMI Europe’s loss reserves by $23.7 million in 2007 primarily due to a loss provision related to the deteriorating performance of a small number of U.S. exposures on which PMI Europe provided reinsurance coverage, and higher delinquencies associated with certain credit default swaps accounted for as insurance and PMI Europe’s Italian primary mortgage insurance
The rating agencies have assigned the following ratings to The PMI Group and certain of its affiliates and its equity investee subsidiaries:
In October 2007, Fitch downgraded its debt ratings of The PMI Group to “A” from “A+”, and the debt ratings of PMI Capital I to “A-” from “A”. Fitch affirmed its “AA” insurer financial strength ratings of PMI Mortgage Insurance Co., PMI Insurance Co., PMI Australia, PMI Europe and PMI Guaranty Co. Fitch also revised the Rating Outlook on all ratings to Negative from Stable. Also, in October, Fitch affirmed its “AA” insurer financial rating for CMG MI with a Rating Outlook of Stable.
Other-Than-Temporary Impairment-We have a committee review process for all securities in our investment portfolio, including a review for impairment losses. Factors considered when assessing impairment include:
Equity in earnings from RAM Re was $4.5 million in 2007 compared to $8.7 million in 2006. This decrease was due primarily to unrealized mark-to-market losses of $28.4 million on its credit derivative portfolio as a result of widening credit spreads partially offset by higher premiums earned and net investment income. As we report our equity in earnings/losses from RAM Re on a one quarter lag, our 23.7% share of RAM Re’s fourth quarter 2007 results will be reflected in our consolidated financial results in the first quarter of 2008. Due to, among other things, the continuing deterioration of the credit market, rating agency actions and the decline in RAM Re’s share price, in the fourth quarter of 2007 we realized an other-than-temporary impairment of our investment in RAM Re of $38.5 million. This impairment charge was based on the difference between our investment balance in RAM Re as of December 31, 2007 (before the impairment) and our share of RAM Re’s market value as of September 30, 2007 (due to our one quarter accounting lag). After impairment, the carrying value of our investment in RAM Re as of December 31, 2007 was $60.0 million. We do not expect RAM Re’s fourth quarter of 2007 to be profitable. We expect the carrying value of our investment in RAM Re to be further reduced in the first quarter of 2008 as a result of RAM Re’s losses and/or further impairment by us of our investment. We will continue to evaluate this investment for possible future impairment.
Investments in Unconsolidated Subsidiaries-Investments in the Company’s unconsolidated subsidiaries include both equity investees and other unconsolidated subsidiaries. Investments in equity investees with ownership interests of 20-50% are generally accounted for using the equity method of accounting, and investments of less than 20% ownership interest are generally accounted for using the cost method of accounting if the Company does not have significant influence over the entity. Limited partnerships with ownership interests greater than 3% but less than 50% are primarily accounted for using the equity method of accounting. The Company reports the equity in earnings from FGIC and CMG MI on a current month basis, and RAM Re and the Company’s interest in limited partnerships on a one-quarter lag basis. The carrying value of the investments in the Company’s unconsolidated subsidiaries also includes the Company’s share of net unrealized gains and losses in the unconsolidated subsidiaries’ investment portfolios.
coverage to 25% for any single risk. The Company’s reinsurance agreements typically provide for a recovery of a proportionate level of claim expenses from reinsurers, and a reinsurance receivable is recorded as an asset based on the type of reinsurance coverage. The Company remains liable to its policyholders if the reinsurers are unable to satisfy their obligations under the agreements. Reinsurance recoverables on loss estimates are based on the Company’s actuarial analysis of the applicable business. Amounts the Company will ultimately recover could differ materially from amounts recorded as reinsurance recoverables. Reinsurance transactions are recorded in accordance with the accounting guidance provided in SFAS No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. Accordingly, management assesses, among other factors, risk transfer criteria for all reinsurance arrangements.
In 2007, the Company contributed $10 million to its Retirement Plan. The benefit costs for 2007 decreased from 2006 primarily due to the settlement charges in 2006 and the amendment to the Retirement Plan in May 2007 (discussed above). The amendment reduced the Plan’s projected benefit obligation by $11.8 million and the reduction was recorded as an adjustment to accumulated other comprehensive income on the Company’s consolidated balance sheet. The adjustment will be amortized through other underwriting and operating expenses over time.