We own our headquarters facility and an additional office/warehouse facility, both located in Milwaukee, Wisconsin, which contain an aggregate of approximately 310,000 square feet of space.
Includes dilutive shares in years with net income. See Note 3 - "Summary of Significant Accounting Policies" to our consolidated financial statements in Item 8 for a discussion of our Earnings Per Share.
As discussed in Note 8 - "Debt" to our consolidated financial statements in Item 8, our 5.375% Senior Notes matured on November 1, 2015 and were repaid with cash at our holding company.
As used below, “we” and “our” refer to MGIC Investment Corporation’s consolidated operations. In the discussion below, we refer to Fannie Mae and Freddie Mac collectively as the “GSEs.”
As a provider of mortgage insurance, our results are subject to macroeconomic conditions and specific events that impact the mortgage origination environment and the credit performance of the underlying insured mortgages. During 2015, the residential mortgage market experienced an increase in mortgage loan originations driven by two factors: (1) an increase in purchase volume that was favorably impacted by increasing household formations and continued recovery in the labor market, and (2) an increase in refinance transactions especially in the first half of 2015, as interest rates remained near historical lows and nationally home prices continued to appreciate. These favorable conditions resulted in a 6% increase in our insurance in force at the end of 2015 compared to 2014 and we wrote our highest annual level of new insurance since 2008. We consider the new insurance written to generally be of high quality as lenders maintained stringent underwriting standards, a trend that has been in place since 2009. Our recent loss results reflect the improved lending environment as the level of losses on our 2009-2014 books remain low, and also reflect positive trends on our pre-2009 business regarding new delinquency notices, paid claims, and the declining delinquent inventory.
While macroeconomic conditions were favorable for our business in 2015, we remain subject to competition from other private mortgage insurers, the FHA and VA, and significant regulatory oversight, both of which have implications on our ability to operate in the mortgage insurance industry. As of December 31, 2015 private mortgage insurers became subject to the revised private mortgage insurer eligibility requirements (the "PMIERs") of the GSEs which contain compliance, reporting, and financial requirements that impact our business. Of the various changes required under PMIERs, the financial requirements have the most fundamental impact on us. For example, decisions made in 2015 regarding our reinsurance structure and capital allocations among our subsidiary companies were influenced by the financial requirements of PMIERs. The competitive landscape remains intense and we have seen: (1) continued demands for lender-paid single premium policies, which include discounts from our published rate card, (2) a decrease in premium rates offered by the FHA, and (3) adjustments by our competition to borrower-paid mortgage premium rates.
force and increasing the industry's market share is difficult under these conditions, but we expect a modest increase in our insurance in force in 2016. In consideration of the PMIER's financial requirements and the competitive landscape, we are revising our premium rates on both borrower-paid and lender-paid premium plans. Across the spectrum of loans we insure the revised rates will include both increases and decreases to previously published rate cards and we expect to achieve life-time after tax returns on required PMIERs capital in the mid-teens, after considering reinsurance. The revised rate structure is likely to result in a reduction of new insurance written in some lower FICO score segments and overall we expect to write modestly less new business in 2016 compared to 2015. While the premium rate changes will not have a significant impact on premium yields on new insurance written, our premium yields are expected to decline due to a number of other factors, including: a reduction in the profit commission from our reinsurance transaction as more losses are ceded to reinsurers as expected losses on covered books are anticipated to increase, a modest overall increase in the amount of our insurance in force subject to reinsurance, lower premium rates on books written in 2013 and after, and the effect of premium rate resets on our 2005 and 2006 remaining insurance in force. Recent loss trends have resulted in a declining level of new delinquency notices, losses paid, and delinquent notice inventory. We expect these trends to continue in 2016. However, we have experienced significant favorable loss development over the past two years, which may not continue in 2016.
Substantially all of our insurance written since 2008 has been for loans purchased by the GSEs. The GSEs each revised its PMIERs effective December 31, 2015. The financial requirements of the PMIERs require a mortgage insurer’s “Available Assets” (generally only the most liquid assets of an insurer) to equal or exceed its “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).
The GSEs may reduce the amount of credit they allow under the PMIERs for the risk ceded under our quota share reinsurance transaction. The GSEs’ ongoing approval of that transaction is subject to several conditions and the transaction will be reviewed under the PMIERs at least annually by the GSEs. For more information about the transaction, see our risk factor titled “The mix of business we write affects the likelihood of losses occurring, our Minimum Required Assets under the PMIERs, and our premium yields” in Item 1A.
At December 31, 2015, MGIC’s risk-to-capital ratio was 12.1 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements, and its policyholder position was $1.2 billion above the required MPP of $1.1 billion. In calculating our risk-to-capital ratio and MPP, we are allowed full credit for the risk ceded under our reinsurance transaction with a group of unaffiliated reinsurers. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the PMIERs, MGIC may terminate the reinsurance agreement, without penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, you should read our risk factors for information about matters that could negatively affect such compliance.
At December 31, 2015, the risk-to-capital ratio of our combined insurance operations (which includes reinsurance affiliates) was 13.6 to 1. Reinsurance transactions with affiliates permit MGIC to write insurance with a higher coverage percentage than it could on its own under certain state-specific requirements. A higher risk-to-capital ratio on a combined basis may indicate that, in order for MGIC to continue to utilize reinsurance arrangements with its affiliates, additional capital contributions to the reinsurance affiliates could be needed.
The Federal Housing Finance Agency (“FHFA”) is the conservator of the GSEs and has the authority to control and direct their operations. The increased role that the federal government has assumed in the residential housing finance system through the GSE conservatorship may increase the likelihood that the business practices of the GSEs change in ways that have a material adverse effect on us and that the charters of the GSEs are changed by new federal legislation. The financial reform legislation that was passed in July 2010 (the “Dodd-Frank Act” or “Dodd-Frank”) required the U.S. Department of the Treasury to report its recommendations regarding options for ending the conservatorship of the GSEs. This report did not provide any definitive timeline for GSE reform; however, it did recommend using a combination of federal housing policy changes to wind down the GSEs, shrink the government’s footprint in housing finance (including FHA insurance), and help bring private capital back to the mortgage market. Since then, members of Congress introduced several bills intended to change the business practices of the GSEs and the FHA; however, no legislation has been enacted. As a result of the matters referred to above, it is uncertain what role the GSEs, FHA and private capital, including private mortgage insurance, will play in the residential housing finance system in the future or the impact of any such changes on our business. In addition, the timing of the impact of any resulting changes on our business is uncertain. Most meaningful changes would require Congressional action to implement and it is difficult to estimate when Congressional action would be final and how long any associated phase-in period may last.
Dodd-Frank requires lenders to consider a borrower’s ability to repay a home loan before extending credit. The Consumer Financial Protection Bureau (“CFPB”) rule defining “Qualified Mortgage” (“QM”) for purposes of implementing the “ability to repay” law became effective in January 2014 and included a temporary category of QMs for mortgages that satisfy the general product feature requirements of QMs and meet the GSEs’ underwriting requirements (the “temporary category”). The temporary category will phase out when the GSEs’ conservatorship ends, or if sooner, on January 21, 2021.
Dodd-Frank requires a securitizer to retain at least 5% of the risk associated with mortgage loans that are securitized, and in some cases the retained risk may be allocated between the securitizer and the lender that originated the loan. The final rule implementing that requirement became effective on December 24, 2015 for asset-backed securities collateralized by residential mortgages. The final rule exempts securitizations of qualified residential mortgages (“QRMs”) from the risk retention requirement and generally aligns the QRM definition with that of QM. Because there is a temporary category of QMs for mortgages that satisfy the general product feature requirements of QMs and meet the GSEs’ underwriting requirements, lenders that originate loans that are sold to the GSEs while they are in conservatorship would not be required to retain risk associated with those loans. The final
One loan modification program is the Home Affordable Modification Program (“HAMP”). We are aware of approximately 5,065 loans in our primary delinquent inventory at December 31, 2015 for which the HAMP trial period has begun and which trial periods have not been reported to us as completed or cancelled. Through December 31, 2015, approximately 62,500 primary loans that we continue to insure have cured their delinquency after entering HAMP and are not in default. The interest rates on certain loans modified under HAMP are subject to adjustment five years after the modification date. Such adjustments are limited to an increase of one percentage point per year.
As shown in the following table, as of December 31, 2015 approximately 23% of our primary risk in force has been modified:
Over the past several years, the average time it takes to receive a claim associated with a defaulted loan has increased. This is, in part, due to new loss mitigation protocols established by servicers and to changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation processes. Unless a loan is cured during a foreclosure delay, at the completion of the foreclosure, additional interest and expenses may be due to the lender from the borrower. In some circumstances, our paid claim amount may include some additional interest and expenses.
New insurance written, which increases insurance in force, and is the aggregate principal amount of the mortgages that are insured during a period. Many factors affect new insurance written, including the volume of low down payment home mortgage originations and competition to provide credit enhancement on those mortgages, including competition from the FHA, the VA, other mortgage insurers, GSE programs that may reduce or eliminate the demand for mortgage insurance and other alternatives to mortgage insurance. New insurance written does not include loans previously insured by us which are modified, such as loans modified under HARP.
Cancellations, which reduce insurance in force. Cancellations due to refinancings are affected by the level of current mortgage interest rates compared to the mortgage coupon rates throughout the in force book. Cancellations due to refinancings are also affected by current home values compared to values when the loans in the in force book became insured and the terms on which mortgage credit is available. Cancellations also include rescissions, which require us to return any premiums received related to the rescinded policy, and policies cancelled due to claim payment, which require us to return any premium received from the date of default. Finally, cancellations are affected by home price appreciation, which can give homeowners the right to cancel the mortgage insurance on their loans.
Our investment portfolio is composed principally of investment grade fixed maturity securities. The principal factors that influence investment income are the size of the portfolio and its yield. As measured by amortized cost (which excludes changes in fair value, such as from changes in interest rates), the size of the investment portfolio is mainly a function of cash generated from (or used in) operations, such as net premiums received, investment income, net claim payments and expenses, and cash provided by (or used for) non-operating activities, such as debt or stock issuances or repurchases. From time to time we may elect to sell securities to realize gains on securities that are trading above our cost basis. Realized gains and losses are a function of the difference between the amount received on the sale of a security and the security’s amortized cost, as well as any other than temporary impairments ("OTTI") recognized in earnings. The amount received on the sale of fixed maturity securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale.
Losses ceded under reinsurance agreements. See Note 11 - “Reinsurance” to our consolidated financial statements in Item 8 for a discussion of our reinsurance agreements.
Each quarter, we evaluate whether a premium deficiency reserve on the remaining Wall Street bulk insurance in force is required. When a premium deficiency reserve is required, we re-estimate the reserve quarterly and changes in the reserve from quarter to quarter are a result of two factors. First, it changes as the actual premiums, losses and expenses that were previously estimated are recognized. Each period such items are reflected in our financial statements as earned premium, losses incurred and expenses. The difference between the amount and timing of actual earned premiums, losses incurred and expenses and our previous estimates used to establish the premium deficiency reserve has an effect (either positive or negative) on that period’s results. Second, the premium deficiency reserve changes as our assumptions relating to the present value of expected future premiums, losses and expenses on the remaining Wall Street bulk insurance in force change. Changes to these assumptions also have an effect on that period’s results.
The majority of our operating expenses are fixed, with some variability due to contract underwriting volume. Contract underwriting generates fee income included in “Other revenue.” Underwriting and other expenses are net of any ceding commission associated with our reinsurance agreements. See Note 11 - “Reinsurance” to our consolidated financial statements in Item 8 for a discussion of our reinsurance agreements.
Interest expense reflects the interest associated with our outstanding debt obligations. For information about our outstanding debt obligations, see Note 8 - “Debt” to our consolidated financial statements in Item 8 and under “Liquidity and Capital Resources” below.
In our industry, a “book” is the group of loans insured in a particular calendar year. In general, the majority of any underwriting profit (premium revenue minus losses) that a book generates occurs in the early years of the book, with the largest portion of any underwriting profit realized in the first year following the year the book was written. Subsequent years of a book generally result in modest underwriting profit or underwriting losses. This pattern of results typically occurs because relatively few of the claims that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments), and increasing losses.
We began writing business in Australia in June 2007. We stopped writing new business in Australia in 2008 and in the fourth quarter of 2015 we settled all of our remaining risk in force. As of December 31, 2015 the equity value in our Australian operations was approximately $38 million.
Our results of operations for 2015 were principally affected by the factors referred to below.
Net premiums written and earned during 2015 increased when compared to 2014. The increase was attributable to a commutation of our 2013 quota share reinsurance agreement ("2013 QSR Transaction") and higher average insurance in force. The reinsurance commutation resulted in a return to us of written premiums previously ceded to reinsurers and an increase in our profit commission due to a related return of ceding commissions to the reinsurers.
Interest expense for 2015 decreased when compared to 2014. The decrease in interest expense was due to the maturity of our Senior Notes on November 1, 2015, which were repaid with holding company cash.
The increase in new insurance written in 2015 compared to 2014 was primarily attributable to an increase in mortgage originations overall, which increased the volume of originations with private mortgage insurance. Although private mortgage insurance volume increased from the prior year, the penetration rate of private mortgage insurance declined as the FHA recaptured market share due to a 2015 premium rate reduction. Purchase mortgage origination volume was the largest driver of our higher new insurance written in 2015 compared to 2014, while robust refinancing activity in the first half of 2015 also increased our overall volume. The increase in mortgage origination volume can largely be attributed to low mortgage interest rates and decreased levels of unemployment.
The PMIERs require more Minimum Required Assets be maintained by a private mortgage insurer for loans dated on or after January 1, 2016, that are insured under lender-paid mortgage insurance policies or other policies that are not subject to automatic termination under the Homeowners Protection Act (“HPA”) or an automatic termination consistent with the HPA termination requirements for borrower-paid mortgage insurance. This requirement may reduce our future returns because we will be required to maintain more Available Assets in connection with a portion of our business.
In January 2016, we announced our intention to revise our premium rate cards in the near future. We expect that this will result in a decrease in premium rates on some higher-FICO loans and an increase in premium rates on some lower-FICO loans. If we do not revise our premium rates in this manner, we believe lenders may select our competitors to insure higher-FICO loans because, in many cases, they currently offer lower premiums rates for those loans and lenders may select MGIC to insure lower-FICO loans because, in many cases, we currently offer lower rates for those loans. We expect that our premium rate changes will modestly decrease our new insurance written; however, we expect the premium yield on new insurance written to remain approximately the same as on 2015 new insurance written, and our returns on a portfolio basis to be comparable to those we expect to earn on the business we wrote in 2015.
The FHA increased its share of the low down payment residential mortgages that were subject to FHA, VA or primary private mortgage insurance 40.1% in 2015 from 33.9% in 2014. In the past ten years, the FHA’s share has been as low as 15.5% in 2006 and as high as 70.8% in 2009. Factors that influence the FHA’s market share include relative rates and fees, underwriting guidelines and loan limits of the FHA, VA, private mortgage insurers and the GSEs; flexibility for the FHA to establish new products as a result of federal legislation and programs; returns obtained by lenders for Ginnie Mae securitization of FHA-insured loans compared to those obtained from selling loans to Fannie Mae or Freddie Mac for securitization; and differences in policy terms, such as the ability of a borrower to cancel insurance coverage under certain circumstances. We cannot predict how these factors or the FHA’s share of new insurance written will change in the future.
In 2015, the VA accounted for 24.8% of all low down payment residential mortgages that were subject to FHA, VA or primary private mortgage insurance, down from down from 25.4% in 2014 (which had been its highest annual market share in ten years). The VA’s lowest market share in the past ten years was 5.4% in 2007. We believe that the VA’s market share has generally been increasing because the VA offers 100% LTV loans and charges a one-time funding fee that can be included in the loan amount but no additional monthly expense, and because of an increase in the number of borrowers that are eligible for the VA’s program.
We monitor the competitive landscape and will make adjustments to our pricing and underwriting guidelines as warranted. We also make exceptions to our underwriting requirements on a loan-by-loan basis and for certain customer programs. Together, the number of loans for which exceptions were made accounted for fewer than 2% of the loans we insured in 2014 and 2015.
New insurance written and cancellations of primary insurance in force during the years ended December 31, 2015, 2014 and 2013 were as follows:
Net premiums written and earned during 2014 decreased when compared to 2013. The decrease was primarily due to an increase in premiums ceded under reinsurance agreements, offset, in part, by an increase in profit commissions. The increase in premiums ceded and profit commissions in 2014 was due to an addendum entered into in December 2013 for our 2013 QSR Transaction that expanded the applicable coverage to insurance written prior to April 1, 2013 that had never been delinquent. The profit commission was subject to the performance of the policies under the 2013 QSR Transaction. See “Reinsurance agreements” below.
Although we expect that our insurance in force will increase in 2016 compared to 2015, net premiums written and earned as well as the ratio of net premiums earned divided by the average primary insurance in force outstanding for the year or other reporting period (sometimes referred to as “premium rate/yield” or “effective premium rate/yield”) are likely to decline in 2016 from 2015 levels. As discussed below, we see this occurring for two reasons. The largest portion of the decline relates to the restructuring of our reinsurance transaction because it will cover insurance in force that was previously excluded, as well as certain new insurance written through 2016. A modest amount of the decline relates to the premium rates themselves: the books we wrote before 2009, which have a higher average premium rate than subsequent business, are expected to continue to decline as a percentage of the insurance in force; and the average premium rate on these books is also expected to decline as the premium rates reset to lower levels at the time the loans reach the ten-year anniversary of their initial coverage date.
The insurance in force associated with the 2008 and prior book years was approximately 37% and 46% of the primary insurance in force as of December 31, 2015 and 2014, respectively. The business written after 2008 has a lower average premium rate because of its lower risk characteristics and, beginning in the second half of 2014, the increase in the business mix represented by lender-paid single premium business, which had a lower average premium rate than borrower-paid monthly premium business (see “New insurance written” above). Persistency will affect the average premium rate on single premium policies because the premium is not generally refundable and is earned over the estimated life of the policy. If a single premium policy is cancelled, because the loan is repaid, the remaining unearned premium is earned immediately. When persistency is lower than the assumption used to set the estimated life, the average premium rate will increase; the opposite effect will occur when persistency is greater than such assumption.
The effects described above result in a net cost of the reinsurance, with respect to a covered loan, of 6% (but can be lower if losses are materially higher than we expect). This cost is derived by dividing the reduction in our pre-tax net income from such loans with reinsurance by our direct (that is, without reinsurance) premiums from such loan. Although the net cost of the reinsurance is generally constant at 6%, the effect of the reinsurance on the various components of pre-tax income discussed above will vary from period to period, depending on the level of ceded losses. The 2015 QSR Transaction had the effect of reducing our premium yield in the fourth quarter of 2015 and this trend is expected to continue into 2016, in part due to an increase in the amount of
losses ceded, which reduces our profit commission. Because more of our insurance in force is covered under the 2015 QSR Transaction than was covered under the commuted 2013 QSR Transaction, the absolute dollar cost of the 2015 QSR Transaction will be modestly higher than the cost of the 2013 QSR Transaction.
The following table provides additional information related to our premiums written and earned and risk in force subject to reinsurance agreements for 2015, 2014, and 2013.
(1) As discussed in Note 11 - "Reinsurance" to our consolidated financial statements in Item 8, the 2013 QSR Transaction was terminated on July 1, 2015 and replaced with our 2015 QSR Transaction, which increased the insurance in force and corresponding risk in force covered by reinsurance. Premiums are ceded on an earned and received basis under the 2015 QSR Transaction.
Net investment income in 2015 increased when compared to 2014. The increase in investment income was due to higher investment yields attributable to an increase in duration driven by our increased allocation to municipal fixed maturity securities.
Net realized gains for 2015 of $28.4 million were driven by sales of fixed maturity securities in the first quarter to realize gains under favorable market conditions. As of December 31, 2015, the net unrealized losses in our investment portfolio were $26.6 million, which included $67.8 million of gross unrealized losses, partially offset by $41.3 million of gross unrealized gains.
Estimation of losses is inherently judgmental. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment and the current and future strength of local housing markets. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrower income and thus their ability to make mortgage payments, and a drop in housing values, that could result in, among other things, greater losses on loans, and may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Our estimates are also affected by any agreements we enter into regarding our claims paying practices, such as the settlement agreements discussed in Note 20 - “Litigation and Contingencies” to our consolidated financial statements in Item 8. Changes to our estimates could result in a material impact to our results of operations and capital position, even in a stable economic environment.
In 2015, net losses incurred were $344 million, reflecting $454 million of current year loss development partially offset by $110 million of favorable prior years’ loss development. In 2014, net losses incurred were $496 million, reflecting $596 million of current year loss development offset by $100 million of favorable prior years’ loss development. In 2013, net losses incurred were $839 million, reflecting of $899 million of current year loss development offset by $60 million of favorable prior years’ loss development.
they judged to have higher credit quality. We also understand that the GSEs terminated their “doc waiver” programs, with respect to new commitments, in the second half of 2008.
The primary average claim paid for the top 5 jurisdictions (based on 2015 paid claims) for the years ended December 31, 2015, 2014 and 2013 appears in the table below.
The primary average loan size of our insurance in force at December 31, 2015, 2014 and 2013 appears in the table below.
In this report we classify loans without complete documentation as "reduced documentation" loans regardless of FICO credit score rather than as prime, "A-" or "subprime" loans; in the table above, such loans appear only in the reduced documentation category and they do not appear in any of the other categories.
2013 includes $105 million associated with the implementation of the Countrywide settlement as discussed in Note 20 - "Litigation and Contingencies" to our consolidated financial statements in Item 8.
The primary default inventory for the top 15 jurisdictions (based on 2015 paid claims) at December 31, 2015, 2014 and 2013 appears in the table below.
Our results of operations continue to be negatively impacted by the mortgage insurance we wrote during 2005 through 2008. Although uncertainty remains with respect to the ultimate losses we may experience on these books of business, as we continue to write new insurance on high-quality mortgages, those books have become a smaller percentage of our total portfolio, and we expect this trend to continue. Our 2005 through 2008 books of business represented approximately 32% and 40% of our total primary risk in force at December 31, 2015 and 2014, respectively. Approximately 36% of the remaining primary risk in force on our 2005-2008 books of business benefited from HARP as of December 31, 2015, compared to 33% as of December 31, 2014.
Beginning in 2007, when we stopped writing Wall Street bulk business, we began to separately measure the performance of these transactions and established a premium deficiency reserve related to this business. The premium deficiency reserve reflected the present value of expected future losses and expenses that exceeded the present value of expected future premiums and already established loss reserves. There was no premium deficiency reserve required as of December 31, 2015. The premium deficiency reserve as of December 31, 2014 and 2013 was $24 million and $48 million, respectively.
Interest expense for 2015 decreased when compared to 2014. The decrease was due to the maturity of our senior notes on November 1, 2015, which were repaid with holding company cash on hand.
Net investment income was $103.7 million in 2015, an increase of 18.4% from $87.6 million in 2014.
Interest rates were in a state of flux during 2015 as market participants digested data showing slowing global growth and sought greater clarity on the Federal Open Market Committee's ("FOMC") positions on employment, inflation, and U.S. growth when considering their timing of federal fund rate changes. Although the FOMC has indicated that as many as four interest rate increases may occur in 2016, we anticipate that interest rates may remain below historical averages for an extended period of time and that financial markets will continue to have periods of elevated volatility. We seek to manage our exposure to interest rate risk and volatility by maintaining a diverse mix of high quality securities that have an intermediate duration profile.
The composition of our fixed maturity security ratings, based on fair value, at December 31, 2015, 2014 and 2013 are shown in the chart below.
During 2015, we reversed the valuation allowance that had been recorded against our deferred tax assets since 2009. The reversal of the valuation allowance was based on analysis that it was more likely than not that our deferred tax assets would be fully realizable as more fully described in Note 14 - "Income Taxes" to our consolidated financial statements in Item 8. The recognition of our net deferred tax assets as of December 31, 2015 is reflected on our consolidated balance sheet in the amount of $762.1 million. A substantial portion of our deferred tax assets are the result of net operating losses experienced in prior years that we expect to realize in future periods.
We continue to have unresolved tax matters primarily related to reviews of our 2000-2007 federal income tax returns by the Internal Revenue Service ("IRS"). The outcome of any litigation or settlement with the IRS on these matters, including timing and amounts that may be ultimately owed, is uncertain. Our consolidated financial statements reflect our estimates of the tax contingencies discussed more fully in Note 14 - "Income Taxes" to our consolidated financial statements in Item 8.
Our largest source of cash is from premiums received from our insurance policies, which we receive on a monthly installment basis for most policies. Premiums are received at the beginning of the coverage period for single premium and annual premium policies. Our largest cash outflow is for claims that arise when a default results in an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest. We also use cash to pay for our ongoing expenses such as salaries, debt interest, and rent. We also utilize reinsurance to manage the risk we take on our mortgage guaranty policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid.
The change in net cash from operating activities in 2015 compared to 2014 was primarily due to a lower level of losses paid and the result of commuting our 2013 QSR Transaction. Upon final settlement of the 2013 QSR Transaction, we received return payment for written premiums previously ceded by us and received payment of our profit commission accrued during the term of the agreement. Cash flows from operations in 2015 also increased compared to 2014 due to an increase in premiums collected as our mix of single premium policies written and our insurance in force increased, and also from a higher level of investment income.
We maintain an investment portfolio that is primarily invested in a diverse mix of fixed maturity securities. Our main portfolio objectives are to maximize yield, protect principal, maximize statutory capital, and minimize losses. As of December 31, 2015, our portfolio had a fair value of $4.7 billion. As of December 31, 2015 the value of our investment portfolio increased by $50.5 million, or 1.1% from December 31, 2014.
Cash used in financing activities for 2015 reflect the repayment of our Senior Notes that matured on November 1, 2015 and repurchases of $11.5 million par value of our Convertible Senior Notes due in May 2017, offset in part by tax benefits related to share-based compensation.
Cash provided by financing activities in 2013 reflect the issuance of common stock and Convertible Senior Notes due in 2020 as discussed above.
For information about the first quarter 2016 purchase by our holding company of a portion of our 5% Convertible Senior Notes and purchase by MGIC of a portion of our outstanding 9% Junior Convertible Debentures, see “Debt at Our Holding Company and Holding Company Capital Resources” below. The remaining outstanding Convertible Senior Notes and Convertible Junior Debentures are obligations of MGIC Investment Corporation and not of its subsidiaries.
The increase in our total shareholders' equity in 2015 compared to 2014 was primarily due to our net income generated in 2015, which included a substantial tax benefit from the reversal of our valuation allowance on deferred tax assets. Our shareholders' equity also increased in 2014 relative to 2013 primarily due to net income generated in 2014 as well as other comprehensive income, which includes the effects of changes in our investment values.
The Convertible Senior Notes and Convertible Junior Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. The payment of dividends from our insurance subsidiaries which, other than investment income and raising capital in the public markets, is the principal source of our holding company cash inflow, is restricted by insurance regulation. MGIC is the principal source of dividend-paying capacity and Office of the Commissioner of Insurance of the State of Wisconsin (the "OCI") authorization is required for MGIC to pay dividends. Although MGIC has not paid any dividends to our holding company since 2008, we are discussing with the OCI the resumption of ongoing extraordinary dividends in 2016. During 2015, dividends of $38.5 million were paid to the holding company from other subsidiaries.
During the first quarter of 2016 through February 26, 2016, we purchased $127.7 million in par value of our 5% Convertible Senior Notes (the "5% Notes") due in 2017 at a purchase price of $132.4 million using funds held at our holding company. The excess of the purchase price over par value will be reflected as a loss in our statement of operations in the first quarter of 2016. While this repurchase will reduce our annual cash interest paid, it will improve our liquidity (which for this purpose is our expected cash balance immediately after the maturity of the these 5% Notes) only modestly taking into account the above-par purchase price and the lost investment income on the funds used for the repurchase. The purchase of the 5% Notes reduced our potentially dilutive shares by approximately 9.5 million shares.
In February 2016, MGIC purchased $132.7 million of par value of our 9% Convertible Junior Subordinated Debentures (the "9% Debentures") due in 2063 at a purchase price of $150.7 million. The difference between the fair value of the debt component of the purchased 9% Debentures and our current carrying value (which is par value) will be reflected as a gain or loss in our statement of operations in the first quarter of 2016. The difference between the purchase price and the fair value of the debt component will be attributable to the equity component of the purchased 9% Debentures and will be a reduction in our shareholders’ equity.
In February 2016, MGIC borrowed $155.0 million in the form of a fixed rate advance from the FHLBC (the “Advance”) to provide funds used to purchase the 9% Debentures. Interest on the Advance is payable monthly at an annual rate, fixed for the term of the Advance, of 1.91%. The principal of the Advance matures on February 10, 2023. MGIC may prepay the Advance at any time. Such prepayment would be below par if interest rates have risen after the Advance was originated, or above par if interest rates have declined. The Advance is secured by eligible collateral whose market value must be maintained at 102% of the principal balance of the Advance. MGIC provided eligible collateral from its investment portfolio.
During 2014 we repurchased $20.9 million in par value of the 5.375% Senior Notes and on November 2, 2015 we repaid the remaining $61.9 million of outstanding par value of those notes with cash at the holding company. The repurchases in 2014 were at a cost slightly above par, for which we recognized a loss of $0.8 million.
We may from time to time continue to seek to acquire our debt obligations through cash purchases and/or exchanges for other securities. We may do this in open market purchases, privately negotiated acquisitions or other transactions. The amounts involved may be material.
As discussed above, MGIC entered into an Advance with the FHLBC secured by eligible collateral whose market value must be maintained at 102% of the principal balance of the Advance. The collateral used to secure the Advance was included in our "Available Assets" for PMIERs as of December 31, 2015. It is unclear if the collateral will be considered "Available Assets" for the purposes of the PMIERs in future periods. MGIC used the Advance to purchase the 9% Debentures, which will be assets of MGIC, but we will not consider them "Available Assets" for purposes of the PMIERs.
Although we were in compliance with PMIERs as of December 31, 2015, our capital requirements under PMIERs may increase in the future because the GSEs have indicated that the tables of factors used to determine the 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. We plan to continuously comply with the existing PMIERs through our operational activities or through the contribution of funds from our holding company, subject to demands on the holding company's resources, as outlined above.
The reduction in MGIC's and our combined insurance companies risk-to-capital in 2015 was primarily due to an increase in statutory policyholders' position due to a lower level of incurred losses, partially offset by an increase in net risk in force in both calculations. Our risk in force, net of reinsurance, increased in 2015, due to an increase in our insurance in force. Our risk-to-capital ratio will decrease if the percentage increase in capital exceeds the percentage increase in insured risk.
For additional information regarding regulatory capital see Note 1 - “Nature of Business - Capital” to our consolidated financial statements in Item 8 as well as our risk factor titled “State capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis” in Item IA.
The financial strength of MGIC is rated Baa3 by Moody’s Investors Service with a stable outlook. Standard & Poor’s Rating Services’ insurer financial strength rating of MGIC is BB+ with a positive outlook. For further information about the importance of MGIC’s ratings, see our risks factor titled “We may not continue to meet the GSEs’ mortgage insurer eligibility requirements and our returns may decrease as we are required to maintain significantly more capital in order to maintain our eligibility” and “Competition or changes in our relationships with our customers could reduce our revenues, reduce our premium yields and/or increase our losses” in Item 1A.
As of December 31, 2015, the approximate future payments under our contractual obligations of the type described in the table below are as follows:
Our long-term debt obligations as of December 31, 2015 include $333.5 million of 5% Convertible Senior Notes due in 2017, $500.0 million 2% Convertible Senior Notes due in 2020 and $389.5 million in convertible debentures due in 2063, including related interest, as discussed in Note 8 - “Debt” to our consolidated financial statements in Item 8 and under “Liquidity and Capital Resources” above. For information about the first quarter 2016 purchase by our holding company of a portion of our 5% Convertible Senior Notes and purchase by MGIC of a portion of our outstanding 9% Convertible Junior Subordinated Debentures, see “Debt at Our Holding Company and Holding Company Capital Resources” above. Our operating lease obligations include operating
leases on certain office space, data processing equipment and autos, as discussed in Note 19 - “Leases” to our consolidated financial statements in Item 8. Tax obligations consist primarily of amounts related to our current dispute with the IRS, as discussed in Note 14 - “Income Taxes” to our consolidated financial statements in Item 8. Purchase obligations consist primarily of agreements to purchase data processing hardware or services made in the normal course of business. See Note 13 - “Benefit Plans” to our consolidated financial statements in Item 8 for discussion of expected benefit payments under our benefit plans.
The incurred but not reported, or IBNR, reserves referred to above result from defaults occurring prior to the close of an accounting period, but which have not been reported to us. Consistent with reserves for reported defaults, IBNR reserves are established using estimated claim rates and claim severities for the estimated number of defaults not reported. As of December 31, 2015 and 2014, we had IBNR reserves of approximately $98 million and $99 million, respectively.
The claim rates and claim severities are likely to be affected by external events, including actual economic conditions such as changes in unemployment rate, interest rate or housing value. Our estimation process does not include a correlation between claim rates and claim amounts to projected economic conditions such as changes in unemployment rate, interest rate or housing value. Our experience is that analysis of that nature would not produce reliable results. The results would not be reliable as the change in one economic condition cannot be isolated to determine its sole effect on our ultimate paid losses as our ultimate paid losses are also influenced at the same time by other economic conditions. Additionally, the changes and interaction of these economic conditions are not likely homogeneous throughout the regions in which we conduct business. Each economic environment influences our ultimate paid losses differently, even if apparently similar in nature. Furthermore, changes in economic conditions may not necessarily be reflected in our loss development in the quarter or year in which the changes occur. Actual claim results often lag changes in economic conditions by at least nine to twelve months.
When a premium deficiency exists, we reduce the related deferred insurance policy acquisition costs by the amount of the deficiency or to zero through a charge to current period earnings. If the deficiency is more than the deferred insurance policy acquisition costs balance, we then establish a premium deficiency reserve equal to the excess, by means of a charge to current period earnings.
For the years ended December 31, 2015, 2014 and 2013, we did not elect the fair value option for any financial instruments acquired for which the primary basis of accounting is not fair value.
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.
In accordance with fair value guidance, we applied the following fair value hierarchy in order to measure fair value for assets
Residential Mortgage-Backed Securities are evaluated by monitoring interest rate movements, and other pertinent data daily. Incoming market data is enriched to derive spread, yield and/or price data as appropriate, enabling known data points to be extrapolated for valuation application across a range of related securities.
Our entire investment portfolio is classified as available-for-sale and is reported at fair value or, for certain equity securities carried at cost, amounts that approximate fair value. The related unrealized investment gains or losses are, after considering the related tax expense or benefit, recognized as a component of accumulated other comprehensive income in shareholders' equity. Realized investment gains and losses on investments are recognized in income based upon specific identification of securities sold.
MGIC Investment Corporation is a holding company which, through Mortgage Guaranty Insurance Corporation (“MGIC”) 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 to protect against loss from defaults on low down payment residential mortgage loans. Our principal product is primary mortgage insurance. Primary insurance provides mortgage default protection on individual loans and covers unpaid loan principal, delinquent interest and certain expenses associated with the default and subsequent foreclosure or sale approved by us. Through certain other non-insurance subsidiaries, we also provide various services for the mortgage finance industry, such as contract underwriting, analysis of loan originations and portfolios, and mortgage lead generation. We began writing business in Australia in June 2007. We stopped writing new business in Australia in 2008 and in the fourth quarter of 2015 we settled all of our remaining risk in force. Our Australian operations, including amounts settled, are included in our consolidated financial statements; however they are not material to our consolidated results.
The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“GAAP”), as codified in the Accounting Standards Codification. In accordance with GAAP, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
We have considered subsequent events through the date of this filing. Refer to Note 8 - "Debt" for disclosure of debt transactions executed subsequent to December 31, 2015 through the date of this filing and also Note 3 - "Summary of Significant Accounting Policies" for the resulting impact on potentially dilutive shares.
Home office and equipment is carried at cost net of depreciation. For financial reporting purposes, depreciation is determined on a straight-line basis for the home office, equipment and data processing hardware over estimated lives of 45, 5 and 3 years, respectively. For income tax purposes, we use accelerated depreciation methods.
Home office and equipment is shown net of accumulated depreciation of $26.1 million, $54.9 million and $53.0 million as of December 31, 2015, 2014 and 2013, respectively. Depreciation expense for the years ended December 31, 2015, 2014 and 2013 was $3.2 million, $2.2 million and $1.8 million, respectively.
Costs directly associated with the successful acquisition of mortgage insurance business, consisting of employee compensation and other policy issuance and underwriting expenses, are initially deferred and reported as deferred insurance policy acquisition costs (“DAC”). The deferred costs are net of any ceding commissions received associated with our reinsurance agreements. For each underwriting year of business, these costs are amortized to income in proportion to estimated gross profits over the estimated life of the policies. We utilize anticipated investment income in our calculation. This includes accruing interest on the unamortized
balance of DAC. The estimates for each underwriting year are reviewed quarterly and updated when necessary to reflect actual experience and any changes to key variables such as persistency or loss development. If a premium deficiency exists (in other words, no gross profit is expected), we reduce the related DAC by the amount of the deficiency or to zero through a charge to current period earnings. If the deficiency is more than the related DAC balance, we then establish a premium deficiency reserve equal to the excess, through a charge to current period earnings.
Reserves are established for insurance losses and loss adjustment expenses when we receive notices of default on insured mortgage loans. We consider a loan in default when it is two or more payments past due. Even though the accounting standard, Accounting Standards Codification (“ASC”) 944, regarding accounting and reporting by insurance entities specifically excludes mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish loss reserves for future claims on insured loans which are not currently in default. Loss reserves are established by estimating the number of loans in our inventory of delinquent loans that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity. Our loss estimates are established based upon historical experience, including rescission and loan modification activity. Adjustments to reserve estimates are reflected in the financial statements in the years in which the adjustments are made. The liability for reinsurance assumed is based on information provided by the ceding companies.
We write policies which are guaranteed renewable contracts at the insured's option on a monthly, single, or annual premium basis. We have no ability to reunderwrite or reprice these contracts. Premiums written on monthly premium policies are earned as coverage is provided. Premiums written on single premium policies and annual premium policies are initially deferred as unearned premium reserve and earned over the policy life. Premiums written on policies covering more than one year are amortized over the policy life in relationship to the anticipated incurred loss pattern based on historical experience. Premiums written on annual premium policies are earned on a monthly pro rata basis. When a policy is cancelled for a reason other than rescission or claim payment, all premium that is non-refundable is immediately earned. Any refundable premium is returned to the servicer or borrower. Cancellations also include rescissions and policies cancelled due to claim payment. When a policy is rescinded, all previously collected premium is returned to the servicer and when a claim is paid we return any premium received since the date of default. The liability associated with our estimate of premium to be returned is accrued for separately and included in "Other liabilities" on our consolidated balance sheets. When a premium deficiency exists a separate component of the premium refund
We offer both medical and dental benefits for retired domestic employees, their eligible spouses and dependents until the retiree reaches the age of 65. Under the plan retirees pay a premium for these benefits. We accrue the estimated costs of retiree medical and dental benefits over the period during which employees render the service that qualifies them for benefits. (See Note 13 - “Benefit Plans.”)
Loss reserves and unearned premiums are reported before taking credit for amounts ceded under reinsurance agreements. Ceded loss reserves are reflected as "Reinsurance recoverable on loss reserves." Ceded unearned premiums are reflected as “Prepaid reinsurance premiums.” Amounts due from reinsurers on paid claims are reflected as “Reinsurance recoverable on paid losses.” Ceded premiums payable are included in “Other liabilities.” Any profit commissions are included with “Premiums written - Ceded” and any ceding commissions are included with “Other underwriting and operating expenses, net.” We remain liable for all insurance ceded. (See Note 11 - “Reinsurance.”)
We have certain share-based compensation plans. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period which generally corresponds to the vesting
period. The fair value of awards classified as liabilities is remeasured at each reporting period until the award is settled. Awards under our plans generally vest over periods ranging from one to three years. (See Note 18 - “Share-based Compensation Plans.”)
GAAP requires unvested share-based compensation awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, to be treated as participating securities and included in the computation of EPS pursuant to the two-class method. Our participating securities are composed of vested restricted stock and restricted stock units with non-forfeitable rights to dividends. There have been no dividends declared by us since the issuance of these participating securities and there has been no reduction to net income available to common shareholders. For the years ended December 31, 2015 and 2014, participating securities of 0.1 million have been included in basic EPS, respectively, and 0.1 million have been excluded for the year ended December 31, 2013 as they were anti-dilutive due to our net loss.
As discussed in Note 8 - "Debt," we purchased $127.7 million par value of our 5% Convertible Senior Notes due May 2017 ("5% Notes") and MGIC purchased $132.7 million par value of our 9% Convertible Junior Subordinated Debentures due April 2063 ("9% Debentures") in the first quarter of 2016 through the date of this filing. These purchases effectively retired the debt instruments for GAAP accounting purposes. The purchases of the 5% Notes and 9% Debentures reduced our potentially dilutive shares by approximately 9.5 million and 9.8 million shares, respectively.
In April 2015, the FASB issued updated 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 and interim reporting periods beginning after December 15, 2015, but early adoption is permitted. As of December 31, 2015 debt issuance costs of approximately $11 million associated with our Convertible Senior Notes are recorded in "Other assets" on the consolidated balance sheet. We will adopt this amended guidance in the first quarter of 2016.
In May 2014, the FASB issued updated 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. The guidance is effective for reporting periods beginning after December 15, 2017 with early adoption for reporting periods beginning after December 15, 2016 permitted. We are currently evaluating the impact of this update, but it is not expected to have a material impact on our consolidated financial statements and disclosures.
The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio as of December 31, 2015 and 2014 are shown below:
There were no other-than-temporary impairment losses recorded in other comprehensive income (loss) as of December 31, 2015 and 2014.
Our foreign investments primarily consist of the investment portfolio supporting our Australian domiciled subsidiary. The portfolio is comprised of Australian government and semi government securities, representing 87% of the market value of our foreign investments with the remaining 7% invested in corporate securities and 6% in cash equivalents. Eighty-nine percent of the Australian portfolio is rated AAA, by one or more of Moody’s, Standard & Poor’s and Fitch Ratings, and the remaining 11% is rated AA. As of December 31, 2015, the investment portfolio fair value in our Australian operations was approximately $34 million.
The amortized cost and fair values of debt securities as of December 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.
At December 31, 2015 and 2014, the investment portfolio had gross unrealized losses of $67.8 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:
The unrealized losses in all categories of our investments as of December 31, 2015 were primarily caused by the difference in interest rates at December 31, 2015 compared to interest rates at the time of purchase. There were 303 and 423 securities in an unrealized loss position as of December 31, 2015 and 2014, respectively. As of December 31, 2015, the fair value as a percent of amortized cost of the securities in an unrealized loss position was 98% and approximately 15% of the securities in an unrealized loss position were backed by the U.S. Government.
The net realized investment gains, including impairment losses, and change in net unrealized gains (losses) of investments are as follows:
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.
As of December 31, 2015, the majority of the $4.1 million balance of Level 3 securities are equity securities that can only be redeemed or sold at their par value and only to the security issuer, with the remainder of the balance held in state premium tax credit investments. The state premium tax credit investments have an average maturity of less than 5 years and credit ratings of AA+ or higher, and their balance reflects their remaining scheduled payments discounted at an average annual rate of 7.2%. As of December 31, 2014 the majority of our Level 3 securities were state premium tax credit investments. During 2013 we sold our remaining auction rate securities.
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 December 31, 2015 and 2014. The fair values of our Senior Notes, Convertible Senior Notes and Convertible Junior Debentures were determined using available pricing for these notes, debentures, or similar instruments and they are categorized as Level 2 as described in Note 3 - “Summary of Significant Accounting Policies - Fair Value Measurements.”
Long-term debt as of December 31, 2015 and 2014 consisted of the following obligations.
The provisions of the 9% Debentures are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the 9% Debentures, including their covenants and events of default. We were in compliance with all covenants at December 31, 2015.
We may redeem the 9% Debentures in whole or in part from time to time, at our option, at a redemption price equal to 100% of the principal amount of the 9% Debentures being redeemed, plus any accrued and unpaid interest, if the closing sale price of our common stock exceeds 130% of the then prevailing conversion price of the 9% Debentures for at least 20 of the 30 trading days preceding notice of the redemption. 130% of such conversion price is $17.55.
Estimation of losses is inherently judgmental. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment, and the current and future strength of local housing markets. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, and a drop in housing values which may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Changes to our estimates could result in a material impact to our results of operations and capital position, even in a stable economic environment.
A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves. See table below regarding prior year loss development.
The “Losses incurred” section of the table above shows losses incurred on default notices received in the current year and in prior years. The amount of losses incurred relating to default notices received in the current year represents the estimated amount to be ultimately paid on such default notices. The amount of losses incurred relating to default notices received in prior years represents the actual claim rate and severity associated with those default notices resolved in the current year differing from the estimated liability at the prior year-end, as well as a re-estimation of amounts to be ultimately paid on defaults remaining in inventory and estimated incurred but not reported items from the end of the prior year. This re-estimation of the estimated claim rate and estimated severity is the result of our review of current trends in the default inventory, such as percentages of defaults that have resulted in a claim, the amount of the claims, changes in the relative level of defaults by geography and changes in average loan exposure.
Losses incurred on default notices received in the current year decreased in 2015 compared to 2014, and in 2014 compared to 2013, primarily due to a decrease in the number of new default notices received, net of cures, as well as a decrease in the estimated claim rate on recently reported delinquencies.
(1) A negative number for prior year loss development indicates a redundancy of prior year loss reserves.
The “Losses paid” section of the table above shows the breakdown between claims paid on default notices received in the current year, claims paid on default notices received in prior years and the decrease in losses paid related to terminated reinsurance agreements as noted in footnote (2) of that table. Until a few years ago, it took, on average, approximately twelve months for a default that was not cured to develop into a paid claim. Over the past several years, the average time it takes to receive a claim associated with a default has increased. This is, in part, due to new loss mitigation protocols established by servicers and to changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation processes. It is difficult to estimate how long it may take for current and future defaults that do not cure to develop into paid claims.
MGIC and Freddie Mac disagreed on the amount of the aggregate loss limit under certain pool insurance policies (the “Disputed Policies”). On December 1, 2012, an Agreement of Settlement, Compromise and Release (the “Settlement Agreement”) between MGIC, Freddie Mac and the FHFA became effective, settling their dispute regarding the Disputed Policies. Under the Settlement Agreement, MGIC is to pay Freddie Mac a total of $267.5 million in satisfaction of all obligations under the Disputed Policies. Of the total, $100 million was paid in December 2012, as required by the Settlement Agreement, and the remaining $167.5 million is being paid out in 48 equal monthly installments that began on January 2, 2013.
A rollforward of our primary default inventory for the years ended December 31, 2015, 2014 and 2013 appears in the table below. The information concerning new notices and cures is compiled from monthly reports received from loan servicers. The
Approximately 50%, 53% and 49% of the primary default inventory in default for 12 consecutive months or more has been in default for at least 36 consecutive months as of December 31, 2015, 2014 and 2013, respectively.
Our claims received inventory includes suspended rescissions, as we have voluntarily suspended rescissions of coverage related to loans that we believed would be included in a potential resolution. As of December 31, 2015, rescissions of coverage on approximately 435 loans had been voluntarily suspended.
Pool insurance default inventory decreased from 3,797 at December 31, 2014 to 2,739 at December 31, 2015. The pool insurance notice inventory was 6,563 at December 31, 2013.
The liability associated with our estimate of premiums to be refunded on expected future rescissions is accrued for separately. At December 31, 2015 and 2014 the estimate of this liability totaled $7 million and $28 million, respectively. As of December 31, 2015, this liability was included in "Other liabilities" on our consolidated balance sheet. As of December 31, 2014, separate components of this liability are included in “Other liabilities” and “Premium deficiency reserve” on our consolidated balance sheet. Changes in the liability affect premiums written and earned and change in premium deficiency reserve.
Effective July 1, 2015, we settled our 2013 quota share reinsurance agreement ("2013 QSR Transaction") by commutation. The settlement included unearned premiums, loss reserves, and profit commission. The commutation resulted in an increase in net premiums written and earned of $69.4 million and $11.6 million, respectively, and a decrease in ceding commissions of $11.6 million in the third quarter of 2015. Receipt of our profit commission of $142.5 million, in addition to other premium and loss amounts, was also completed as part of the settlement.
Effective July 1, 2015, we entered into a quota share reinsurance agreement ("2015 QSR Transaction") with a group of unaffiliated reinsurers that are the same as our 2013 QSR Transaction. Each of the reinsurers has an insurer financial strength rating of A- or better by Standard and Poor’s Rating Services, A.M. Best or both. The 2015 QSR Transaction will provide coverage on policies that were in the 2013 QSR Transaction; additional qualifying in force policies as of the agreement effective date which
Under the terms of 2015 QSR Transaction, reinsurance premiums, ceding commission and profit commission are settled net on a quarterly basis. The reinsurance premium due after deducting the related ceding commission and profit commission is reported within "Other liabilities" on the consolidated balance sheet as of December 31, 2015. As of December 31, 2014, we had accrued a profit commission receivable of $91.5 million.
reserves related to captive agreements was $34 million at December 31, 2015 which was supported by $137 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.
The pretax and related income tax (expense) benefit components of the amounts reclassified from our accumulated other comprehensive loss to our consolidated statements of operations for the years ended December 31, 2015, 2014 and 2013 are included in the table below:
(2) Decreases (increases) Other underwriting and operating expenses, net on the consolidated statements of operations.
Includes lump sum payments of $22.4 million and $11.8 million in 2015 and 2014, respectively, from our pension plan to eligible participants, which were former employees with vested benefits.
The changes in the fair value of the net assets available for plan benefits are as follows:
In selecting a discount rate, we performed a hypothetical cash flow bond matching exercise, matching our expected pension plan and postretirement medical plan cash flows, respectively, against a selected portfolio of high quality corporate bonds. The
Level 1 - Quoted prices for identical instruments in active markets that we have the ability to access. Financial assets utilizing Level 1 inputs include equity securities, mutual funds, money market funds, certain U.S. Treasury securities and exchange traded funds ("ETF’s").
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.
The components of the net deferred tax asset (liability) as of December 31, 2015 and 2014 are as follows:
In our analysis we evaluated both subjective and objective evidence and assigned a weight to each. Significant weight was given to our most recent operating results and our ability to sustain them. We have experienced a significant reduction in losses incurred as our level of default notices received and in inventory has declined, as the effects of the financial crisis continue to ebb. New insurance written in recent years has been of high quality and is expected to be profitable well into the future. Historically, the results of mortgage insurers have been cyclical, where periods of operating losses have been followed by significant amounts
of income. All of these factors have had a positive effect on operating results. Our level of pre-tax income for each quarter of 2015 was at least $100 million. We viewed the recurring nature of our income as very important, objectively verifiable evidence and gave it great weight in our analysis. Based on the above, we believe that we will have significant sources of pre-tax income which will allow for utilization of our deferred tax assets.
Generally, a significant component of any analysis for the recognition of deferred tax assets includes the objective observation of operating results for a period of time. In this regard, we considered the level of cumulative operating income, as adjusted for any permanent tax differences. There is no specific requirement that indicates the time span for this evaluation. In our evaluation, we used a three year period. Prior to the third quarter of 2015, this three year cumulative total had been materially negative for an extended period of time, which we considered to be objectively verifiable negative evidence which would not support the reversal of the valuation allowance. In the third quarter, this amount became positive, which we believe provided additional objectively verifiable evidence which supported the reversal of the valuation allowance. The three year cumulative pre-tax income is $687.3 million as of December 31, 2015.
Giving full effect to the carryback of net operating losses for federal income tax purposes, we have approximately $1,946 million of net operating loss carryforwards on a regular tax basis and $1,051 million of net operating loss carryforwards for computing the alternative minimum tax as of December 31, 2015. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2033.
We paid $5.4 million, $1.3 million, and $0.1 million in federal income tax in 2015, 2014 and 2013, respectively.
The reconciliation of the federal statutory income tax rate to the effective tax rate (benefit) provision is as follows:
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 December 31, 2015, there would also be interest related to these matters of approximately $182.9 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.
In January 2013, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax return for the year 2010. 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 results of these examinations had no material effect on the financial statements.
Our Amended and Restated Rights Agreement dated July 25, 2012, which was approved by shareholders, was amended and restated on July 23, 2015. It seeks to diminish the risk that our ability to use our NOLs to reduce potential future federal income tax obligations may become substantially limited and to deter certain abusive takeover practices. The benefit of the NOLs would be substantially limited, and the timing of the usage of the NOLs could be substantially delayed, if we were to experience an “ownership change” as defined by Section 382 of the Internal Revenue Code.
In June 2013, we amended our Articles of Incorporation to increase our authorized common stock from 680 million shares to 1.0 billion shares. We have 28.9 million authorized shares reserved for conversion under our convertible junior subordinated debentures and 96.7 million authorized shares reserved for conversion under our convertible senior notes. (See Note 8 - “Debt”)
Under a permitted practice effective September 30, 2012, the OCI had approved MGIC to report its net deferred tax asset as an admitted asset in an amount not to exceed 10% of adjusted surplus as regards policyholders, notwithstanding any contrary provisions of SSAP No. 101. Deferred tax assets of $138 million were included in MGIC’s statutory capital at December 31, 2014. Due to the deferred tax asset valuation allowance reversal as of September 30, 2015, MGIC no longer relies on the permitted practice and the deferred tax asset is admitted according to the stated provisions of SSAP No. 101. Under the stated provisions of SSAP No. 101, the admitted net deferred tax asset is 15% of adjusted surplus as regards policyholders. Net deferred tax assets of $205 million were included in MGIC's statutory capital as of December 31, 2015.
The statutory net (loss) income, surplus and contingency reserve liability of the insurance subsidiaries of our holding company, as well as the surplus contributions made to MGIC and other insurance subsidiaries and dividends paid by MGIC and other insurance subsidiaries to us, are shown in the tables below. The statutory net loss in 2015 was driven by the dissolution of an MGIC non-insurance subsidiary. The surplus amounts included below are the combined surplus of our insurance operations as utilized in our risk-to-capital calculations.
At December 31, 2015, MGIC’s risk-to-capital ratio was 12.1 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements and its policyholder position was $1.2 billion above the required MPP of $1.1 billion. In calculating our risk-to-capital ratio and MPP, we are allowed full credit for the risk ceded under our reinsurance transaction with a group of unaffiliated reinsurers. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the PMIERs, MGIC may terminate the reinsurance agreement, without penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, you should read the rest of these financial statement footnotes for information about matters that could negatively affect such compliance.
The compensation cost that has been charged against income for share-based plans was $11.9 million, $9.2 million, and $6.6 million for the years ended December 31, 2015, 2014 and 2013, respectively. The related income tax benefit, before valuation allowance, recognized for share-based plans was $4.2 million, $3.2 million, and $2.3 million for the years ended December 31, 2015, 2014 and 2013, respectively. See Note 14 - “Income Taxes” for a discussion of our valuation allowance.
A summary of restricted stock or restricted stock unit (collectively called “restricted stock”) activity during 2015 is as follows:
At December 31, 2015, the 3.3 million shares of restricted stock outstanding consisted of 2.4 million shares that are subject to performance conditions (“performance shares”) and 0.9 million shares that are subject only to service conditions (“time vested shares”). The weighted-average grant date fair value of restricted stock granted during 2014 and 2013 was $8.43 and $2.75, respectively. The fair value of restricted stock granted is the closing price of the common stock on the New York Stock Exchange on the date of grant. The total fair value of restricted stock vested during 2015, 2014 and 2013 was $17.2 million, $12.1 million, and $4.3 million, respectively.
Total rental expense under operating leases was $2.2 million in 2015, $2.8 million in 2014, and $4.6 million in 2013.
At December 31, 2015, minimum future operating lease payments are as follows (in thousands):
Before paying a claim, we review the loan and servicing files to determine the appropriateness of the claim amount. All of our insurance policies provide that we can reduce or deny a claim if the servicer did not comply with its obligations under our insurance policy, including the requirement to mitigate our loss by performing reasonable loss mitigation efforts or, for example, diligently pursuing a foreclosure or bankruptcy relief in a timely manner. We call such reduction of claims submitted to us “curtailments.” In each of 2014 and 2015, curtailments reduced our average claim paid by approximately 6.7%. 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.
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.
In 2013, we entered into a settlement with the CFPB that resolved a federal investigation of MGIC’s participation in captive reinsurance arrangements 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.
Various regulators, including the CFPB, state insurance commissioners and state attorneys general may bring other actions seeking various forms of relief in connection with alleged 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.
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. The underwriting remedy expense for 2015 was approximately $1 million, but may increase in the future.
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.
In periods where convertible debt instruments are dilutive to earnings per share the “if-converted” method of computing diluted EPS requires an interest expense adjustment, net of tax, to net income available to shareholders. The interest expense adjustment was not tax effected for all 2014 periods presented due to our valuation allowance on deferred tax assets. See Note 3 - “Summary of Significant Accounting Policies” for further discussion.