The increases in our 2002 consolidated net income and net income per share over 2001 were due primarily to increases in premiums earned and equity earnings of our unconsolidated strategic investments, partially offset by higher losses and underwriting and operating expenses. During the fourth quarter of 2002, we made cumulative adjustments for our Australian operations covering the period commencing August 31, 1999 and ending September 30, 2002 to conform the results to GAAP as applied in the U.S. As a result, our reported premiums earned increased by $6.3 million, interest and dividend income decreased by $9.8 million, realized investment gains increased by $4.4 million, and amortization of deferred policy acquisition costs decreased by $1.0 million. The net impact was an increase to net income of $1.3 million. The increases in consolidated net income and net income per share in 2001 over 2000 were largely attributable to increases in premiums earned and interest and dividend income, partially offset by higher losses and underwriting and operating expenses.
The decrease in interest and dividend income in 2002 over 2001 was the result of the deployment of capital into PMI Plaza, a decline in our portfolio yield, and the cumulative adjustments for our Australian operations as discussed above. The increase in interest and dividend income in 2001 over 2000 was due to the returns on the net proceeds of our convertible debentures offering in July 2001 and the inclusion of PMI Indemnity’s investment portfolio. Our pre-tax current book yield was 5.6% at December 31, 2002, down from 5.9% at December 31, 2001 and 6.3% at December 31, 2000. Included in our net realized investment gains were impairment losses recognized for financial reporting purposes on certain impaired securities of $6.9 million in 2002 and $3.2 million in 2001.
Our primary operating subsidiary, PMI, provides private mortgage insurance against losses in the event of borrower default to residential mortgage lenders and investors in the United States. Mortgage insurance is purchased by lenders and investors, including the GSEs, seeking protection against default risk, capital relief or credit enhancement for mortgage transactions in the capital markets. PMI’s revenues increased by 9% in 2002 over 2001 and increased by 8% in 2001 over 2000, due primarily to increases in NIW and growth in PMI’s insurance portfolio.
The results of our U.S. mortgage insurance operations include the operating results of PMI and affiliated U.S. mortgage insurance and reinsurance companies. CMG and its affiliates are accounted for under the equity method of accounting. Equity earnings of CMG were $12.4 million in 2002, $10.7 million in 2001 and $8.6 million in 2000.
The components of the total primary NIW by PMI based on PMI’s definitions as well as MICA’s definitions, and the total primary NIW for the private mortgage insurance industry as reported by MICA are as follows:
MICA modified the definitions used to compile its statistical reports on a prospective basis in the third quarter of 2001. Accordingly, primary NIW based on MICA definitions in the table for 2002, 2001 and 2000 are not comparable.
for the entire pool. PMI’s pool risk in force is the aggregate of the stop loss limits of all pools less the sum of claims paid and deductibles, when applicable. GSE Pool covers mortgage loans held by or sold to the GSEs. GSE Pool risk in force was $794.1 million at December 31, 2002, $801.3 million at December 31, 2001 and $785.6 million at December 31, 2000. Old Pool is a capital markets pool product issued prior to 1994. Old Pool risk in force was approximately $0.9 billion as of December 31, 2002, $1.1 billion as of December 31, 2001 and $1.3 billion as of December 31, 2000.
Modified pool insurance-PMI currently offers modified pool insurance products that, in addition to having a stated stop loss and other risk reduction features, have exposure limits on each individual loan in the pool. Modified pool insurance may be attractive to investors and lenders seeking capital relief or a reduction of default risk beyond the protection provided by existing primary mortgage insurance or to cover loans that do not require primary mortgage insurance. To date, PMI has issued modified pool insurance principally to the GSEs as supplemental coverage. In 2002, PMI wrote $807.9 million of modified pool risk, compared to $398.8 million in 2001 and $15.9 million in 2000. Modified pool risk in force was $1,159.6 million at December 31, 2002, $414.5 million at December 31, 2001 and $15.9 million at December 31, 2000.
Credit characteristics-PMI insures less-than-A quality loans and non-traditional loans through all of its acquisition channels. PMI defines less-than-A quality loans to include loans with FICO scores generally less than 620. PMI considers a loan non-traditional if it does not conform to GSE requirements, including loan size limits, or if it includes certain other characteristics such as reduced documentation of the borrower’s income, deposit information and/or employment. PMI expects higher default and delinquency rates and generally faster prepayment speeds for less-than-A quality loans and non-traditional loans than for PMI’s A quality loans.
The following table presents PMI’s less-than-A quality loans and non-traditional loans as percentages of its bulk and flow primary NIW and modified pool insurance written:
PMI believes that the structure of its modified pool products mitigates the risk of loss to PMI from the less-than-A quality loans and non-traditional loans insured by those products. Since 2001, a majority of PMI’s modified pool risk written was through a market outreach program offered by Fannie Mae and targeted to low-income and underserved borrowers. PMI’s modified pool insurance product enhances the credit quality of these loans.
Primary insurance in force based on MICA’s definitions for 2002, 2001 and 2000 are not comparable due to the definitional changes implemented in the third quarter of 2001.
PMI’s less-than-A quality loans (loans with FICO scores less than 620) accounted for 12% of PMI’s primary risk in force in 2002 and 11% in 2001. Approximately 3% of primary risk in force was comprised of loans with FICO scores below 575 in 2002 and 2001.
Premiums written and earned-PMI’s net premiums written refers to the amount of premiums recorded based on effective coverage during a given period, net of refunds and premiums ceded under reinsurance agreements including captive reinsurance. In captive reinsurance agreements, PMI shares portions of its risk written on loans originated by certain lenders with captive reinsurance companies affiliated with such lenders. In return, a proportionate amount of PMI’s gross premiums written is ceded to captive reinsurance companies. The components of PMI’s net premiums written and premiums earned are as follows:
The increases in 2002 and 2001 ceded premiums were the result of increases in the percentage of insurance in force subject to captive reinsurance agreements. Heavy refinance volume and a higher percentage of NIW by lenders with captive reinsurance programs resulted in an increasing penetration of loans subject to captive reinsurance agreements in PMI’s portfolio. In 2002, 56% of primary NIW was subject to captive agreements compared to 45% in 2001 and 34% in 2000. At December 31, 2002, 43% of primary insurance and risk in force were subject to captive agreements, compared to 33% at December 31, 2001 and approximately 23% at December 31, 2000. We anticipate that higher levels of captive reinsurance cessions will continue to reduce PMI’s premiums earned, and that the percentage of PMI’s primary risk in force subject to captive reinsurance agreements will continue to increase as a percentage of total risk in force.
Upon cancellation of certain categories of policies, PMI refunds the portion of premiums that is unearned to the borrower or servicer. Refunded premiums in 2002 and 2001 increased significantly from 2000 due to higher levels of policy cancellations.
In 2002, PMI reported an increase in claims paid and loss adjustment expenses of 37% or $32.7 million, and an increase in loss reserves of 161% or $17.6 million. These increases were due to: higher default and claim rates associated with the maturation of PMI’s 1997 through 2000 books of primary insurance business and PMI’s GSE pool insurance portfolio; the increases in less-than-A quality loans and non-traditional loans in PMI’s 2000 insurance portfolio; and generally weaker economic conditions and higher unemployment rates throughout the U.S. The 1997 through 2000 primary insurance books of business accounted for 28% of PMI’s total primary policies in force and 25% of primary insurance in force at December 31, 2002. The increases in losses and loss adjustment expenses in 2001 were a result of the economic downturn in 2001 and to the maturation of our 1996 though 1999 books of business. The 1996 through 1999 books of business accounted for 37% of PMI’s total primary policies in force and 35% of primary insurance in force at December 31, 2001.
PMI experienced a decline in the average size of primary claims paid in 2002 over 2001 due to continued appreciation of home prices in many regions of the United States, our loss mitigation efforts, and a decrease in average insurance coverage on the loans for which claims were paid. The average size of primary claims paid increased in 2001 over 2000 due to the U.S. economic slowdown, offset by appreciation of home values and PMI’s loss mitigation efforts. PMI’s loss mitigation efforts could be limited by a deterioration in housing prices, an increase in interest rates, a further weakening of the economy, or a combination of these factors. PMI’s primary default data are presented in the following table:
Total underwriting and operating expenses-Total underwriting and operating expenses reported in the current period are comprised of (i) amortization of deferred policy acquisition costs and (ii) other underwriting and operating expenses. The composition of PMI’s total underwriting and operating expenses is shown below:
largely due to expense allocations to the Other business segment associated with contract underwriting activity, which offset total operating expenses of U.S. mortgage insurance operations, and higher ceding commissions related to captive reinsurance agreements. Contract underwriting allocations were $46.1 million in 2002, $38.8 million in 2001 and $20.2 million in 2000, and these increases reflected higher contract underwriting activity. The increase in other underwriting and operating expenses in 2001 compared to 2000 was due largely to increased payroll and related expenses and higher depreciation expenses.
PMI’s loss ratio is the ratio of total losses and loss adjustment expenses to premiums earned. The increase in the loss ratio in 2002 over 2001 was due to increased claim payments and loss reserve strengthening. The decline in the 2001 loss ratio compared with 2000 was attributable to the increase in premiums earned, partially offset by the increase in claim payments.
PMI’s expense ratio is the ratio of amortization of deferred policy acquisition costs and other underwriting and operating expenses to the net premiums written. PMI’s expense ratio excludes interest expense and non-operating and non-recurring items, as discussed previously. The decline in the expense ratio in 2002 over 2001 was primarily attributable to the increase in net premiums written. The combined ratio is the sum of the loss ratio and the expense ratio.
International mortgage insurance operations include the results of PMI Australia, PMI Europe and PMI’s Hong Kong reinsurance operations. The financial and statistical results of international operations are subject to currency rate adjustments in translation to U.S. dollar reporting.
Primary new insurance written-PMI Australia’s primary NIW includes flow channel insurance and insurance on residential mortgage-backed securities, or RMBS. In Australia, an active securitization market exists due in part to the absence of U.S.-type GSEs. RMBS transactions include insurance on seasoned portfolios comprised of prime credit quality loans that are often below 80% LTV. The following table presents the components of primary NIW by PMI Australia:
The increase in primary NIW in 2002 over 2001 was primarily the result of the inclusion of PMI Indemnity’s business in PMI Australia’s results, a large mortgage lending market and an increase in PMI Australia’s market share. The increase in primary NIW in 2001 over 2000 was due to overall mortgage market expansion driven by a first-time homeowners’ grant program from the Australian government, offset by the devaluation of the Australian dollar relative to the U.S. dollar in 2001 from 2000. A strong Australian economy combined with historically low interest rates led the momentum in residential mortgage originations in 2002. In 2002, the Australian central bank raised interest rates by 50 basis points. Growth in primary NIW could moderate in 2003 if the housing market declines, due to a reduction in the first-time homeowners’ grant and if the central bank raises interest rates and mortgage rates follow.
Primary insurance and risk in force-PMI Australia’s primary insurance in force increased to $54.1 billion at December 31, 2002, from $40.3 billion at December 31, 2001 and $19.6 billion at December 31, 2000. PMI Australia’s primary risk in force increased to $48.7 billion at December 31, 2002, from $36.6 billion at December 31, 2001 and $18.5 billion at December 31, 2000. The increases in 2002 and 2001 were the result of the inclusion of PMI Indemnity’s results and of increases in NIW as discussed above.
Premiums written and earned-PMI Australia’s net premiums written and premiums earned are as follows:
Investment income-PMI Australia’s interest and dividend income was $12.5 million in 2002, $18.3 million in 2001 and $11.7 million in 2000. The interest and dividend income decrease in 2002 was primarily the result of cumulative adjustments, discussed above in Consolidated Results. The increase in 2001 over 2000 was due largely to the acquisition of PMI Indemnity. PMI Australia’s investment portfolio at December 31, 2002 totaled $377.3 million compared to $288.6 million at December 31, 2001 and $162.1 million at December 31, 2000. The growth of PMI Australia’s investment portfolio in 2002 was primarily attributable to positive cash flows from its operations. The growth in the investment portfolio in 2001 was due to the inclusion of PMI Indemnity and a capital contribution from PMI. The pre-tax book yield was 6.4% at December 31, 2002, 6.5% at December 31, 2001 and 6.2% at December 31, 2000.
PMI Australia’s realized investment gains were $5.7 million in 2002, $5.6 million in 2001 and $0.4 million in 2000. Realized investment gains increased in 2002 primarily as a result of cumulative adjustments, discussed above. The increase in 2001 over 2000 was due to gains derived from the sale of certain fixed-income securities in PMI Australia’s investment portfolio.
PMI’s Hong Kong branch reinsures mortgage risk for the Hong Kong Mortgage Corporation. Our Hong Kong operations generated $5.9 million of gross reinsurance premiums written and $3.6 million of reinsurance premiums earned in 2002, compared to $7.1 million of gross reinsurance premiums written and $2.5 million of reinsurance premiums earned in 2001, and $4.3 million of gross reinsurance premiums written and $1.2 million of reinsurance premiums earned in 2000. The decrease in 2002 reinsurance premiums written was the result of a reduction in the penetration rate of the Hong Kong Mortgage Corporation’s mortgage insurance program and the effect of a risk retention agreement between PMI and the Hong Kong Mortgage Corporation.
The following table sets forth the results of our title insurance subsidiary, APTIC:
The increases in premiums earned in 2002 and 2001 were attributable to record volumes of total residential mortgage originations and the continued geographic expansion of our title insurance operations. The increases in 2002 and 2001 underwriting and other expenses were the result of increases in agency fees and commissions related to higher premiums earned. Agency commissions were $168.4 million in 2002, $110.0 million in 2001 and $68.3 million in 2000. The increases in losses and loss adjustment expenses in 2002 and 2001 were due primarily to additions to loss reserves, which increased to $17.3 million as of December 31, 2002, compared to $10.8 million as of December 31, 2001 and $8.0 million as of December 31, 2000. The combined ratio for our title insurance operations is the ratio of total losses and loss adjustment expenses and underwriting and other operating expenses to revenues excluding interest income.
MSC generated $38.7 million of revenue in 2002 compared to $29.2 million in 2001 and $8.3 million in 2000. These increases were largely attributable to increased contract underwriting activity in connection with higher mortgage origination volume, and to increases in fees charged for contract underwriting services. Other operating expenses, which were incurred by MSC and The PMI Group, increased to $76.6 million in 2002 from $62.9 million in 2001 and $36.2 million in 2000. These increases were the result of increased contract underwriting expense allocations (see U.S. mortgage insurance operations business segment discussions above) related to higher mortgage origination volume, and to higher contract underwriting remedies expenses. Contract underwriting allocations were $46.1 million in 2002, $38.8 million in 2001 and $20.2 million in 2000. Contract underwriting remedies incurred were $6.5 million in 2002, compared to $3.3 million in 2001 and $2.3 million in 2000.
Interest and dividend income was $18.7 million in 2002 compared to $14.1 million in 2001 and $6.0 million in 2000. The increases were driven by growth of our investment portfolios, due primarily to the proceeds of our convertible debentures offering in July 2001. The $360.0 million proceeds from the offering were reduced by underwriting fees, repayment of a loan by PMI Australia in 2001, and extinguishment of $88.6 million of long-term debt and preferred capital securities in 2001. Interest expense on the convertible debentures and long-term debt and distributions on the preferred capital securities were $19.5 million in 2002, compared to $20.2 million in 2001 and $15.8 million in 2000. The decrease in 2002 was attributable to the partial extinguishment of our long-term debt and preferred capital securities. The increase in 2001 was primarily due to the interest expense on the convertible debentures.
domicile for insurance regulatory purposes, provide that PMI may pay out of any available surplus account, without prior approval of the Director of the Arizona Department of Insurance, dividends during any 12-month period in an amount not to exceed the lesser of 10% of policyholders’ surplus as of the preceding year end or the last calendar year’s investment income. In addition to Arizona, other states may limit or restrict PMI’s ability to pay shareholder dividends. For example, California, New York and Illinois prohibit mortgage insurers from declaring dividends except from undivided profits remaining above the aggregate of their paid-in capital, paid-in surplus and contingency reserves. Under Arizona law, PMI would be able to pay dividends of approximately $27.8 million in 2003 without prior approval of the Director of the Arizona Department of Insurance. In 2002, PMI declared and paid dividends of $100.0 million to The PMI Group.
The laws of Florida limit the payment of dividends by APTIC to The PMI Group to, subject to certain restrictions, the greater of (i) 10% of policyholders’ surplus derived from realized net operating profits and net realized capital gains, or (ii) APTIC’s entire net operating profits and realized net capital gains derived during the immediately preceding calendar year. As with PMI, the various credit rating agencies and insurance regulatory authorities have broad discretion to affect the payment of dividends to The PMI Group by APTIC. Under Florida law, APTIC would be able to pay dividends of $9.0 million in 2003 without prior permission from the Florida Department of Insurance. APTIC declared and paid a cash dividend of $2.5 million to The PMI Group in 2002.
The PMI Group’s principal uses of funds are the payments of dividends to shareholders, common stock repurchases, investments and acquisitions, and interest payments. The PMI Group’s board of directors authorized a stock repurchase program in the amount of $100.0 million in 1998. In December 2002 and January 2003, we repurchased $45.3 million of our common stock, and there is no available balance remaining under the 1998 authorization. On February 20, 2003, The PMI Group’s board of directors authorized a new stock repurchase program in the amount of $100 million. To date, no repurchases have occurred under this authorization.
We manage our capital resources based on our cash flows, total capital and rating agency requirements. As of December 31, 2002, our shareholders’ equity was $2.2 billion. Our long-term debt and other capital securities outstanding at December 31, 2002 was $471.5 million, which consists of the following:
Our consolidated reserves for losses and loss adjustment expenses with respect to insurance claims increased to $350.8 million at December 31, 2002 from $314.6 million at December 31, 2001. This increase was due to: increases in the reserve balances for U.S. primary insurance books of business as a result of higher levels of default; increases in the reserve balances for our title insurance business as a result of increased mortgage origination volume; and increases in the reserve balances for our Australian mortgage insurance books of business, partially as a result of the strengthening of the Australian dollar relative to the U.S. dollar in 2002.
PMI’s claims-paying ability ratings from certain national rating agencies have been based in part on the captive reinsurance agreements and on a capital support commitment from Allstate Insurance Company, or Allstate, PMI’s former parent company. Under the terms of a runoff support agreement with Allstate, in the event (i) PMI’s risk-to-capital ratio exceeds 23 to 1, or exceeds such lesser amount then required by the State of Arizona or California, (ii) PMI’s statutory policyholder surplus is less than $15.0 million, or (iii) a third party beneficiary brings a claim under the runoff support agreement, then Allstate may, at its option, in satisfaction of certain obligations it may have under such agreement (a) pay to PMI (or to The PMI Group for contribution to PMI) an amount equal to claims relating to policies written prior to termination of the Allstate support arrangements which are not paid by PMI or (b) pay such claims directly to the policyholder. In the event Allstate makes any payment contemplated by the runoff support agreement, which possibility we believe is remote, Allstate will be entitled to receive, at its option, subordinated debt or preferred stock of PMI or The PMI Group, as applicable, in return.
Effective December 31, 2002, PMI terminated a capital support agreement dated September 18, 1997 in favor of its sister corporation, APTIC, under which PMI agreed to maintain APTIC’s capital and surplus at an amount not less than that required for a Fitch claims paying ability rating of “AA-,” subject to an aggregate limit of $10 million. The support agreement was replaced on the same date by a substantially equivalent guarantee of The PMI Group in favor of APTIC, its direct subsidiary, under which The PMI Group agrees to maintain APTIC’s capital and surplus at a Fitch “AA-” level subject to an aggregate limit of $10 million.
PMI’s ratio of net risk in force to statutory capital, or statutory risk-to-capital ratio, at December 31, 2002 was 11.3 to 1 compared to 13.0 to 1 at December 31, 2001.
The “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” as well as disclosures included elsewhere in this report, are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingencies. Actual results may differ significantly from these estimates under different assumptions or conditions. We believe that the following critical accounting policies involved significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition-We generate a significant portion of our revenues from mortgage insurance premiums on either a monthly, annual or single payment basis. Monthly premiums are earned as coverage is provided. Annual premiums are earned on a monthly pro-rated basis over the year of coverage. Single premiums
Reserves For Losses and Loss Adjustment Expenses-We establish reserves for losses and loss adjustment expenses, or LAE, to recognize the estimated liability for potential losses and related loss expenses in connection with a borrower default on their mortgage payments. Our losses and LAE reserves are estimated based on unpaid losses and LAE on reported mortgage loans in default, as well as estimated defaults incurred but not reported by the lender. Our loss reserves are determined by assumptions primarily derived from an analysis of default and recovery experience. Key assumptions used in the estimation process, including expected claim rates, average claim sizes, claim severity, and expected costs to settle claims, could have significant effects on the reserve balances. We regularly evaluate our estimates and assumptions based upon historical experience adjusted for current economic conditions and projected future economic trends.
We do not rely on a single estimate to determine our loss reserves. To ensure the reasonableness of the estimates, we develop scenarios using generally recognized actuarial projection methodologies that result in a range of reasonable possible losses and LAE. Each scenario in the loss reserve model is assigned different weightings to actual claims experience in prior years to project the current liability. Our estimate was approximately the midpoint of this range for 2002, which represented the most reasonable estimate based on our analysis and assessment of current economic conditions.
Changes in loss reserves can materially affect our net income. The process of reserving for losses requires significant judgment of management and the establishment of loss reserves is subject to inherent uncertainty associated with key assumptions used in our analysis. Different estimates could have been used in the current period, and changes in the accounting estimates are reasonably likely to occur from period to period based on the economic conditions. We monitor the reasonableness of the judgments made in our prior year estimation process and adjust our current year assumptions as appropriate. However, the loss provisioning process is complex and subjective and, therefore, the ultimate liability may vary significantly from our estimates.
Deferred Policy Acquisition Costs-Our policy acquisition costs are related to the issuance of primary mortgage insurance policies, including acquiring, underwriting and processing new business, as well as sales and marketing related activities. We defer policy acquisition costs when incurred and amortize these costs in proportion to related premiums earned for each policy year. The estimates for each policy year are updated regularly to reflect actual experience and any changes to key assumptions such as persistency or loss development. We review our estimation process on a regular basis and any adjustments made to the estimates are reflected in the current year’s operating results.
General economic factors may adversely affect our loss experience and demand for mortgage insurance.
Our losses result from borrowers’ inability to continue to make mortgage payments. The amount of any loss depends in part on whether the home of a borrower who defaults on a mortgage can be sold for an amount that will cover unpaid principal and interest and the expenses of the sale. Favorable economic conditions generally reduce the likelihood that borrowers will lack sufficient income to pay their mortgages and also favorably affect the value of homes, reducing, and in some cases even eliminating, the risk of a loss from a mortgage default. We believe that our loss experience could materially increase as a result of:
If interest rates decline, home values increase or mortgage insurance cancellation requirements change, the length of time that PMI’s policies remain in force and our revenues could decline.
appreciation in home values experienced by the homes underlying the mortgages of the insurance in force, which can result in the cancellation of mortgage insurance; and
changes in the mortgage insurance cancellation policies of mortgage lenders and investors.
Although we generally have a history of expanding our business during periods of low interest rates, the resulting increase of new insurance written may not be adequate to compensate us for PMI’s loss of insurance in force arising from policy cancellations.
A decline in the volume of low down payment housing could reduce the demand for private mortgage insurance and therefore, our revenues.
The risk-based capital rule issued by the Office of Federal Housing Enterprise Oversight could require us to obtain a claims-paying ability rating of “AAA” and could cause PMI’s business to suffer.
On February 20, 2002, the Office of Federal Housing Enterprise Oversight, or OFHEO, finalized a risk-based capital rule that treats credit enhancements issued by private mortgage insurance companies with claims-paying ability ratings of “AAA” more favorably than those issued by private mortgage insurance companies with “AA” ratings. The rule also provides capital guidelines for the GSEs in connection with their use of other types of credit protection counterparties in addition to mortgage insurers. Under the rule, which became effective in the third quarter of 2002, OFHEO tests the GSEs’ capital position every quarter. PMI has an “AA+” rating. It is not apparent at this point that the finalized rule will result in the GSEs increasing their use of either “AAA”-rated mortgage insurers instead of “AA”-rated entities or credit protection counterparties other than mortgage insurers. Changes in the preferences of the GSEs for private mortgage insurance to other forms of credit enhancement as a result of the new OFHEO risk-based capital rule, or a tiering of mortgage insurers based on their credit rating, could adversely affect our financial condition and results of operations.
PMI’s revenues and profits could decline if we lose market share as a result of industry competition.
federal and state governmental and quasi-governmental agencies, principally the Federal Housing Administration, or FHA, and the Veterans Administration, or VA; and
If mortgage lenders and investors select alternatives to private mortgage insurance, the amount of insurance that we write could decline, which could reduce our revenues and profits.
member institutions providing credit enhancement on loans sold to a Federal Home Loan Bank;
mortgage lenders structuring mortgage originations to avoid private mortgage insurance, such as a first mortgage with an 80% loan-to-value ratio and a second mortgage with a 10% loan-to-value ratio, which is referred to as an 80/10/10 loan, rather than a first mortgage with a 90% loan-to-value ratio.
PMI is dependent upon a small number of customers. Through their various origination channels, PMI’s top ten customers accounted for approximately 44% of PMI’s premiums earned in 2002. The loss of business from any major customer, through the use of self-insurance, other types of credit enhancement or otherwise, could seriously harm our business and results of operations.
Mortgage insurers, including PMI, may acquire significant percentages of their business through negotiated transactions (including bulk primary and modified pool insurance) with a limited number of customers. For one type of negotiated transaction, modified pool insurance, the majority of PMI’s business in 2002 came through PMI’s participation in a market outreach program offered by Fannie Mae in which PMI’s modified pool insurance product enhances the primary coverage offered by PMI and other insurers. This market outreach program allows lenders to take a more comprehensive view of a borrower’s creditworthiness and expand the benefit of conventional financing to homeowners. The loss of Fannie Mae as a customer of PMI could reduce our revenue, and if not replaced, harm our financial condition and results of operations.
The GSEs have products for which they will, upon receipt from lenders of loans with primary mortgage insurance, restructure the mortgage insurance coverage by reducing the amount of primary insurance coverage and adding a second layer of insurance coverage, usually in the form of pool insurance. Under these programs, the GSEs may provide services to the mortgage insurer and the mortgage insurer may be required to pay fees to the GSEs for the benefits provided through the reduced insurance coverage or the services provided. These new products may prove to be less profitable than PMI’s traditional mortgage insurance business and, if they become widely accepted, could harm our financial condition and results of operations.
The institution of new eligibility guidelines by Fannie Mae could harm our profitability and reduce our operational flexibility.
Mortgage lenders increasingly require us to reinsure a portion of the mortgage insurance default risk on mortgages that they originate with their captive mortgage reinsurance companies, which will reduce PMI’s net premiums written.
The premiums PMI charges for mortgage insurance on less-than-A quality loans and non-traditional loans, and the associated investment income, may not be adequate to compensate for future losses from these products.
PMI’s primary insurance and modified pool insurance written includes less-than-A quality loans and non-traditional loans. The credit quality, loss development and persistency, which is the percentage of insurance policies at the beginning of a 12-month period that remain in force at the end of the period, on these loans can vary significantly from PMI’s traditional A-quality loan business. We have experienced higher default rates for these loans and expect that trend to continue. We cannot be sure that this book of business will generate the same
returns as PMI’s standard business or that the premiums that PMI charges on less-than-A quality loans and non-traditional loans will adequately offset the associated risk.
9% of PMI’s primary risk in force consisted of adjustable rate mortgages, which we refer to as ARMs. In our experience, although ARMs have lower initial interest rates, ARMs have claims frequency rates that exceed the rates associated with PMI’s book of business as a whole.
The concentration of primary insurance in force in relatively few states could increase claims and losses and harm our financial performance.
We delegate underwriting authority to mortgage lenders that may cause us to insure unacceptably risky mortgage loans, which could increase claims and losses.
If we fail to properly underwrite mortgage loans under PMI’s contract underwriting services, we may be required to assume the cost of repurchasing those loans. In addition, we may not be able to recruit a sufficient number of qualified underwriting personnel.
assumption of some or all of the costs of repurchasing insured and uninsured loans from the GSEs and other investors; or
the provision of indemnification to customers in the event that the loans default for varying reasons, including, but not limited to, underwriting errors.
The majority of claims with respect to primary insurance written through PMI’s flow channel have historically occurred during the third through the sixth years after issuance of the policies. As of December 31, 2002, approximately 91% of PMI’s risk in force was written after December 31, 1997. As a result, we believe PMI’s loss experience may increase as PMI’s policies continue to age. If the claim frequency, which is the percentage of loans insured that have resulted in a paid claim, on PMI’s risk in force significantly exceeds the claim frequency that was assumed in setting PMI’s premium rates, our financial condition and results of operations and cash flows would be harmed.
Our loss reserves may be insufficient to cover claims paid and loss-related expenses incurred.
We establish loss reserves to recognize the liability for unpaid losses related to insurance in force on mortgages that are in default. These loss reserves are based upon our estimates of the claim rate and average claim amounts, as well as the estimated costs, including legal and other fees, of settling claims. These estimates are regularly reviewed and updated using currently available information. Any adjustments, which may be material, resulting from these reviews are reflected in our consolidated results of operations. Our reserves may not be adequate to cover ultimate loss development on incurred defaults. Our financial condition and results of operations could be seriously harmed if our reserve estimates are insufficient to cover the actual related claims paid and loss-related expenses incurred.
If we are unable to introduce and successfully market new products and programs, our competitive position could suffer.
the necessity to make capital contributions to our subsidiaries pursuant to capital support agreements;
changes in the views of rating agencies of our risk profile.
Our principal sources of funds are dividends from our subsidiaries, investment income and funds that may be raised from time to time in the capital markets. Factors that may affect our ability to maintain and meet our capital and liquidity needs include:
The state of Arizona, PMI’s state of domicile for insurance regulatory purposes, and other states limit the amount of insurance risk that may be written by PMI, based on a variety of financial factors, primarily the ratio of net risk in force to statutory capital, or the risk-to-capital ratio.
PMI has several alternatives available to help control its risk-to-capital ratio, including:
We may not be able to raise additional funds, or do so on a timely basis, in order to make a capital contribution to PMI. In addition, third party credit enhancements may not be available to PMI or, if available, may not be available on satisfactory terms. A material reduction in PMI’s statutory capital, whether resulting from underwriting or investment losses or otherwise, or a disproportionate increase in risk in force, could increase its risk-to-capital ratio. An increase in PMI’s risk-to-capital ratio could limit its ability to write new business, impair PMI’s ability to pay dividends to The PMI Group and seriously harm our financial condition and results of operations.
challenges in attracting and retaining key foreign-based employees, customers and business partners in international markets;
the burdens of complying with a wide variety of foreign laws;
potential increases in the level of defaults and claims on policies insured by foreign-based subsidiaries;
the need to integrate our domestic insurance subsidiaries’ risk management technology systems and products with those of our foreign operations;
We have made significant investments in the equity securities of several privately-held companies, including:
CMG, which offers mortgage insurance for loans originated by credit unions; and
Fairbanks, RAM Re Holdings, CMG and Truman are accounted for on the equity method of accounting in our consolidated financial statements. Our investments in these unconsolidated strategic investments totaled $289.8 million as of December 31, 2002, compared to $204.9 million as of December 31, 2001, and our equity in earnings from these unconsolidated strategic investments was $44.2 million in 2002, compared to $18.8 million in 2001. Although our ability to engage in additional strategic investments is subject to the availability of capital and maintenance of our claims-paying ability ratings by rating agencies, we currently expect to make additional strategic investments in the future.
The nature of the businesses conducted by Fairbanks, RAM Re and Truman differs significantly from our core business of providing residential mortgage insurance. Accordingly, these companies are subject to a number of significant risks that arise from the nature of their business. For example, Fairbanks’ business is subject to extensive regulation, supervision and licensing by various state and federal agencies. On the federal level, Fairbanks’ business is regulated by, among other statutes and regulations, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, RESPA, the Truth in Lending Act and the Home Ownership and Equity Protection Act of 1994. Fairbanks is also subject to the laws of the states in which it is licensed as a debt collector relating to its practices, procedures and type and amount of fees it can collect from borrowers. Subprime servicers, including Fairbanks, have come under increasing regulatory and public scrutiny. In October 2002, the Federal Trade Commission, or FTC, informed Fairbanks that it is the subject of an FTC investigation to determine whether Fairbanks’ loan servicing or other practices violate or have violated the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, Section 5 of the Federal Trade Commission Act or other laws enforced by the FTC. In March 2003, Senators Barbara Mikulski and Paul Sarbanes requested the U.S. Department of Housing and Urban Development to initiate an investigation into Fairbanks’ servicing practices. Failure to comply with applicable regulations can lead to, among other remedies, termination or suspension of licenses, class action lawsuits and administrative enforcement actions. Also in March 2003, S&P placed its “Strong” residential subprime and residential special service rankings assigned to Fairbanks on “CreditWatch with negative implications.” S&P stated that the CreditWatch placement reflected increased regulatory scrutiny of Fairbanks’ servicing practices.
Fairbanks is also subject to private litigation, including a number of purported class action suits, alleging violations of federal and state laws governing the activities of servicers. We expect that as a result of the publicity surrounding lending and servicing practices, Fairbanks may be subject to other purported class action suits in the future.
Fairbanks has procedures and controls to monitor compliance with numerous federal, state and local laws and regulations. More restrictive laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive which could hinder Fairbanks ability to operate profitably.
Our investment in Fairbanks, and consequently our financial results, could be negatively impacted by the ultimate resolution of the litigation and/or pending or threatened actions involving Fairbanks.
We do not control Fairbanks and cannot prevent Fairbanks from defaulting on its indebtedness, which default could under certain circumstances constitute an event of default under our convertible debentures.
Fairbanks utilizes various notes payable and line of credit arrangements to finance servicing advances that it makes in the normal course of business and to finance the acquisition of mortgage servicing rights. These borrowing arrangements require repayment of the financed amount as servicing receivables are collected or in the case of mortgage servicing rights, using monthly amortizing payments not to exceed 18 months. Financing counterparties include various Wall Street investment banks and national commercial lenders. Fairbanks’ total notes payable, cash and cash equivalents and shareholders equity as of December 31, 2002 were approximately $261 million, $44 million and $177 million, respectively. As of December 31, 2002, Fairbanks owned approximately $140 million of purchased mortgage servicing rights.
result from acts by affiliates of Fairbanks, which may include entities over which Fairbanks does not have complete control. In addition, a default may occur as a result of certain actions by rating agencies with respect to Fairbanks’ ratings. Upon the occurrence of an event of default, we may not have sufficient funds to pay the amounts due under our convertible debentures. If we do not have sufficient funds on hand or available to us through the declaration and payment of dividends by our subsidiaries (which dividends are subject to significant restrictions), we will need to seek additional financing to obtain the cash due on the convertible debentures. Additional financing may not be available to us in the amounts necessary or on terms we deem favorable.
Participants in the mortgage lending and mortgage insurance industries increasingly rely on e-commerce and other technology to provide and expand their products and services. An increasing number of our customers require that we provide our products and services electronically via the Internet or electronic data transmission, and the percentage of our new insurance written delivered electronically is increasing. We expect this trend to continue, and accordingly, we believe that it is essential that we continue to invest substantial resources in maintaining electronic connectivity with our customers and, more generally, on e-commerce and technology. Our business will suffer if we do not satisfy all technological demands of our customers and keep pace with the technological capabilities of our competitors.
Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and
Investments-The Company has designated its entire portfolio of fixed income and equity securities as available-for-sale. These securities are recorded at fair value, based on quoted market prices, with unrealized gains and losses, net of deferred income taxes, accounted for as a component of accumulated other comprehensive income in shareholders’ equity. The Company evaluates its investments regularly to determine whether there are declines in value and if such declines meet the definition of other-than-temporary impairment in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities. The market value of a security below cost or amortized cost for consecutive quarters is a potential indicator of an other-than-temporary impairment. When the Company determines a security has suffered an other-than-temporary impairment, the impairment loss is recognized, to the extent of the decline, as a realized investment loss in the current period’s earnings.
The Securities and Exchange Commission requires public companies to disclose condensed financial statement information in the footnotes for significant unconsolidated subsidiaries, individually or in the aggregate if income from unconsolidated subsidiaries is in excess of 10% of total income. In 2002, this income test was exceeded for unconsolidated subsidiaries in the aggregate for the Company. As such, a footnote has been provided for the Company’s proportionate share of balance sheet and statement of operations line items. The condensed financial statements have been presented on a combined basis in the footnotes.
Property and Equipment-Property and equipment, including software, are carried at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to 39 years. Leasehold improvements are recorded at cost and amortized over the lesser of the useful life of the assets or the remaining term of the related lease.
Policy Acquisition Costs-The Company defers certain costs in its mortgage insurance operations relating to the acquisition of new insurance and amortizes these costs against related premium revenue in order to match costs and revenues. These costs are primarily associated with the acquisition, underwriting and processing of new business, including contract underwriting and sales related activities. To the extent the Company is compensated by customers for contract underwriting, those underwriting costs are not deferred. Costs related to the issuance of mortgage insurance business are initially deferred and reported as deferred policy acquisition costs. SFAS No. 60, Accounting and Reporting for Insurance Enterprises, specifically excludes mortgage guaranty insurance from its guidance relating to the amortization of deferred policy acquisition costs. Amortization of these costs for each underwriting year book of business is charged against revenue in proportion to estimated gross profits. The estimates for each underwriting year are updated regularly to reflect actual experience and any changes to key assumptions such as persistency or loss development.
Title policy claims reserves are established based on estimated amounts required to settle claims, including expenses for defending claims, for which notice has been received and an amount estimated to satisfy future claims incurred but not reported for policies issued through December 31, 2002. Management believes that the title policy claim reserves at December 31, 2002 are appropriately established in the aggregate and are adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred as of that date.
The Company’s reserving process is based upon assumptions from past experience, adjusted for the anticipated effect of current economic conditions and projected future economic trends, including the real estate market, housing values, unemployment rates and their effect on recent claim rates and claim severity. Therefore, the reserves are necessarily based on estimates and the ultimate liability may vary materially from such estimates. Management regularly reviews the evaluation of the loss reserves utilizing current information and updates the assumptions in the estimation process accordingly. Any resulting adjustments are reflected in the current period’s earnings. Management believes that the reserves for losses and loss adjustment expenses at December 31, 2002 were appropriately established on an aggregate basis and were adequate to cover the ultimate net cost of settling reported and unreported claims.
Revenue Recognition-Primary and pool mortgage insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide payment of premiums on a monthly, annual or single basis. Upon renewal, the Company is not able to re-underwrite or re-price its policies. SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the earning of insurance premiums. Premiums written on a monthly basis are earned as coverage is provided. Monthly premiums accounted for approximately 75% of gross premiums written from our mortgage insurance operations in 2002, compared with 79% in 2001 and 78% in 2000. Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage. Primary mortgage insurance premiums written on policies covering more than one year is referred to as single premiums. A portion of single premiums is recognized immediately in earnings, and the remaining portion is deferred as unearned premiums and earned over the expected life of the policy, a range of seven to 15 years. Rates used to determine the earning of single premiums are estimates based on the expiration of risk. Accordingly, the unearned premiums represent the portion of premiums written that is applicable to the estimated unexpired risk of insured policies.
Reinsurance-PMI uses reinsurance to reduce net risk in force, optimize capital allocation, and comply with a statutory provision adopted by several states that limits the maximum mortgage insurance coverage to 25% for any single risk. The Company’s reinsurance agreements typically provide for a recovery of a proportionate level of claim expenses from reinsurers, and reinsurance recoverable is recorded as an asset. The Company remains liable to its policyholders if the reinsurers are unable to satisfy their obligations under the agreements as with all reinsurance contracts. Reinsurance recoverable on paid losses and estimates are based on
The majority of the Company’s existing reinsurance contracts are captive reinsurance agreements. In captive reinsurance agreements, a portion of the risk insured by PMI is reinsured with the mortgage originator or investor through a reinsurer that is affiliated with the mortgage originator or investor. Ceded premiums for U.S. captive reinsurance accounted for 77% of total ceded premiums written in 2002 compared to 80% in 2001 and 77% in 2000.
Special Purpose Entities-Certain insurance transactions entered into by PMI Europe require the use of foreign Special Purpose Entities (“SPEs”). These SPEs are wholly-owned subsidiaries of the Company, and accordingly, are consolidated in the Company’s financial statements. The Company is not affiliated with any SPEs that qualify for off-balance sheet treatment.
SFAS No. 123 requires the pro forma disclosure of net income and earnings per share using the fair value method. If the computed fair values of the 2002, 2001 and 2000 awards had been amortized to expense over the vesting period of the awards, the Company’s net income, basic net income per share and diluted net income per share would have been reduced to the pro-forma amounts indicated below:
In March 2000, the Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation (“FIN 44”), was issued. FIN 44 clarifies the application of APB 25 for certain issues. The Company adopted the provisions of FIN 44 in 2000. The adoption of the interpretation did not have a material effect on the Company’s consolidated financial statements.
asset or liability is expected to be realized or settled. Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable or deductible amounts in future years.
Foreign Currency Translation-The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with SFAS No. 52, Foreign Currency Translation. Assets and liabilities denominated in non-U.S. dollar currencies are translated into U.S. dollar equivalents using either the year-end spot exchange rates or historical rates. Revenues and expenses are translated at weighted-average exchange rates. The effects of translating operations with a functional currency other than the reporting currency are reported as a component of accumulated other comprehensive income included in shareholders’ equity.
The Company reported the components of comprehensive income in its consolidated statements of stockholders’ equity.
Stock Split-In June 2002, the Company effected a two-for-one stock split in the form of a stock dividend. All common share and per share data have been adjusted to reflect the stock split.
Earnings Per Share-Basic earnings per share (“EPS”) excludes dilution and is based on net income available to common shareholders and the weighted-average common shares that are outstanding during the period. Diluted EPS is based on net income available to common shareholders and the weighted-average of dilutive common shares outstanding during the period. Weighted-average dilutive common shares reflect the potential increase of common shares if outstanding securities were converted into common stock, or if contracts to issue common stock, including stock options issued by the Company that have a dilutive impact, were exercised. Net income available to common shareholders is the same for computing basic and diluted EPS. The convertible debt outstanding has not been included in the calculation of diluted shares outstanding as it is antidilutive for the periods presented.
Reclassifications-Certain items in the prior year’s financial statements have been reclassified to conform to the current year’s presentation.
Effective January 1, 2002, the Company adopted SFAS No. 141, Business Combinations (“SFAS No. 141”), and SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). Under SFAS No. 142, any unamortized negative goodwill related to an excess of fair value over cost arising from business combinations completed before July 1, 2001 must be written off and recognized as a cumulative effect of a change in accounting principle upon the adoption of SFAS No. 142. Accordingly, the Company realized a $7.2 million gain for the remaining balance of negative goodwill in the first quarter of 2002, which was originally recorded in connection with the acquisition of PMI Ltd in 1999.
In December 2002, the FASB issued SFAS No. 148, Accountingfor Stock-Based Compensation-Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS
The Company determined that the decline in market value of certain equity securities met the definition of other-than-temporary impairment as prescribed in SFAS No. 115, and recognized realized losses of $6.9 million and $3.2 million in the years ended December 31, 2002 and 2001, respectively.
At December 31, 2002, fixed income and short-term securities with a fair value of $19.6 million were on deposit with regulatory authorities as required by law.
The following table summarizes deferred policy acquisition cost activity for the years ended December 31, 2002, 2001 and 2000:
Deferred policy acquisition costs are affected by qualifying costs deferred in the period and amortization of previously deferred costs in such period. In periods where there is growth in new business, the asset will generally increase because the amount of acquisition costs being deferred exceeds amortization expenses. Included in 2001 policy acquisition costs incurred and deferred was $4.5 million of deferred costs from the acquisition of PMI Indemnity.
In December 2000, the Company executed a purchase agreement for a seven-story commercial building to serve as its new executive offices. The total purchase price was $74.0 million in cash. In connection with relocating its corporate headquarters in August 2002, the Company performed an evaluation of the estimated costs with respect to the relocation and recognized a $12.2 million pre-tax charge related to lease abandonment and relocation costs in the second quarter of 2002. The charge consists of $8.3 million for the estimated loss on the abandonment of the lease obligations for the previous home office space, $1.7 million for the write-off of abandoned fixed assets, and $2.2 million for other relocation and employee retention expenses.
The effects of reinsurance on premiums written, premiums earned and losses and loss adjustment expenses of the Company’s operations for the years ended December 31, 2002, 2001 and 2000 are as follows:
The components of the income tax expense for 2002 included a foreign provision for current tax expense of approximately $15 million and a deferred tax expense of approximately $1 million primarily related to PMI Australia and PMI Europe.
A reconciliation of the statutory federal income tax rate to the effective tax rate reported on income before income taxes is shown in the following table:
NOTE 12. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURE OF THE COMPANY
debenture and a related guarantee and expense agreement constitute a full and unconditional guarantee by TPG of the Issuer Trust’s obligations under the Capital Securities. The Capital Securities are subject to mandatory redemption under certain circumstances. In 2001, the Company repurchased $51.5 million of the Capital Securities. The early extinguishment of a portion of this debt resulted in an extraordinary loss of $2.9 million, net of tax.
Rent expense for all leases was $11.5 million for 2002, $12.8 million for 2001 and $11.3 million for 2000.
Income Taxes-In the fourth quarter of 2002, the Company received a notice of assessment from the California Franchise Tax Board (“FTB”) for 1997 in the amount of $2.8 million, not including the federal tax benefits from the payment of such assessment or interest that might be included on amounts, if any, ultimately paid to the FTB. The assessment is the result of a memorandum issued by the FTB in April 2002. The memorandum, which is based partly on the California Court of Appeals decision in Ceridian v. Franchise Tax Board, challenges the exclusion from California income tax of dividends received by holding companies from
Dividends-Under Arizona insurance law, PMI may pay during any twelve-month period, without prior approval of the Arizona Director of Insurance (“Director”), dividends in an amount not to exceed the lesser of (i) 10% of policyholders’ surplus as of the preceding year-end, and (ii) the previous calendar year’s investment income. Dividends that exceed this amount are known as “extraordinary dividends” and require the prior approval of the Director. While Arizona permits dividends, whether ordinary or extraordinary, to be paid out of any capital and surplus account (other than paid-in capital), other state insurance laws require the payment of dividends to be made from the unassigned funds surplus account only. In 2002, following receipt of approval from the Director, PMI declared and paid an extraordinary dividend of $100 million to TPG. The dividend was paid in cash ($66 million) and stock of PMI’s former subsidiary, Fairbanks Capital Corp. as well as its limited partnership interest in Truman. The combined value of the stock of Fairbanks and Truman at time of dividend was approximately $34 million. Following the dividend, Fairbanks became a direct subsidiary of TPG.
Florida, where APTIC is domiciled, also limits the amount of dividends that an insurer may pay in any 12 month period without the prior approval of the Florida Department of Insurance and require all dividends to be paid only from its available and accumulated surplus funds derived from realized net operating profits on its business and net realized capital gains. Dividends that exceed the applicable limits are subject to the prior approval of the Florida Department of Insurance. In 2002, APTIC declared and paid a cash dividend of $2.5 million to TPG, substantially the full amount of the dividend that could be paid that year without prior permission from the Florida Department of Insurance. In addition to the dividend restrictions under various state laws discussed above, the Company’s credit agreement limits the amount of annual dividends that can be paid by PMI to its net income in the prior year.
Preferred Stock-TPG’s restated certificate of incorporation authorizes the Board of Directors to issue up to 5,000,000 shares of preferred stock of TPG in classes or series and to set the designations, preferences,
qualifications, limitations or restrictions of any class or series with respect to the rate and nature of dividends, the price and terms and conditions on which shares may be redeemed, the amount payable in the event of voluntary or involuntary liquidation, the terms and conditions for conversion or exchange into any other class or series of the stock, voting rights and other terms. The Company may issue, without the approval of the holders of common stock, preferred stock that has voting, dividend or liquidation rights superior to the common stock, which may adversely affect the rights of holders of common stock.
Pursuant to the support agreement described in Note 20, Capital Support Agreements, the Company has agreed that, in the event that Allstate makes a payment contemplated by the Allstate Support Agreements or the runoff support agreement, Allstate will have the right to receive preferred stock of TPG or PMI with a liquidation preference equal to the amount of such payment. Such preferred stock will rank senior in right of payment to the issuer’s common stock and, so long as such preferred stock is outstanding, the issuer thereof will be prohibited from paying any dividends or making any other distributions on its common stock.
After one year of service, full-time and part-time employees of the Company participate in The PMI Group, Inc. Retirement Plan (“Plan”), a noncontributory defined benefit plan. The Plan has been funded by the Company to the fullest extent permitted by federal income tax rules and regulations. In addition, certain employees whose earnings exceed $200,000 per year participate in The PMI Group, Inc. Supplemental Employee Retirement Plan, a noncontributory defined benefit plan. Benefits under both plans are based upon the employees’ length of service, average annual compensation and estimated social security retirement benefits.
The Company provides certain health care and life insurance benefits for retired employees, which we refer to as “OPEB Plan”. Generally, qualified employees may become eligible for these benefits if they retire in accordance with the Company’s established retirement policy and are continuously insured under the Company’s group plans or other approved plans for ten or more years prior to retirement. The Company shares the cost of the retiree medical benefits with retirees based on years of service. The Company has the right to modify or terminate these plans.
The following table presents certain information with respect to the Company’s benefit plans as of December 31, 2002, 2001 and 2000:
The following is a summary of the stock option activity in the Equity Incentive Plan during 2002, 2001 and 2000:
Considerable judgment is required in interpreting market data to develop the estimates of fair value and, therefore, changes in the assumptions may have a material effect on the fair valuation estimates. A number of the Company’s significant assets and liabilities, including deferred policy acquisition costs, property and equipment, loss reserves, unearned premiums and deferred income taxes are not considered financial instruments.
Included in the results of international mortgage insurance are the results of the Australian, European, and Hong Kong operations. We commenced operations in Europe in February 2001. The Australian operating results for 2000 results reflected eleven months of activity of PMI Ltd due to the one-month lag reporting period, whereas 2001 reflected thirteen months of activity as we began to report our foreign subsidiaries on the same calendar month as U.S. operations. The Australian operating results for 2001 also includes four months of PMI Indemnity’s activity.
The Company’s domestic insurance subsidiaries prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by their respective state’s department of insurance, which is a comprehensive basis of accounting other than GAAP.
PMI’s claims-paying ratings from certain national rating agencies have been based on various capital support commitments from Allstate (“Allstate Support Agreements”). On October 27, 1994, the Allstate Support Agreements were terminated with respect to policies issued after October 27, 1994, but continue in modified form (as so modified, the “Runoff Support Agreement”) for policies written prior to such termination. Under the terms of the Runoff Support Agreement, Allstate may, at its option, either directly pay or cause to be paid, claims relating to policies written during the terms of the respective Allstate Support Agreements if PMI fails to pay such claims or, in lieu thereof, make contributions directly to PMI or TPG. In the event any amounts are paid or contributed, which possibility management believes is remote, Allstate would receive subordinated debt or preferred stock of PMI or TPG in return. No payment obligations have arisen under the Runoff Support Agreement. The Runoff Support Agreement provides PMI with additional capital support for rating agency purposes.
In 2001, PMI executed a capital support agreement whereby it agreed to contribute funds, under specified conditions, to maintain CMG’s risk-to-capital at or below 18.0 to 1. PMI’s obligation under the agreement is limited to an aggregate amount of $37.7 million, exclusive of capital contributions made prior to April 10, 2001. A 1999 CMG capital support agreement was superceded by execution of the new agreement. On December 31, 2002, CMG’s risk-to capital ratio was 14.2 to 1.
As of December 31, 2002, the Company was in compliance with all covenants included in its capital support agreements.
The following condensed financial statement information has been presented on a combined basis for all unconsolidated subsidiaries accounted for under the equity method as of and for the year ended December 31, 2002.
Revenues, net income and earnings per share are computed independently for the quarters presented. Therefore, the sum of the quarterly amounts may not equal the total computed for the year.
In March 2003, the Company received a notice of assessment from the FTB for 1998 through 2000 years in the amount of $11.1 million related to results of their audit initiated in the fourth quarter of 2002. This assessment was anticipated by the Company and is consistent with the $2.8 million assessment made by FTB for 1997 discussed previously in the Commitments and Contingencies footnote. The assessed amounts if paid may be offset, in part, by federal tax benefits. While the Company intends to protest the current assessments, there can be no assurance as to the ultimate outcome of these protests.