Through our subsidiary, MGIC, we are a leading provider of PMI in the United States, as measured by $194.9 billion of primary IIF on a consolidated basis at December 31, 2017.
Losses incurred, net were $53.7 million, down 78% as the estimated claim rate on new delinquent notices declined and we experienced higher favorable reserve development on prior year delinquencies when compared to the prior year. New delinquent notices in 2017 increased slightly compared to the prior year due to hurricane activity in the third quarter of 2017, however the estimated claim rate on new notices was approximately 10%, down from approximately 12.5% in the prior year. Our estimated claim rate on new notices primarily reflects improved cure activity due to the current economic environment, but also reflects a materially lower estimated claim rate on our estimate of new notices caused by hurricanes. When excluding our estimate of new notices caused by hurricanes, our new notice claim rate was approximately 10.5%.
During 2017, MGIC paid $140 million in dividends to our holding company.
Current U.S. economic conditions continue to support favorable housing fundamentals, such as low unemployment, household formations, and appreciating home values. Given the supply and demand dynamics of the current market, home prices are expected to further appreciate in 2018. Home price appreciation can have a dampening effect on home purchase activity as it reduces affordability for some borrowers, conversely it may increase the demand for mortgage insurance and/or amount of mortgage insurance due to decreased ability of borrowers to fund a similar down payment percentage absent the appreciation. This recent period of favorable housing fundamentals, coupled with, in our view, high lending standards, has provided a favorable credit backdrop for the business we have written in recent years. In that regard, we have experienced a declining delinquent inventory and lower losses and claims paid. Our most recent book years continue to experience a low level of losses.
The 10 year (and other) U.S. Treasury benchmark interest rates have increased in recent quarters and mortgage interest rates in response have been, on average, higher during 2017 compared to the historically low rates of 2016. The gradual increase in mortgage interest rates benefited our business in 2017 as persistency increased, while not materially impacting affordability for first-time homebuyers. Further increases in mortgage rates may impact affordability, which could slow housing activity. Historically however, purchase origination volume has been impacted more by the level and direction of consumer confidence than by changes in interest rates.
Impact of tax reform. In the fourth quarter of 2017, the Tax Act was enacted that, among other things, reduced federal income tax rates on corporations and eliminated the corporate Alternative Minimum Tax ("AMT"). The reduction in the corporate income tax rate will reduce our effective tax rate in 2018 and we expect it to be approximately 21%, compared to approximately 34% when excluding the impact of remeasuring our net deferred tax assets due to the Tax Act and the additional provision recorded for our expected IRS settlement in 2017. In recent years, we have utilized NOLs to reduce our taxes payable, however we were subject to paying taxes under the AMT. The elimination of the corporate AMT eliminates any cash taxes that would have been paid in 2018. We do not expect the changes to individual income taxes included in the Tax Act to materially impact our business.
Results of operations. We expect our earned premiums growth rate in 2018 to be comparable to that experienced in 2017. The headwinds that have limited earned premium growth in recent years, even with a larger book of IIF, are expected to persist to a certain extent in 2018. Our premium yield is expected to decline in 2018 from 2017, primarily due to changing premium rates, as more fully discussed along with other factors in our "Consolidated Results of Operations - Premium yield." However, we expect increasing IIF to counteract the effect on earned premium of a lower premium yield.
PMIERs. In December 2017, we received a summary of proposed changes to the PMIERs that are being recommended to the FHFA by the GSEs. We expect the revised PMIERs to be finalized in 2018 and effective no earlier than the fourth quarter of 2018. See "Capital - GSEs" below for our discussion of the proposed changes we have received.
We must comply with the PMIERs to be eligible to insure loans purchased by the GSEs. In addition to their financial requirements, the PMIERs include business, quality control and certain transaction approval requirements. If MGIC ceases to be eligible to insure loans purchased by one or both of the GSEs, it would significantly reduce the volume of our NIW. Factors that may negatively impact MGIC’s ability to continue to comply with the financial requirements of PMIERs include the following:
We have non-disclosure obligations to each of the GSEs and cannot provide further comment on the specific provisions of the GSE-recommended changes other than as described above. Until the GSEs and/or FHFA provide public disclosure of proposed or final changes to the existing PMIERs, we do not plan to update or correct any of the disclosure above or provide any additional disclosure regarding any modifications that may occur in the GSE-recommended changes to PMIERs.
Should capital be needed by MGIC in the future, capital contributions from our holding company may not be available due to competing demands on holding company resources, including for repayment of debt.
At December 31, 2017, MGIC’s risk-to-capital ratio was 9.5 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements, and its policyholder position was $2.1 billion above the required MPP of $1.2 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 transaction, 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, 2017, the risk-to-capital ratio of our combined insurance operations (which includes a reinsurance affiliate) was 10.5 to 1. Reinsurance transactions with our affiliate permit MGIC to write insurance with a higher coverage percentage than it could on its own under certain state-specific requirements.
The FHFA has been the conservator of the GSEs since 2008 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. In the past, members of Congress have introduced several bills intended to change the business practices of the GSEs and the FHA; however, no legislation has been enacted. The Administration has indicated that the conservatorship of the GSEs should end; however, it is unclear whether and when that would occur and how that would impact us. As a result of the matters referred to above, it is uncertain what role the GSEs, FHA and private capital, including PMI, 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.
NIW, which increases IIF. Many factors affect NIW, including the volume of low down payment home mortgage originations and competition to provide credit enhancement on those mortgages 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. NIW does not include loans previously insured by us that are modified, such as loans modified under HARP.
Premiums are generated by the insurance that is in force during all or a portion of the period. A change in the average IIF in the current period compared to an earlier period is a factor that will increase (when the average in force is higher) or reduce (when it is lower) premiums written and earned in the current period, although this effect may be enhanced (or mitigated) by differences in the average premium rate between the two periods, as well as by premiums that are returned or expected to be returned in connection with claim payments and rescissions, and premiums ceded under reinsurance agreements. Also, NIW and cancellations during a period will generally have a greater effect on premiums written and earned in subsequent periods than in the period in which these events occur.
Adjusted net operating income (loss) per diluted share is calculated in a manner consistent with the accounting standard regarding earnings per share, by dividing (i) adjusted net operating income (loss) after making adjustments for interest expense on convertible debt, whenever the impact is dilutive, by (ii) diluted weighted average common shares outstanding, which reflects share dilution from unvested restricted stock units and from convertible debt when dilutive under the "if-converted" method.
The primary mortgage insurance market is estimated to have declined in 2017 (table t.02), due to lower refinancing originations (chart c.01). Refinance originations fell as a result of higher mortgage interest rates on average, but continued solid housing fundamentals, such as household formations, low unemployment, and low interest rates supported home purchase activity. Mortgage origination estimates indicate that the decline in refinance volume offset an increase in purchase volume in 2017 compared to the prior year. Mortgage originations in 2018 are forecast to decrease from 2017 estimated levels because of an additional decline in refinancing volume as mortgage interest rates are anticipated to trend higher. However, purchase originations are expected to increase again which generally has a greater impact on the PMI industry as historically the industry's share is 3-4 times higher for purchase originations than refinancing originations. Competition from government mortgage insurance programs, discussed below, will also continue to impact the market share of PMI. In consideration of these factors, our 2018 NIW is expected to be slightly higher than that of 2017.
Source: GSEs and MBA estimates/forecasts as of January 2018. Amounts represent the average of all sources.
Source: Inside Mortgage Finance - February 15, 2018 or SEC filings. Includes HARP NIW.
We compete against five other private mortgage insurers, as well as government mortgage insurance programs such as the FHA, VA, and USDA. We believe that we currently compete with other private mortgage insurers based on pricing, underwriting requirements, financial strength, customer relationships, name recognition, reputation, the strength of our management team and field organization, the ancillary products and services provided to lenders and the effective use of technology and innovation in the delivery and servicing of our mortgage insurance products. Much of the competition in the industry centers on pricing practices which, in the last few years included: (i) reductions in standard filed rates on BPMI policies, (ii) use by certain competitors of a spectrum of filed rates to allow for formulaic, risk-based pricing (commonly referred to as "black-box" pricing); and (iii) use of customized rates (discounted from published rates). These pricing practices were driven by both the implementation of the financial requirements of the PMIERs, as well as industry competition to maintain or grow market share. The result of pricing changes in 2016, in which we participated, generally decreased filed premium rates on higher-FICO score loans and increased rates on
lower-FICO score loans. We also continue to use authority set forth in our rate filings to provide customized premium rates to qualified lenders. We believe our current rates allow us to compete effectively across many FICO scores; however, there is no assurance that pricing competition will not intensify further, which could result in a decrease in our NIW and/or returns.
Source: Inside Mortgage Finance - February 15, 2018 or SEC filings. Excludes HARP NIW.
From our perspective, the 2017 NIW has favorable underlying risk characteristics as we and lenders, in our view, maintained high underwriting standards, despite an increase in the percentage of business with LTVs 95% and above (see table t.06) and the GSEs underwriting requirements for DTIs became more liberal in the second half of 2017. We maintained a high percentage of monthly premium business, which is almost exclusively BPMI (see table t.07). Refinancing activity declined in 2017 compared to 2016 when it was particularly strong due to historically low mortgage interest rates that persisted for much of that year. The percentage of NIW from LTVs 95.01% and above increased due to 97% LTV programs offered by lenders, while the percentage of NIW from LTVs 90.00% down to 80.01% declined due to a lower amount of refinancing originations by borrowers whose home values increased but still were required to have PMI.
The proportion of our total primary RIF written after 2008 has been steadily increasing in proportion to our total primary RIF. Our 2009 and later books possess significantly improved risk characteristics when compared to our 2005-2008 origination years. The loans we insured beginning in 2009, on average, have substantially higher FICO scores and lower LTVs than those insured in 2005-2008. The credit profile of our pre-2009 RIF has benefited from programs such as HARP. HARP allows borrowers who are not delinquent, but who may not otherwise be able to refinance their loans under the current GSE underwriting standards due to, for example, the current LTV exceeding 100%, to refinance and lower their note rate. Loans associated with 96.8% of all our HARP modifications were current as of December 31, 2017. The aggregate of our 2009-2017 books and our HARP modifications accounted for approximately 86% of our total primary RIF at December 31, 2017.
MGIC has written no new pool insurance since 2008, however, for a variety of reasons, including responding to capital market alternatives to private mortgage insurance and customer demands, MGIC may write pool risk in the future. Our direct pool RIF was $471 million ($236 million on pool policies with aggregate loss limits and $235 million on pool policies without aggregate loss limits) at December 31, 2017 compared to $547 million ($244 million on pool policies with aggregate loss limits and $303 million on pool policies without aggregate loss limits) at December 31, 2016. If claim payments associated with a specific pool reach the aggregate loss limit, the remaining IIF within the pool would be cancelled and any remaining defaults under the pool would be removed from our default inventory.
The following section of the MD&A provides a comparative discussion of our Consolidated Results of Operations for the three-year period ended December 31, 2017. For a discussion of the Critical Accounting Policies used by us that affect the Consolidated Results of Operations, see "Critical Accounting Policies" below.
2016 compared to 2015. NPW decreased 4% from the prior year primarily because ceded premiums were lower in 2015 due to the commutation of our 2013 QSR Transaction in the third quarter of 2015, which was a non-recurring transaction. As part of the commutation, unearned ceded premiums were remitted back to us from the reinsurers, and we returned the related ceding commissions, which had the effect of increasing our profit commission. Partially offsetting the higher 2016 ceded premiums was an increase in new business premiums in 2016 and a reduction in premium refunds due to lower claim activity.
Changing premium rates decreased our premium yield in 2017 and 2016 primarily due to the following factors.
The books we wrote in 2009 and after have a lower average premium rate than prior books due to several factors, including, lower risk characteristics.
2016 compared to 2015. The reduction in our 2016 premium yield compared to 2015 was primarily due to the increase in the percentage of our IIF that was written in 2009 and after to 72% as of December 31, 2016 from 63% as of December 31, 2015. In addition, as of December 31, 2015, approximately 2% of our total IIF was written in 2006 and was subject to premium rate resets in 2016, which resulted in a reduction in our premium yield. Our 2016 premium yield also reflects the full-year impact of IIF written in 2005 that was subject to premium rate resets during 2015.
amount we had accrued for our estimate of premiums to be refunded on expected claim payments as of December 31, 2017 and 2016, respectively.
2016 compared to 2015. Our net losses and LAE paid and ending delinquent inventory both declined in 2016 from 2015 levels resulting in less premium being refunded and reducing the amount we estimated to be refunded in future periods.
2017 compared to 2016. The effect of cancellations of single premium policies prior to the completion of their estimated policy life on our earned premiums was approximately $9 million less in 2017 than 2016. Cancellation activity in 2016 was elevated as historically low mortgage interest rates led to high refinancing activity.
2016 compared to 2015. The effect of cancellations of single premium policies prior to the completion of their estimated policy life on our earned premiums was approximately $19 million more in 2016 than 2015. Cancellation activity in 2016 was elevated as historically low mortgage interest rates led to high refinancing activity.
The amount of our IIF covered by reinsurance affects the amount of premiums and losses incurred that are subject to the 30% cede rate. We cede premiums earned and received, which are reduced by a profit commission that varies by the level of losses we cede.
2017 compared to 2016. The adverse impact of reinsurance to our premium yield in 2017 was 0.8 basis points less than in 2016, as our average IIF during the year increased by a higher percentage than the increase in premiums ceded, before considering our profit commission. In addition, our profit commission increased in 2017 compared to 2016 due to a lower level of ceded losses incurred, thereby resulting in a lower amount of earned premiums ceded on a net basis.
2016 compared to 2015. The adverse impact of reinsurance to our premium yield in 2016 was 1.5 basis points more than in 2015, which was in part due the commutation of our 2013 QSR Transaction in 2015 that resulted in a non-recurring increase in our profit commission and in turn reduced ceded premiums.
We receive the benefit of a ceding commission through a reduction in underwriting expenses equal to 20% of premiums ceded (before the effect of the profit commission).
Table t.13 below provides information related to our captive reinsurance agreements for 2017, 2016, and 2015.
The net unrealized gains (losses) position of our investments as of December 31, 2017, 2016, 2015 was primarily caused by changes in interest rates between the time of purchase and the respective year end. See Note 5 - "Investments" for additional information on our investment portfolio.
2016 compared to 2015. Other revenue increased to $18M in 2016 from $13 million in 2015 primarily due to the substantial liquidation of our Australian operations for which we recognized approximately $4 million of gains related to changes in foreign currency exchange rates in 2016. Other revenue also increased compared to the prior year due to an increase in contract underwriting fees attributable to higher mortgage origination volumes.
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. Historically, losses incurred have followed a seasonal trend in which the second half of the year has weaker credit performance than the first half, with higher new notice activity and a lower cure rate. Our estimates are also affected by any agreements we enter into regarding our claims paying practices, such as the settlement agreements discussed in Note 17 - “Litigation and Contingencies” to our consolidated financial statements. Changes to our estimates could result in a material impact to our consolidated results of operations and financial position, even in a stable economic environment.
2016 compared to 2015. Losses incurred, net decreased 30% to $240 million compared to $344 million in 2015. The decrease was due both to a decrease in losses and LAE incurred in respect to delinquencies reported in the current year and favorable development on prior year delinquencies. Current year losses declined due to a 9% reduction in new notices received and a lower estimated claim rate on those notices. Favorable development on prior year delinquencies occurred in 2016 and 2015 due to a lower estimated claim rate on previously reported delinquencies, partially offset by increases in our expected severity assumption on previously reported delinquencies. In 2015, the amount of development was also favorably impacted by $21 million due to re-estimation of previously recorded reserves related to disputes on our claims paying practices and IBNR, partially offset by increases in our expected severity assumption on previously reported delinquencies.
The loss ratio is the ratio, expressed as a percentage, of the sum of incurred losses and LAE, net to net premiums earned. The decline in the loss ratio in 2017 when compared to 2016, and in 2016 when compared to 2015 reflects the lower level of losses incurred, net.
YTD 2017: ~10.0% compared to YTD 2016: ~12.5%. The estimated claim rate on new notices in each quarter of 2017 was lower than the comparable period of the prior year which reflects the current economic environment and our expectation of cure activity on the notices received. We also estimated a materially lower new notice claim rate for those notices received in the fourth quarter of 2017 that we estimated to have been caused by hurricane activity that occurred in the third quarter of 2017. When excluding our estimate of new notices caused by hurricanes, our new notice claim rate was approximately 10.5%.
New notice activity continues to be primarily driven by loans insured in 2008 and prior, which continue to experience a cycle whereby many loans become delinquent, cure, and become delinquent again (see chart c.05). As a result of this cycle significant judgment is required in establishing the estimated claim rate.
Net losses and LAE paid decreased 28% in 2017 compared to 2016 due to lower claim activity on our primary business and the completion of our settlement payments to Freddie Mac in 2016 related to our pool business.
Net losses and LAE paid decreased 16% in 2016 compared to 2015 due to lower claim activity on our primary business. During each of 2017 and 2016, losses paid included payments for settlements of disputes for claims paying practices and commutations of coverage on pools of NPLs as we continue to resolve legacy delinquencies. We believe losses and LAE paid will be lower in 2018 compared to 2017.
Primary losses paid for the top 15 jurisdictions (based on 2017 losses paid, excluding settlement amounts) and all other jurisdictions for the years ended December 31, 2017, 2016 and 2015 appear in table t.17 below.
The primary and pool loss reserves as of December 31, 2017, 2016 and 2015 appear in table t.20 below.
See our Form 8-K filed with the Securities and Exchange Commission on November 30, 2012 for a discussion of our settlement with Freddie Mac regarding a pool policy. As of December 31, 2016, we had completed our obligation under this settlement agreement.
The primary default inventory for the top 15 jurisdictions (based on 2017 losses paid, excluding settlement amounts) at December 31, 2017, 2016 and 2015 appears in table t.21 below.
The primary default inventory by policy year at December 31, 2017, 2016 and 2015 appears in table t.22 below.
The losses we have incurred on our 2005 through 2008 books have exceeded our premiums from those books. Although uncertainty remains with respect to the ultimate losses we will experience on these books of business, as we continue to write new insurance on high-quality loans, those books are a declining percentage of our total mortgage insurance portfolio. Our 2005 through 2008 books of business represented approximately 19% and 25% of our total primary RIF at December 31, 2017 and 2016, respectively. Approximately 39% and 38% of the remaining primary RIF on our 2005 through 2008 books of business benefited from HARP as of December 31, 2017, and December 31, 2016, respectively.
2017 compared to 2016. Underwriting and other expenses includes items such as employee compensation, fees for professional services, depreciation and maintenance expense, and premium taxes, and are reported net of ceding commissions. Underwriting and other expenses for 2017 increased when compared to 2016 primarily due to higher compensation, professional services, and depreciation expenses.
2016 compared to 2015. Interest expense for 2016 decreased from 2015 primarily due to MGIC's purchase of a portion of our 9% Debentures and the maturity of our 5.375% Notes. We also repurchased portions of our 5% and 2% Notes at various times during 2016, but we incurred new debt obligations to execute the repurchases thereby offsetting any reductions in interest expense from the repurchases.
The return we generate on our investment portfolio is an important component of our consolidated financial results. Our investment portfolio primarily consists of a diverse mix of highly rated fixed income securities (see table t.26) and targets an intermediate 4 to 6 year duration that is designed to achieve the following main portfolio objectives:
Total liabilities decreased 23% to $2,465 million as of December 31, 2017 from $3,186 million as of December 31, 2016. Loss reserves, which represent our estimated liability for losses and settlement expenses under our mortgage guaranty insurance policies, net of related reinsurance balances recoverable, decreased 32% to $937 million as of December 31, 2017 from $1,388 million as of December 31, 2016. This decrease was driven by the payment of losses during 2017 and favorable development on delinquencies received in prior years, offset in part by losses incurred on new delinquency notices received in 2017. Unearned premiums increased 19% to $393 million as of December 31, 2017 (2016: $330 million), primarily due to an increase in the amount of NIW from single premium policies. Long-term debt, at carrying value, declined 30% to $830 million as of December 31, 2017 versus $1,179 million as of December 31, 2016 due to the maturity of our 5% Notes and conversion and partial redemption of our 2% Notes. See Note 7 - "Debt" for further discussion of these transactions. Other liabilities increased 7% to $256 million as of December 31, 2017 (2016: $238 million), primarily due to increases in our income taxes payable, primarily due to our expected IRS settlement, and in our pension plan benefit obligation, offset in part by declines in our premium refund accrual and other liabilities.
Total equity increased 24% to $3,155 million as of December 31, 2017 from $2,549 million as of December 31, 2016. This increase from the prior year was driven by net income generated during 2017 and the conversion of our 2% Notes to shares of our common stock.
We have a non-contributory defined benefit pension plan covering substantially all domestic employees, as well as a supplemental executive retirement plan. Retirement benefits are based on compensation and years of service. We maintain plan assets to fund our defined benefit pension plan obligations. The supplemental executive retirement plan benefits are accrued for and are paid from MGIC assets following employee retirements. As of December 31, 2017, we have accrued a $6.4 million liability related to our defined benefit pension plan as the projected obligation was in excess of plan assets, while at December 31, 2016, it had plan assets in excess of the projected obligation. Our projected benefit obligations under these plans are subject to numerous actuarial assumptions that may change in the future and as a result could substantially increase or decrease our obligations. Plan assets held to pay our defined benefit pension plan obligations are primarily invested in a portfolio of debt securities to preserve capital and to provide monthly cash flows aligned with the liability component of our obligations, with a lesser percentage invested in a mix of equity securities. If the performance of our invested plan assets differs from our expectations, the funded status of the benefit pension plan may decline, even with no significant change in the obligations. See Note 11 - "Benefit Plans" to our consolidated financial statements for a complete discussion of these plans and their effect on the consolidated financial statements.
Net cash flows used in investing activities in 2017 and 2016 primarily reflect purchasing fixed income securities in an amount that exceeded our proceeds from sales and maturities of fixed income securities during the year as cash from operations was available for additional investment.
cultivate relationships with intermediaries and end-providers to ensure access to capital and reinsurance markets,
size the level of capital to balance competitive needs, handle contingencies and create shareholder value,
position our mix of debt, equity and/or reinsurance to support our business strategy while considering the competing needs of credit ratings, regulators and shareholders, and
Total shareholders' equity increased in 2017 from the prior year primarily due to net income during 2017 and conversion of substantially all of our then-remaining 2% Notes into shares of common stock. See Note 13 - "Shareholders' Equity" for further information on the 2% Notes conversion. The increase in shareholders' equity in 2016 from 2015 was due to net income in 2016, which was offset in part by the cost of repurchasing the shares of common stock issued in connection with the repurchase of a portion of our 2% Notes.
company's 9% Debentures is eliminated in consolidation, but they remain outstanding obligations owed by our holding company to MGIC.
The conversion and partial redemption of our 2% Notes and maturity of our 5% Notes in 2017 eliminated the debt obligations with a maturity less than five years. The remaining outstanding holding company debt obligations have more than five years to maturity as of December 31, 2017. The 9% Debentures are a convertible debt issuance. Subject to certain limitations and restrictions, holders of the 9% Debentures may convert their notes into shares of our common stock at their option prior to certain dates prescribed under the terms of their issuance, in which case our corresponding obligation will be eliminated prior to the scheduled maturity.
As of December 31, 2017, we had approximately $216 million in cash and investments at our holding company. These resources are maintained primarily to service our debt interest expense, pay debt maturities, repurchase outstanding debt obligations as opportunities arise, and to settle intercompany obligations. We may also use available holding company cash to repurchase shares of our common stock. While these assets are held, we generate investment income that serves to offset a portion of our interest expense. Investment income and the payment of dividends from our insurance subsidiaries are the principal sources of holding company cash inflow. MGIC is the principal source of dividends, and their payment is restricted by insurance regulation. See Note 14 - "Statutory Information" to our consolidated financial statements for additional information about MGIC's dividend restrictions. The payment of dividends from MGIC is also influenced by our view of the appropriate level of PMIERs Available Assets to maintain in excess of Minimum Required Assets. Other sources of holding company cash inflow include any unused capacity on our unsecured revolving credit facility and raising capital in the public markets. The ability to raise capital in the public markets is subject to prevailing market conditions, investor demand for the securities to be issued, and our deemed creditworthiness.
Over the next twelve months the principal demand on holding company resources will be interest payments on our 5.75% Notes and 9% Debentures approximating $60 million. We expect MGIC will continue to pay dividends of at least $50 million per quarter in 2018. Our unsecured revolving credit facility provides $175 million of borrowing capacity, of which no amount is currently drawn. We believe our holding company has sufficient sources of liquidity to meet its payment obligations for the foreseeable future.
The net unrealized losses on our holding company investment portfolio were approximately $1.8 million at December 31, 2017 and the portfolio had a modified duration of approximately 1.8 years.
We may from time to time acquire our debt obligations through cash purchases and/or exchanges for other securities. We may also from time to time acquire our common stock through cash purchases, including with
funds provided by debt. We may make such acquisitions in open market purchases, privately negotiated acquisitions or other transactions. The amounts involved may be material.
MGIC is a member of the FHLB. Membership in the FHLB provides MGIC access to an additional source of liquidity via a secured lending facility. MGIC has $155.0 million in the form of a fixed rate advance from the FHLB outstanding. 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 in the form of pledged securities from the investment portfolio, whose market value must be maintained at 102% of the principal balance of the Advance.
We operate under the PMIERs of the GSEs that became effective December 31, 2015. The PMIERS were most recently revised in December 2016, but the revision had no impact on our calculation of Available Assets or Minimum Required Assets, or on our operations. Refer to "Overview - Capital - GSEs" of this MD&A for further discussion of PMIERs.
As of December 31, 2017, MGIC’s Available Assets under PMIERs totaled approximately $4.8 billion, an excess of approximately $0.8 billion over its Minimum Required Assets; and MGIC is in compliance with the requirements of the PMIERs and eligible to insure loans purchased by the GSEs. Maintaining a sufficient level of excess Available Assets will allow MGIC to remain in compliance with the PMIERs financial requirements, including, we believe, to the extent they are revised. Our QSR Transactions provided an aggregate of approximately $0.8 billion of PMIERs capital credit as of December 31, 2017. Our 2018 QSR transaction terms are expected to be no less favorable than our 2017 and 2015 QSR transactions and will also provide PMIERs capital credit. Refer to Note 9 - "Reinsurance" to our consolidated financial statements for additional information on our QSR transactions.
We compute our risk-to-capital ratio on a separate company statutory basis, as well as on a combined insurance operations basis. The risk-to-capital ratio is our net RIF divided by our policyholders’ position. Our net RIF includes both primary and pool RIF, and excludes risk on policies that are currently in default and for which loss reserves have been established and those covered by reinsurance. The risk amount includes pools of loans with contractual aggregate loss limits and without these limits. Policyholders’ position consists primarily of statutory policyholders’ surplus (which increases as a result of statutory net income and decreases as a result of statutory net loss and dividends paid), plus the statutory contingency reserve and a portion of the reserves for unearned premiums. The statutory contingency reserve is reported as a liability on the statutory balance sheet. A mortgage insurance company is required to make annual additions to a contingency reserve of approximately 50% of net earned premiums. These contributions must generally be maintained for a period of ten years. However, with regulatory approval a mortgage insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net earned premiums in a calendar year.
Table t.31 below presents our combined insurance companies’ risk-to-capital calculation (which includes a reinsurance affiliate). Reinsurance transactions with our affiliate permit MGIC to write insurance with a higher coverage percentage than it could on its own under certain state-specific requirements.
Our other long-term liabilities represent the loss reserves established to recognize the liability for losses and LAE related to existing defaults on insured mortgage loans. The timing of the future claim payments associated with the established loss reserves was determined primarily based on two key assumptions: the length of time it takes for a notice of delinquency to develop into a received claim and the length of time it takes for a received claim to be ultimately paid. The future claim payment periods are estimated based on historical experience, and could emerge differently than this estimate, in part, due to uncertainty regarding how certain factors, such as loss mitigation protocols established by servicers and changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation process.
The estimated claim rates and claim severities represent what we estimate will actually be paid on the delinquent loans as of the reserve date. If a policy is rescinded we do not expect that it will result in a claim payment and thus the rescission generally reduces the historical claim rate used in establishing reserves. In addition, if a loan cures its delinquency, including successful loan modifications that result in a cure being reported to us, the cure reduces the historical claim rate used in establishing reserves. Our methodology to estimate claim rates and claim amounts is based on our review of recent trends in the delinquent inventory. To establish reserves we utilize a reserving model that continually incorporates historical data into the estimated claim rate. The model also incorporates an estimate for the amount of the claim we will pay, or severity. The severity is estimated using the historical percentage of our claim paid compared to our loan exposure, as well as the RIF of the loans currently in default. We do not utilize an explicit rescission rate in our reserving methodology, but rather our reserving methodology incorporates the effects rescission activity has had on our historical claim rate and claim severities. We review recent trends in the claim rate, severity, levels of defaults by geography and average loan exposure. As a result, the process to determine reserves does not include quantitative ranges of outcomes that are reasonably likely to occur.
In considering the potential sensitivity of the factors underlying our estimate of loss reserves, it is possible that even a relatively small change in our estimated claim rate or severity could have a material impact on reserves and, correspondingly, on our consolidated results of operations even in a stable economic environment. For example, assuming all other factors remain constant, a $1,000 increase/decrease in the average severity reserve factor would change the reserve amount by approximately +/- $18 million. A 1 percentage point increase/decrease in the average claim rate reserve factor would change the reserve amount by approximately +/- $26 million as of December 31, 2017. Historically, it has not been uncommon for us to
experience variability in the development of the loss reserves through the end of the following year at this level or higher, as shown by the historical development of our loss reserves in the table below:
Reserves are also established for the estimated costs of settling claims, including legal and other expenses and general expenses of administering the claims settlement process.
The independent pricing sources used for our Level 2 investments vary by type of investment See Note 3 - "Significant Accounting Policies" for further information on the independent pricing sources used.
our intent to sell the security or whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis;
For the years ended December 31, 2017, 2016, and 2015, we did not elect the fair value option for any financial instruments acquired, or issued, such as our outstanding debt obligations, for which the primary basis of accounting is not fair value.
MGIC Investment Corporation is a holding company which, through Mortgage Guaranty Insurance Corporation ("MGIC"), 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 mortgage 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 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. An insurance subsidiary of MGIC provides credit insurance for certain mortgages under Fannie Mae and Freddie Mac (the "GSEs") credit risk transfer programs in transactions entered into in 2016.
Substantially all of our insurance written since 2008 has been for loans purchased by the GSEs. We operate under the Private Mortgage Insurer Eligibility Requirements ("PMIERs") of the GSEs that became effective December 31, 2015 and which have been amended from time to time. 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, calculated from tables of factors with several risk dimensions and subject to a floor amount). Based on our interpretation of the PMIERs, as of December 31, 2017, MGIC’s Available Assets are in excess of its Minimum Required Assets; and MGIC is in compliance with the financial requirements of the PMIERs and eligible to insure loans purchased by the GSEs.
Certain reclassifications to 2016 and 2015 amounts have been made in the accompanying consolidated financial statements to conform to the 2017 presentation. See Note 3 - "Significant Accounting Policies" for a discussion of our adoption of accounting guidance in 2017 that resulted in other reclassifications.
The authoritative accounting guidance includes a framework for measuring fair value. Fair value is disclosed using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value and includes Levels 1, 2, and 3. 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.
Obligations of U.S. States & Political Subdivisions are evaluated by tracking, capturing, and analyzing quotes for active issues and trades reported via the Municipal Securities Rulemaking Board records. Daily briefings and reviews of current economic conditions, trading levels, spread relationships, and the slope of the yield curve provide further data for evaluation.
Commercial Mortgage-Backed Securities ("CMBS") are evaluated using valuation techniques that reflect market participants’ assumptions and maximize the use of relevant observable inputs including quoted prices for similar assets, benchmark yield curves and market corroborated inputs. Evaluation utilizes regular reviews of the inputs for securities covered, including executed trades, broker quotes, credit information, collateral attributes and/or cash flow waterfall as applicable.
amortized cost at the time of our intent to sell, the security is classified as other-than-temporarily impaired and the full amount of the impairment is recognized as a loss in the statement of operations. Otherwise, when a security is considered to be other-than-temporarily impaired, the losses are separated into the portion of the loss that represents the credit loss and the portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other factors is recognized in accumulated other comprehensive loss, net of taxes. A credit loss is determined to exist if the present value of the discounted cash flows, using the security’s original yield, expected to be collected from the security is less than the cost basis of the security.
Home office and equipment is shown net of accumulated depreciation of $33.9 million, $30.6 million and $26.1 million as of December 31, 2017, 2016 and 2015, respectively. Depreciation expense for the years ended December 31, 2017, 2016 and 2015 was $5.4 million, $4.6 million and $3.2 million, respectively.
The calculation of premium deficiency reserves requires the use of significant judgments and estimates to determine the present value of future premium and present value of expected losses and expenses on our business. Similar to our loss reserve estimates, our estimates for premium deficiency reserves could be adversely affected by several factors discussed in Note 8 - Loss Reserves. To the extent premium patterns and actual loss experience differ from the assumptions used in calculating the premium deficiency reserves, the differences between the actual results and our estimate will affect future period earnings and could be material.
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 estimated policy life. Premiums written on single premium policies 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. When a policy is cancelled due to rescission, all previously collected premium is returned to the servicer and when a policy is cancelled because a claim is paid, premium collected since the date of default is returned. 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 the premium refund liability is included in “Premium deficiency reserves” on our consolidated balance sheets. Changes in these liabilities affect premiums written and earned and change in premium deficiency reserve, respectively. The actual return of premium for all periods affects premiums written and earned.
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. Awards under our plans generally vest over periods ranging from one to three years. (See Note 15 - “Share-based Compensation Plans.”)
Accounting standards effective in 2017, or early adopted, and relevant to our financial statements
Table 3.1 shows the relevant amendments to accounting standards that have been implemented for the fiscal year beginning January 1, 2017; none had a material impact on our consolidated financial statements or disclosures.
Recognition of a tax benefit is no longer required to be delayed until it reduces current taxes payable.
Adoption impact: We recognized an immaterial cumulative effect adjustment in opening retained earnings as of January 1, 2017 related to the recognition of a deferred tax asset related to suspended tax benefits from vesting transactions occurring in prior years and from the elimination of our forfeiture estimate on share-based awards, which was previously applied only to awards with service conditions.
Tax related cash flows resulting from share-based compensation are to be reported as operating activities on the statement of cash flows, instead of as an inflow from financing activities and an outflow from operating activities.
The update also allows, for tax withholding purposes, entities to withhold an amount of shares up to the employee’s maximum individual tax rate (as opposed to the minimum statutory tax rate) in the relevant jurisdiction without resulting in liability classification of the award. A change in tax withholding is to be applied on a modified retrospective approach.
employees during the period. The other components of net benefit cost are required to be presented in the statement of operations separately from the service cost component and outside a subtotal of income from operations, if one is presented. Current guidance does not prescribe where the amount of net benefit cost should be presented in an employer’s statement of operations and does not require entities to disclose by line item the amount of net benefit cost that is included in the statement of operations. The updated guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures.
In March 2017, the FASB issued updated guidance to amend the amortization period for premiums on certain purchased callable debt securities, shortening the amortization period to the earliest call date. Under current GAAP, there is diversity in practice in the amortization period for premiums of callable debt securities and in how the potential for exercise of a call is factored into current impairment assessments. This updated guidance aligns with how callable debt securities, in the United States, are generally quoted, priced, and traded, which incorporates consideration of calls (also referred to as “yield-to-worst” pricing). The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures. We currently account for premium amortization on our purchased callable debt securities on a yield-to-worst basis, which generally aligns with the earliest call date.
In June 2016, the FASB issued updated guidance that requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial instruments. Entities will be required to utilize a current expected credit losses (“CECL”) methodology that incorporates their forecasts of future economic conditions into their loss estimate unless such forecasts are not reasonable and supportable, in which case the entity will revert to historical loss experience. Any allowance for CECL reduces the amortized cost basis of the financial instrument to the amount an entity expects to collect. Credit losses relating to available-for-sale fixed maturity securities are to be recorded through an allowance for credit losses, rather than a write-down of the asset, with the amount of the allowance limited to the amount by which fair value is less than amortized cost. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. The updated guidance is not prescriptive about certain aspects of estimating expected credit losses, including the specific methodology to use, and therefore will require significant judgment in application. The updated guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted for annual and interim periods in fiscal years beginning after December 15, 2018. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures.
For the years ended December 31, 2017, 2016, and 2015, all of our then outstanding Convertible Senior Notes and Convertible Junior Subordinated Debentures are reflected in diluted earnings per share using the “if-converted” method. Under this method, if dilutive, the common stock related to the outstanding Convertible Senior Notes and/or Convertible Junior Debentures is assumed issued as of the beginning of the reporting period and the related interest expense, net of tax, is added back to earnings in calculating diluted EPS.
Table 5.2 compares the amortized cost and fair values of debt securities, by contractual maturity, as of December 31, 2017.
The analysis in table 5.2 is based upon contractual maturity. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties. Because most mortgage and asset-backed securities provide for periodic payments throughout their lives, they are listed separately in the table.
Tables 5.3a and 5.3b show the components of our unrealized losses on our investment portfolio in the amount of $32 million and $61 million as of December 31, 2017 and 2016, respectively.
For those securities in an unrealized loss position, the length of time the securities were in such a position, is measured by their month-end fair values. The unrealized losses in all categories of our investments as of December 31, 2017 and 2016 were primarily caused by changes in interest rates between the time of purchase and the respective year end. There were 586 and 607 securities in an unrealized loss position as of December 31, 2017 and 2016, respectively. As of December 31, 2017, the fair value as a percent of amortized cost of the securities in an unrealized loss position was 99% and approximately 27% of the securities in an unrealized loss position were backed by the U.S. Government.
For the years ended December 31, 2017, 2016, and 2015, there were no OTTI losses in earnings.
The net realized investment gains (table 5.5) and the change in unrealized gains (losses) of investments (table 5.6) are shown below.
Real estate acquired through claim settlement, which is held for sale, is reported in other assets on the consolidated balance sheets.
For assets and liabilities measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the years ended December 31, 2017, 2016, and 2015 is shown in the following tables. There were no transfers into or out of Level 3 in those years and there we no losses included in earnings for those years attributable to the change in unrealized losses on assets still held at the end of each applicable year.
Authoritative guidance over disclosures about the fair value of financial instruments requires additional disclosure for financial instruments not measured at fair value. Certain financial instruments, including insurance contracts, are excluded from these fair value disclosure requirements. The carrying values of cash and cash equivalents (Level 1) and accrued investment income (Level 2) approximated their fair values. Additional fair value disclosures related to our investment portfolio are included in Note 5 - “Investments.”
Interest on the 2% Notes was payable semi-annually in arrears on April 1 and October 1 of each year. Debt issuance costs were being amortized to interest expense over the contractual life of the notes.
In February 2016, MGIC borrowed $155.0 million in the form of a fixed rate advance from the Federal Home Loan Bank of Chicago ("FHLB Advance"). 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.
As of December 31, 2017 and 2016 we had outstanding $256.9 million principal amount of our 9% Debentures due in 2063 ("9% Debentures"). In February 2016, MGIC purchased $132.7 million in aggregate principal of our outstanding 9% Debentures at a purchase price of $150.7 million, plus accrued interest. The 9% Debentures include a conversion feature that allows us, at our option, to make a cash payment to converting holders in lieu of issuing shares of common stock upon conversion of the 9% Debentures. The accounting standards applicable to extinguishment of debt with a cash conversion feature require the consideration paid to be allocated between the extinguishment of the liability component and reacquisition of the equity component. The purchase of the 9% Debentures resulted in an $8.3 million loss on debt extinguishment on the consolidated statement of operations for the year ended December 31, 2016, which represents the difference between the fair value and the carrying value of the liability component on the purchase date. In addition, our shareholders’ equity was separately reduced by $6.3 million related to the reacquisition of the equity component. For GAAP accounting purposes, the 9% Debentures owned by MGIC are considered retired and are eliminated in our consolidated financial statements and the underlying common stock equivalents, approximately 9.8 million shares, are not included in the computation of diluted shares.
home is below the mortgage balance. Changes to our estimates could result in a material impact to our consolidated results of operations and financial position, even in a stable economic environment.
See "Hurricane activity" below for additional information on new notice activity and items in our delinquent inventory from the hurricane impacted areas. Based on our analysis and past experience, new notices received in areas impacted by hurricanes generally cure at a higher rate than notices received in the normal course of business and we have estimated a materially lower claim rate on the estimated new notices caused by the hurricane activity; however, our estimated severity was similar to other new notices received.
The “Losses paid” section of table 8.1 below shows the amount of losses paid on delinquent notices received in the current year and losses paid on delinquent notices received in prior years. For several years, the average time it took to receive a claim associated with a delinquency had increased significantly from our historical experience of approximately twelve months. This was, 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. In recent quarters, we have experienced a decline in the average time servicers are utilizing to process foreclosures, which has reduced the average time to receive a claim associated with new delinquent notices that do not cure. All else being equal, the longer the period between delinquency and claim filing, the greater the severity.
During 2017 and 2016, our losses paid included amounts paid upon commutation of coverage on pools of non-performing loans ("NPLs"), and in 2016 our losses paid also included amounts paid in connection with settlements for disputes concerning our claims paying practices. Losses paid in 2015 included amounts paid in connection with settlements for disputes concerning our claims paying practices. The impacts of the commutations of coverage on NPLs and/or settlements in each of the past three years were as follows:
2016 - 1,273 notices removed from default inventory with an amount paid of $53 million,
2015 - 1,121 notices removed from default inventory with an amount paid of $10 million.
In each of 2016 and 2015, we paid $42 million in connection with a 2012 settlement agreement with Freddie Mac regarding the aggregate loss limit under certain pool insurance policies. The final payment under that settlement agreement was made on December 1, 2016.
Table 8.2 below shows the development of reserves in 2017, 2016 and 2015 for previously received delinquencies.
For the years ended December 31, 2017, 2016 and 2015, we experienced favorable development on previously received delinquencies. This development was, in part, due to the resolution of approximately 67%, 63% and 60% for the years ended December 31, 2017, 2016 and 2015, respectively, of the prior year delinquent inventory, with improved cure rates. During 2017, cure activity on loans that were delinquent twelve months or more was significantly higher than our previous estimates. During 2015, the claim rate development was also favorably impacted by re-estimations of previously recorded reserves relating to disputes on our claims paying practices and adjustments to IBNR. The favorable development for the years ended 2017, 2016, and 2015 was offset, in part, by an increase in the estimated severity on previously reported delinquencies remaining in the delinquent inventory.
can be influenced by, among other things, the date on which a servicer generates its report, the number of business days in a month and transfers of servicing between loan servicers.
New default notice activity increased in 2017 compared to the prior year (particularly in the fourth quarter) because of hurricane activity that primarily impacted Puerto Rico, Texas, and Florida in the third quarter of 2017. In response to the hurricanes, the Federal Emergency Management Agency has declared Individual Assistance Disaster Areas ("IADA") which we are utilizing to identify new notices of delinquency for reserving and loss mitigation purposes. We received 9,294 new notices of delinquency on loans in the IADAs in the fourth quarter of 2017, which compares to 1,968 new notices in the same areas in the fourth quarter of 2016. Loans in our ending delinquent inventory within the IADAs were 12,446 and 7,162 as of December 31, 2017 and 2016, respectively.
The length of time a loan is in the delinquent inventory can differ from the number of payments that the borrower has not made or is considered delinquent. These differences typically result from a borrower making monthly payments that do not result in the loan becoming fully current. The number of payments that a borrower is delinquent is shown in table 8.5 below.
Pool insurance default inventory decreased to 1,309 at December 31, 2017 from 1,883 at December 31, 2016 and 2,739 at December 31, 2015.
Our consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to the acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance involves transferring certain insurance risks (along with the related earned premiums) we have underwritten to other insurance companies who agree to share these risks. The purpose of ceded reinsurance is to protect us, at a cost, against a fixed percentage of losses arising from our mortgage guaranty policies covered by the agreement and to manage our capital requirements under PMIERs. Reinsurance is currently placed on a quota-share basis, but we also have captive reinsurance agreements that remain in effect. The reinsurance agreements we have entered into are discussed below.
2015 QSR Transaction. Effective July 1, 2015, this transaction provides coverage on policies that were in the 2013 quota share reinsurance agreement ("2013 QSR Transaction"); additional qualifying in force policies as of the agreement effective date which either had no history of defaults, or where a single default had been cured for twelve or more months at the agreement effective date; and all qualifying new insurance written through December 31, 2016. Compared to the 2013 QSR Transaction, the 2015 QSR Transaction increased the amount of our IIF covered by reinsurance and the amount of premiums and losses that will be ceded. The agreement cedes losses incurred and premiums on or after the effective date through December 31, 2024, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2018 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.
The structure of the 2017 and 2015 QSR Transactions are both 30% quota share agreements for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under each transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%, with higher levels of losses ceded reducing our profit commission.
2018 QSR Transaction. We have agreed to terms on a 2018 QSR Transaction with a group of unaffiliated reinsurers to manage our exposure to losses resulting from the covered mortgage guaranty insurance policies and to provide reinsurance capital credit under the PMIERs. The GSEs have approved the terms of our proposed 2018 QSR Transaction. The 2018 QSR Transaction is expected to be executed during the first quarter of 2018 with an effective date of January 1, 2018, and will provide coverage on new business written January 1, 2018 through December 31, 2018 that meets certain eligibility requirements. Under the agreed upon terms, the 2018 QSR Transaction will cede losses incurred and premiums on or after the effective date through December 31, 2029, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021, and annually thereafter, for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.
Table 9.2 provides a summary of our quota share reinsurance agreements, excluding captive agreements, for 2017, 2016 and 2015.
The year ended December 31, 2015 includes the non-recurring impact of commuting our 2013 QSR Transaction (see "2013 QSR Transaction" above for additional information). The commutation had no impact on ceded losses incurred.
In the past, MGIC also obtained captive reinsurance. In a captive reinsurance arrangement, the reinsurer is affiliated with the lender for whom MGIC provides mortgage insurance. As part of our settlement with the Consumer Financial Protection Bureau ("CFPB") in 2013 and with the Minnesota Department of Commerce in 2015, MGIC has agreed to 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 subsequent to the respective settlements. In accordance with the CFPB settlement, all of our active captive arrangements were placed into run-off. In addition, the GSEs will not approve any future reinsurance or risk sharing transaction with a mortgage enterprise or an affiliate of a mortgage enterprise.
The pretax and related income tax benefit (expense) components of the amounts reclassified from our accumulated other comprehensive loss ("AOCL") to our consolidated statements of operations for the years ended December 31, 2017, 2016 and 2015 are included in table 10.2 below:
See Note 12 - “Income Taxes” for a discussion of the valuation allowance recorded against deferred tax assets in 2015.
A rollforward of AOCL for the years ended December 31, 2017, 2016, and 2015, including amounts reclassified from AOCL, is included in table 10.3 below.
We have a non-contributory defined benefit pension plan covering substantially all domestic employees, as well as a supplemental executive retirement plan. We also offer both medical and dental benefits for retired domestic employees, their eligible spouses and dependents under a postretirement benefit plan. The following tables 11.1, 11.2, and 11.3 provide the components of aggregate annual net periodic benefit cost for each of the years ended December 31, 2017, 2016, and 2015 and changes in the benefit obligation and the funded status of the pension, supplemental executive retirement and other postretirement benefit plans as recognized in the consolidated balance sheets as of December 31, 2017 and 2016.
Includes lump sum payments of $6.3 million and $11.2 million in 2017 and 2016, respectively, from our pension plan to eligible participants, which were former employees with vested benefits.
The year-end asset allocations of the plans are shown in table 11.9 below.
To determine the fair value of securities 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 market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model. In addition, on a quarterly basis, we perform quality controls over values received from the pricing source (the “Trustee”) which include comparing values to other independent pricing sources. In addition, we review annually the Trustee’s auditor’s report on internal controls in order to determine that their controls around valuing securities are operating effectively. We have not made any adjustments to the prices obtained from the independent sources.
Tables 11.10a and 11.10b set forth by level, within the fair value hierarchy, the pension plan assets and related accrued investment income at fair value as of December 31, 2017 and 2016. There were no securities that utilized Level 3 inputs.
Total return should exceed growth in the Consumer Price Index by 5.75% annually
Given the long term nature of this portfolio and the lack of any immediate need for significant cash flow, it is anticipated that the equity investments will consist of growth stocks and will typically be at the higher end of the allocation ranges above.
For measurement purposes for the other post retirement benefits plan, the increase in health care costs is estimated to be 6.5% for 2017 and 2018, decreasing to 5.0% by 2024 and remaining at this level beyond.
Table 12.2 includes the components of the net deferred tax asset as of December 31, 2017 and 2016.
Table 12.3 provides a rollforward of our deferred tax asset valuation allowance for the year ended December 31, 2015.
Table 12.4 shows the effect of the change in valuation allowance on the provision for (benefit from) income taxes for the year ended December 31, 2015.
The change in the valuation allowance that was included in other comprehensive income was a decrease $54.5 million for the year ended December 31, 2015.
We paid $22.0 million, $4.5 million, and $5.4 million in federal income tax in 2017, 2016 and 2015, respectively.
As previously disclosed, the Internal Revenue Service ("IRS") completed examinations of our federal income tax returns for the years 2000 through 2007 and issued proposed assessments for taxes, interest and penalties related to our treatment of the flow-through income and loss from an investment in a portfolio of residual interests of Real Estate Mortgage Investment Conduits ("REMICs"). The IRS indicated that it did not believe that, for various reasons, we had established sufficient tax basis in the REMIC residual interests to deduct the losses from taxable income. We appealed these assessments within the IRS and in August 2010, we reached a tentative settlement agreement with the IRS which was not finalized.
Should a settlement not be completed, ongoing litigation to resolve our dispute with the IRS could be lengthy and costly in terms of legal fees and related expenses. We would need to make further adjustments, which could be material, to our tax provision and liabilities if our view of the probability of success in this matter changes, and the ultimate resolution of this matter could have a material negative impact on our effective tax rate, results of operations, cash flows, available assets and statutory capital. In this regard, see Note 14 - "Statutory Information."
Under current guidance, when evaluating a tax position for recognition and measurement, an entity shall presume that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information. The interpretation adopts a benefit recognition model with a two-step approach, a more-likely-than-not threshold for recognition and derecognition, and a measurement attribute that is the greatest amount of benefit that is cumulatively greater than 50% likely of being realized. A reconciliation of the beginning and ending amount of unrecognized tax benefits is shown in table 12.7.
As described in Note 7 - "Debt" in April 2017 holders of approximately $202.5 million of the outstanding principal amount of our 2% Notes exercised their rights to convert their notes into shares of our common stock resulting in the delivery of approximately 29.1 million shares of our common stock to the holders. The transactions included the delivery of approximately 18.7 million from our treasury stock and an additional 10.4 million of newly issued shares. Shareholders' equity was increased by the carrying value of the notes at the time of conversion.
As described in Note 7 - "Debt" the purchase of a portion of our 9% Debentures by MGIC, and corresponding elimination of the purchased 9% Debentures in consolidation, resulted in a reduction to our consolidated shareholders' equity of approximately $6.3 million as of December 31, 2016. This reduction represents the allocated portion of the consideration paid to reacquire the equity component of the 9% Debentures, net of tax. The reduction was recognized in paid-in capital and was less than the amount ascribed to paid-in capital at original issuance of the 9% Debentures.
Our Amended and Restated Rights Agreement dated July 23, 2015 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.
Under the Agreement each outstanding share of our Common Stock is accompanied by one Right. The Distribution Date occurs on the earlier of ten days after a public announcement that a person has become an Acquiring Person, or ten business days after a person announces or begins a tender offer in which consummation of such offer would result in a person becoming an Acquiring Person. An Acquiring Person is any person that becomes, by itself or together with its affiliates and associates, a beneficial owner of 5% or more of the shares of our Common Stock then outstanding, but excludes, among others, certain exempt and grandfathered persons as defined in the Agreement. The Rights are not exercisable until the Distribution Date. Each Right will initially entitle shareholders to buy one-tenth of one share of our Common Stock at a Purchase Price of $45 per full share (equivalent to $4.50 for each one-tenth share), subject to adjustment. Each exercisable Right (subject to certain limitations) will entitle its holder to purchase, at the Rights’ then-current Purchase Price, a number of our shares of Common Stock (or if after the Shares Acquisition Date, we are acquired in a business combination, common shares of the acquiror) having a market value at the time equal to twice the Purchase Price. The Rights will expire on August 1, 2018, or earlier as described in the Agreement. The Rights are redeemable at a price of $0.001 per Right at any time prior to the time a person becomes an Acquiring Person. Other than certain amendments, the Board of Directors may amend the Rights in any respect without the consent of the holders of the Rights.
The insurance laws of 16 jurisdictions, including Wisconsin, our domiciliary state, require a mortgage insurer to maintain a minimum amount of statutory capital relative to the RIF (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the “State Capital Requirements” and, together with the GSE Financial Requirements, the “Financial Requirements.” While they vary among jurisdictions, the most common State Capital Requirements allow for a maximum risk-to-capital ratio of 25 to 1. A risk-to-capital ratio will increase if (i) the percentage decrease in capital exceeds the percentage decrease in insured risk, or (ii) the percentage increase in capital is less than the percentage increase in insured risk. Wisconsin does not regulate capital by using a risk-to-capital measure but instead requires a minimum policyholder position ("MPP"). The “policyholder position” of a mortgage insurer is its net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums.
At December 31, 2017, MGIC’s risk-to-capital ratio was 9.5 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements and its policyholder position was $2.1 billion above the required MPP of $1.2 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.
In 2017, MGIC paid a total of $140 million in dividends to our holding company, and we expect MGIC to continue to pay quarterly dividends. During 2016, distributions of $52 million were paid to our holding company from other insurance subsidiaries. These distributions were completed in conjunction with the transfer of risk and the final dissolution of those insurance entities during 2016. Our holding company subsequently contributed the majority of the funds to MGIC in relation to the transfer of risk. During 2015, distributions of $38.5 million were paid to our holding company from other insurance subsidiaries.
We have an omnibus incentive plan that was adopted on April 23, 2015. The purpose of the 2015 plan is to motivate and incent performance by, and to retain the services of, key employees and non-employee directors through receipt of equity-based and other incentive awards under the plan. The maximum number of shares of stock that can be awarded under the 2015 plan is 10.0 million. Awards issued under the plan that are subsequently forfeited will not count against the limit on the maximum number of shares that may be issued under the plan. The 2015 plan provides for the award of stock options, stock appreciation rights, restricted stock and restricted stock units, as well as cash incentive awards. No awards may be granted after April 23, 2025 under the 2015 plan. The vesting provisions of options, restricted stock and restricted stock units are determined at the time of grant. Shares issued under the 2015 plan will be newly issued shares.
The compensation cost that has been charged against income for share-based plans was $14.9 million, $11.4 million, and $11.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. The related income tax benefit recognized for share-based plans was $5.2 million, $4.0 million, and $4.2 million for the years ended December 31, 2017, 2016, and 2015, respectively.
Table 15.1 summarizes restricted stock or restricted stock unit (collectively called “restricted stock”) activity during 2017.
At December 31, 2017, the 3.3 million shares of restricted stock outstanding consisted of 2.5 million shares that are subject to performance conditions (“performance shares”) and 0.8 million shares that are subject only to service conditions (“time vested shares”). The weighted-average grant date fair value of restricted stock granted during 2016 and 2015 was $5.66 and $9.03, 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 2017, 2016 and 2015 was $15.3 million, $12.2 million, and $17.2 million, respectively.
As of December 31, 2017, there was $13.2 million of total unrecognized compensation cost related to non-vested share-based compensation agreements granted under the plans. Of this total, $9.9 million of unrecognized compensation costs relate to performance shares and $3.3 million relates to time vested shares. A portion of the unrecognized costs associated with the performance shares may or may not be recognized in future periods, depending upon whether or not the performance and service conditions are met. The cost associated with the time vested shares is expected to be recognized over a weighted-average period of 1.5 years.
Table 16.1 shows minimum the future operating lease payments as of December 31, 2017.
Total rental expense under operating leases was $2.0 million in 2017, $2.1 million in 2016, and $2.2 million in 2015.
Before paying an insurance claim, we review the loan and servicing files to determine the appropriateness of the claim amount. When reviewing the files, we may determine that we have the right to rescind coverage on the loan. We refer to insurance rescissions and denials of claims collectively as “rescissions” and variations of that term. In addition, our insurance policies generally provide that we can reduce or deny a claim if the servicer did not comply with its obligations under our insurance policy. We call such reduction of claims “curtailments.” In recent quarters, an immaterial percentage of claims received in a quarter have been resolved by rescissions. In 2016 and 2017, curtailments reduced our average claim paid by approximately 5.5% and 5.6%, respectively.
When the insured disputes our right to rescind coverage or curtail claims, we generally engage in discussions in an attempt to settle the dispute. If we are unable to reach a settlement, the outcome of a dispute ultimately would be determined by legal proceedings.
Under ASC 450-20, until a liability associated with settlement discussions or legal proceedings becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes and do not accrue an estimated loss. Where we have determined that a loss is probable and can be reasonably estimated we have recorded our best estimate of our probable loss. If we are not able to implement settlements we consider probable, we intend to defend MGIC vigorously against any related legal proceedings.
While these proceedings in the aggregate have not resulted in material liability for MGIC, there can be no assurance that the outcome of future proceedings, if any, under these laws would not have a material adverse affect on us. In addition, 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.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure, Controls and Procedures, and Other Information