In 2017, we remeasured our net deferred tax assets at the lower enacted corporate income tax rate under the Tax Act. In 2015 we reversed the valuation allowance against our deferred tax assets. See Note 12 - "Income Taxes" to our consolidated financial statements in Item 8 for a discussion of tax matters and their impact on our consolidated financial statements.
As used below, “we” and “our” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as a separate entity, as the context requires. References to "we" and "our" in the context of debt obligations refer to MGIC Investment Corporation. See the "Glossary of terms and acronyms" for definitions and descriptions of terms used throughout this annual report. The Risk Factors contained in Item 1A discuss trends and uncertainties affecting us and are an integral part of the MD&A.
Net income of $673.8 million for 2019 increased by $3.7 million when compared to the prior year, and diluted income per share of $1.85 increased by 4% when compared to the prior year. These increases primarily reflect an increase in revenues and fewer weighted average diluted shares outstanding, which was partially offset by an increase in losses incurred. Adjusted net operating income of $669.7 million for 2019 (2018: $668.7 million) and adjusted net operating income per diluted share of $1.84 (2018: $1.78) each increased from the prior year primarily for the same reasons.
As a result of the current and expected economic conditions, mortgage interest rates have been lower on average in 2019 compared to 2018. The lower mortgage rates materially increased refinancing activity but did not have a material impact on home purchasing activity in 2019. The homeownership rate increased slightly in 2019. The continued favorable housing fundamentals and the increase in refinancing transactions resulted in an increase in our NIW in 2019 when compared to 2018.
After easing somewhat in 2018, lending standards became tighter again in 2019. The percentage of our NIW with DTI ratios over 45% increased significantly in 2018 compared to recent years but declined in 2019. Change in both years was primarily driven by adjustments to GSE underwriting guidelines for loans with DTI ratios over 45%. The increase in the percentage of our NIW from refinance transactions in 2019 due to the low interest rate environment also resulted in a lower percentage of our NIW with LTV ratios over 95% in 2019 compared with 2018.
Refer to "Mortgage Insurance Portfolio" for additional discussion of changes in our NIW mix during 2019.
PMI. The private mortgage insurance industry is highly competitive and is expected to remain so. We believe that we currently compete with other private mortgage insurers based on premium rates, underwriting requirements, financial strength (including based on credit or financial strength ratings), customer relationships, name recognition, reputation, strength of management teams and field organizations, 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 in the last few years has centered on pricing practices which have included: (i) reductions in standard filed rates; (ii) use of customized rate plans (typically lower than standard rates) that are made available to lenders that meet certain criteria; and (iii) use of a spectrum of filed rates to allow for formulaic, risk-based pricing that may be quickly adjusted within certain parameters (referred to as "risk-based pricing systems"). We expect premium rates to continue to decline.
Government programs. PMI also competes against government mortgage insurance programs such as the FHA, VA, and USDA, primarily for lower FICO score business. While the combined market share of primary mortgage insurance written by government programs continued to exceed that written by PMI in 2019, PMI recaptured some share from those programs. The strong refinance markets increased PMI's share of refinances in 2019, and PMI premium rate reductions, have contributed to a PMI market share at its highest level since the financial crisis.
Since December 31, 2015 we have operated under the requirements of the PMIERs of the GSEs in order to insure loans delivered to or purchased by them. The PMIERs include financial requirements as well as business, quality control and certain transactional approval requirements. 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 of insurance in force, calculated from tables of factors with several risk dimensions, reduced for credit given for risk ceded under reinsurance transactions, and subject to a floor amount). Based on our application of the more restrictive PMIERs, MGIC's Available Assets under PMIERs totaled $4.6 billion, an excess of $1.2 billion over its Minimum Required Assets at December 31, 2019.
Our outlook for 2020 should be viewed against the backdrop of the business environment discussed above.
Our NIW is affected by total mortgage originations, the percentage of total mortgage originations using private mortgage insurance (the "PMI penetration rate"), and our market share within the PMI industry. As of late January 2020, the total mortgage origination forecasts indicate mortgage originations of $2 trillion in 2020. The purchase originations are expected to increase in 2020, compared to 2019. Our NIW from refinance originations is expected to be lower in 2020 compared to a strong 2019. In 2019, the majority of the refinances were from recent books that experienced only a modest level of price appreciation. Therefore, many of the refinanced loans in 2019 required mortgage insurance. As a result, we expect the PMI penetration rate to decline somewhat in 2020.
Our IIF increased 6.0% in 2019 and we expect our IIF to grow in 2020. Our book of IIF is an important driver of our future revenues, and its growth is driven by our ability to generate NIW and retain existing policies in force, as measured by our persistency. Interest rates influence both our NIW and persistency. In a rising rate environment, total mortgage originations may decline, however, we would also expect policy cancellation rates to decline, and in turn increase persistency, although the impact generally lags the change in interest rates.
Our 2020 direct premiums written and net premiums earned are expected to be lower than 2019. Our net premiums earned will be impacted by the decrease in premium rates noted above and by the amount of premiums we cede under our quota share and excess of loss reinsurance transactions. The amount of profit commission we receive, which reduces the amount of premiums we cede, is variable year-to-year and is dependent on the amount of losses ceded. Our profit commission in recent years has benefited from favorable loss reserve development associated with delinquency notices received in prior years. The actual amount of premiums we cede in 2020 will be affected
by any changes in our reinsurance coverage, such as the addition of new excess of loss coverage.
Losses. We expect 2020 losses incurred with respect to delinquency notices received in 2020 to be lower than the comparable amount for 2019 as we expect to receive fewer new delinquency notices in 2020.
In 2019 and 2018, we repurchased approximately 8.7 million and 16.0 million shares of our common stock, respectively, using approximately $114 million and $175 million, respectively, of holding company resources. We received approval to repurchase up to an additional $300 million of our common stock through the end of 2021. The following table shows details of our share repurchase programs.
Repurchases may be made from time to time on the open market (including through 10b5-1 plans) or through privately negotiated transactions. The repurchase programs may be suspended for periods or discontinued at any time. As of December 31, 2019, we had approximately 347 million shares of common stock outstanding.
In 2019, MGIC paid dividends of $0.06 per common share to its shareholders in the third and fourth quarters totaling $42 million. On January 27, 2020, our Board of Directors declared a quarterly cash dividend of $0.06 per common share to shareholders of record on February 11, 2020, payable on February 28, 2020.
We must comply with a GSE's PMIERs to be eligible to insure loans delivered to or purchased by that GSE. The PMIERs include financial requirements, as well as business, quality control and certain transaction approval requirements. 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 of insurance in force and are calculated from tables of factors with several risk dimensions, reduced for credit given for risk ceded under reinsurance transactions, and are subject to a floor amount).
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 new business writings. Factors that may negatively impact MGIC’s ability to continue to comply with the financial requirements of the PMIERs include the following:
There may be future implications for PMIERs based upon forthcoming regulatory capital requirements for the GSEs. In 2018, the FHFA issued a proposed capital rule for the GSEs, which included a framework for determining the capital relief allowed to the GSEs for loans with private mortgage insurance. The FHFA recently indicated that it plans to re-propose a capital rule as early as the first quarter of 2020, although the timing and content of the proposal is uncertain. Further, any changes to the GSEs' capital and liquidity requirements resulting from the Treasury Housing Reform Plan could have future implications for PMIERs.
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 its 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.” 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 an MPP. The "policyholder position" of a mortgage insurer is its net
At December 31, 2019, MGIC’s risk-to-capital ratio was 9.7 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements, and its policyholder position was $3.0 billion above the required MPP of $1.7 billion. The calculation of our risk-to-capital ratio and MPP reflect credit for the risk ceded under our QSR Transactions and Home Re Transactions. 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 transactions, without penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, refer to our risk factor titled “State capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis” in Item 1A for more information about matters that could negatively affect such compliance.
In September 2019, at the direction of President Trump, the U.S. Treasury Department ("Treasury") released the “Treasury Housing Reform Plan” (the "Plan"). The Plan
recommends administrative and legislative reforms for the housing finance system, with such reforms intended to achieve the goals of ending the conservatorships of the GSEs; increasing competition and participation by the private sector in the mortgage market including by authorizing the FHFA to approve additional guarantors of conventional mortgages in the secondary market, simplifying the qualified mortgage ("QM") rule of the Consumer Financial Protection Bureau ("CFPB"), transferring risk to the private sector, and eliminating the "GSE Patch" (discussed below); establishing regulation of the GSEs that safeguards their safety and soundness and minimizes the risks they pose to the financial stability of the United States; and providing that the federal government is properly compensated for any explicit or implicit support it provides to the GSEs or the secondary housing finance market. Also in September 2019, the Treasury and FHFA entered into a letter agreement that will allow the GSEs to remit less of their earnings to the government, which will help them rebuild their capital.
We insure loans that do not qualify as QMs; however, we are unsure the extent to which lenders will make non-QM loans because they will not be entitled to the presumptions about compliance with the ATR rule that the law allows with respect to QM loans. We are also unsure the extent to which lenders will purchase private mortgage insurance for loans that cannot be sold to the GSEs.
The following table shows the percentage of our primary RIF that has been modified as of December 31, 2019.
Cancellations, which reduce IIF. Cancellations due to refinancing are affected by the level of current mortgage interest rates compared to the mortgage coupon rates throughout the in force book, current home values compared to values when the loans in the in force book were insured and the terms on which mortgage credit is available. Home price appreciation can give homeowners the right to cancel mortgage insurance on their loans if sufficient home equity is achieved. Cancellations also result from policy rescissions, which require us to return any premiums received on the rescinded policies, and claim payments, which require us to return any premium received on the related policies from the date of default on the insured loans.
Premiums earned 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 transactions. Also, NIW and cancellations during a period will generally have a greater effect on premiums earned in subsequent periods than in the period in which these events occur.
Losses ceded under reinsurance agreements. See Note 9 - “Reinsurance” to our consolidated financial statements for a discussion of our reinsurance agreements.
In general, the majority of any underwriting profit that a book generates occurs in the early years of the book, with the largest portion of any underwriting profit realized in the first year following the year the book was written. Subsequent years of a book may result in either underwriting profit or underwriting losses. This pattern of results typically occurs because relatively few of the incurred losses on delinquencies that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments) and increasing losses. The typical pattern is also a function of premium rates generally resetting to lower levels after ten years.
We believe that use of the Non-GAAP measures of adjusted pre-tax operating income (loss), adjusted net operating income (loss) and adjusted net operating income (loss) per diluted share facilitate the evaluation of the company's core financial performance thereby providing relevant information to investors. These measures are not recognized in accordance with GAAP and should not be viewed as alternatives to GAAP measures of performance.
Net impairment losses recognized in earnings. The recognition of net impairment losses on investments can vary significantly in both size and timing, depending on market credit cycles, individual issuer performance, and general economic conditions.
Infrequent or unusual non-operating items. Our income tax expense for 2017 reflects the remeasurement of our net deferred tax assets to reflect the lower corporate income tax rate under the Tax Act. Our 2018 and 2017 income tax expense also includes amounts related to our IRS dispute and is related to past transactions which are non-recurring in nature and are not part of our primary operating activities.
Additional income tax provision related to the rate decrease included in the Tax Act
Source: GSEs and MBA estimates/forecasts as of December 2019 and January 2020. Amounts represent the average of all sources.
Source: Inside Mortgage Finance - February 21, 2020 or SEC filings. Includes HARP NIW.
The PMI industry increased its share of the primary mortgage insurance market in 2019 and 2018, each when compared to the respective prior year. PMI's share increased primarily due to a higher percentage of refinances; PMI premium rate reductions in recent periods, which increases PMI's competitiveness compared to government programs; and an increase in 97% LTV loan offerings from lenders that sell loans to the GSEs, which provided an alternative to similar FHA loan programs for qualified borrowers.
Source: Inside Mortgage Finance - February 21, 2020. Includes HARP NIW.
NIW for 2019 continued to have what we believe are favorable risk characteristics. The following tables provide information about characteristics of our NIW.
An increase in the percentage of refinances, discussed above and home price appreciation, partially offset by an increase in 97% LTV programs offered by lenders, have decreased the percentage of our NIW with LTV ratios greater than 95% in 2019 compared to 2018.
In 2018, we started considering DTI ratios when setting our premium rates, and we changed our methodology for calculating DTI ratios for pricing and eligibility purposes to exclude the impact of mortgage insurance premiums. As a result of this change, loan originators may have changed the information they provide to us. Although we have changed our operational procedures to account for this, we cannot be sure that the DTI ratio we report for each loan beginning in late 2018 includes the related mortgage insurance premiums in the calculation.
In 2019, the percentage of our NIW on loans with DTI ratios over 45% was 14%, down significantly from 20% in 2018. We believe the decline in 2019 was primarily due
to changes in GSE underwriting guidelines, but was also due in part to our underwriting guideline and pricing changes associated with such loans.The higher percentage in 2018 was primarily driven by adjustments to GSE underwriting guidelines for loans with DTI ratios over 45%.
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 books. The credit profile of our pre-2009 RIF has benefited from modification and refinance programs making outstanding loans more affordable to borrowers with the goal of reducing the number of foreclosures. These programs included HAMP and HARP, which expired at the end of 2016 and 2018, respectively, but have been replaced by other GSE modification programs. HARP allowed borrowers who were not delinquent, but who may not otherwise have been 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 97.6% of all our HARP modifications were current as of December 31, 2019. The aggregate of our 2009 and later books and our HARP modifications accounted for approximately 92% of our total primary RIF at December 31, 2019.
The composition of our primary RIF as of December 31, 2019, 2018, and 2017 is shown below.
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, 2019. For a discussion of the Critical Accounting Policies used by us that affect the Consolidated Results of Operations, see "Critical Accounting Policies" below.
(2) Ceded premiums earned, net of profit commissions and assumed premiums. Assumed premiums include those from our participation in GSE CRT programs, of which the impact on the net premium yield was 0.2 bps in 2019, 0.1 bps in 2018, and 0 bps in 2017.
A larger percentage of our IIF from book years with lower premium rates due to a decline in premium rates in recent years resulting from pricing competition, insuring mortgages with lower risk characteristics, certain policies undergoing premium rate resets on their ten-year anniversaries, and the availability of reinsurance.
As discussed in our Risk Factor titled "Competition or changes in our relationships with our customers could reduce our revenues, reduce our premium yields and/or increase our losses," the private mortgage insurance industry is highly competitive and premium rates have declined over the past several years. We expect that will continue and that our inforce portfolio yield will continue to decline as older insurance policies with higher premium rates run off or have their premium rates reset, and new insurance policies with lower premium rates are written. While our increased use of reinsurance over the past several years has helped to mitigate the negative effect of declining premium rates on our returns, refer to our risk factor titled "Reinsurance may not always be available or affordable" for a discussion of the risks associated with the availability of reinsurance.
See "Overview - Factors Affecting Our Results" above for additional factors that also influence the amount of net premiums written and earned in a year.
Our quota share reinsurance affects various lines of our statements of operations and therefore we believe it should be analyzed by reviewing its effect on our pre-tax net income, as described below.
The following table provides information related to our quota share agreements for 2019, 2018, and 2017.
Our excess-of-loss reinsurance agreements provide $532.0 million of loss coverage on an existing portfolio of inforce policies having an inforce date on or after July 1, 2016 and before March 31, 2019. As of December 31, 2019, the aggregate exposed principal balances under the Home Re 2018-1 and 2019-1 transactions were approximately $5.9 billion and $6.0 billion, respectively, which take into account the mortgage insurance
coverage percentage, net retained risk after quota share reinsurance, and the reinsurance inclusion percentage of the unpaid principal balance. Total ceded premiums for 2019 and 2018 were $17.6 million and $2.8 million, respectively.
2018 compared to 2017. Net investment income increased 17% to $141 million in 2018 compared to $121 million in 2017. The increase in investment income was due to higher average investment yields, as well as a higher average investment portfolio balance.
2018 compared to 2017. Other revenue decreased to $9 million in 2018 from $10 million in 2017, due to lower contract underwriting revenues.
As discussed in “Critical Accounting Policies” below and consistent with industry practices, we establish case loss reserves for future claims only for loans that are currently delinquent. The terms “delinquent” and “default” are used interchangeably by us. We consider a loan to be delinquent when it is two or more payments past due. Case loss reserves are established based on estimating the number of loans in our delinquent inventory that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity.
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.
2019 compared to 2018. Losses incurred, net increased 224% to $119 million compared to $37 million in 2018. The increase was due to a lower amount of favorable loss reserve development on previously received delinquency notices of $71 million in 2019 compared with $167 million in 2018. Current year losses incurred decreased in 2019 from 2018, primarily due to a lower claim rate on new delinquency notices when compared to the prior year.
2018 compared to 2017. Losses incurred, net decreased 32% to $37 million compared to $54 million in 2017. The decrease was due to a decrease in losses and LAE incurred in respect to delinquencies reported in 2018, offset in part by a decrease in favorable loss reserve development on prior year delinquencies. New delinquency notices declined 20% when compared to 2017, in part due to elevated 2017 delinquency notice activity associated with 2017 hurricanes, and the estimated claim rate on new delinquency notices also declined. Favorable development on prior year delinquencies occurred in 2018 due to a lower estimated claim rate on previously reported delinquencies, partially offset by increases in our expected severity assumption on previously reported delinquencies. During 2018, cure activity on loans that were delinquent twelve months or more was significantly higher than our previous estimates.
The quarterly trend in claims severity for each of the three years in the period ended December 31, 2019 is shown in the following table.
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 loss reserves and, correspondingly, on our consolidated results of operations even in a stable economic environment. For example, as of December 31, 2019, assuming all other factors remain constant, a $1,000 increase/decrease in the average severity reserve factor would change the loss reserve amount by approximately +/- $10 million. A one percentage point increase/decrease in the average claim rate reserve factor would change the loss reserve amount by approximately +/- $17 million.
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 the following table.
The primary average claim paid for the top 5 jurisdictions (based on 2019 losses paid, excluding settlement amounts) for each of the three years in the period ended December 31, 2019 appears in table below.
The primary default inventory for the top 15 jurisdictions (based on 2019 losses paid, excluding settlement amounts) at December 31, 2019, 2018 and 2017 appears in table the below.
The delinquent inventory as of December 31, 2017 for most policy years included new delinquency notices from hurricane impacted areas that had not cured. As a result, delinquencies, including in the most recent policy years, were greater than they otherwise would have been as of December 31, 2017. The majority of the notices received in the hurricane impacted areas cured during 2018.
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 may experience on those books, as we continue to write new insurance, those books have become a smaller percentage of our total mortgage insurance portfolio. Our 2005 through 2008 books of business represented approximately 11% and 15% of our total primary RIF at December 31, 2019 and 2018, respectively. Approximately 39% of the remaining primary RIF on our 2005 through 2008 books of business benefited from HARP as of both December 31, 2019 and 2018.
Underwriting and other expenses includes items such as employee compensation costs, fees for professional services, depreciation and maintenance expense, and premium taxes, and are reported net of ceding commissions.
2019 compared to 2018. Interest expense for 2019 was $53 million, unchanged from 2018.
2019 compared to 2018. The income tax expense for 2019 was flat compared to the income tax expense for 2018. Our effective tax rate for 2019 and 2018 was below the federal statutory income tax rate of 21% primarily due to the benefits of tax-preferenced securities.
The increase in shareholders' equity was due to net income during 2019 and an increase in the fair value of our investment portfolio, offset in part by the repurchase of shares of our common stock and dividends paid to shareholders.
As of December 31, 2019, total assets were $6.2 billion and total liabilities were $1.9 billion. Compared to year-end 2018, total assets increased by $551.8 million and total liabilities decreased by $175.6 million.
The investment portfolio increased 12%, to $5.8 billion as of December 31, 2019 (2018: $5.2 billion), as net cash from operations was used in part for additional investment.
To achieve our portfolio objectives, our asset allocation considers the risk and return parameters of the various asset classes in which we invest. This asset allocation is informed by, and based on the following factors:
Our investment portfolio mix was comparable for the years ended December 31, 2019 and December 31, 2018. See Note 5 - “Investments” to our consolidated financial statements for additional disclosure on our investment portfolio.
The U.S. economy continued to grow in 2019 and is expected to continue to grow at a slower rate in 2020. Against this positive macroeconomic backdrop, which includes very low unemployment, the Federal Open Market Committee left its benchmark interest rate at a range of 150 to 175 basis points as of December 31, 2019 and has signaled that it does not expect increases in 2020. Our investment portfolio of fixed income securities is subject to interest rate risk and its fair value is likely to decline in a rising interest rate environment. We seek to manage our exposure to interest rate risk and volatility by maintaining a diverse mix of high quality securities with an intermediate duration profile. While higher interest rates may adversely impact the fair values of our fixed income securities, they present an opportunity to reinvest investment income and proceeds from security maturities into higher yielding securities. In light of the corporate income tax rate reduction in the fourth quarter of 2017, we reduced the percentage of our investments in tax-exempt securities during 2018 and increased our corporate and CLO concentrations. We will continue to evaluate the relative value of tax-exempt versus taxable fixed income securities during 2020, and our investment allocations may shift over time.
Cash and cash equivalents increased 7%, to $162 million as of December 31, 2019 (2018: $152 million), as net cash generated from operating activities was only partly offset by net cash used in investing and financing activities.
Other liabilities decreased 16% to $152 million as of December 31, 2019 (2018: $180 million), primarily due to decreases in our income taxes payable, accounts payable, pension-related liabilities and our premium refund accrual due to lower estimated claim rates, and the settlement of 2018 share repurchases in the first quarter of 2019, partially offset by an increase in accrued salaries and benefits.
We have three primary types of cash flows: (1) operating cash flows, which consist mainly of cash generated by our insurance operations and income earned on our investment portfolio, less amounts paid for claims, interest expense and operating expenses, (2) investing cash flows related to the purchase, sale and maturity of investments and purchases of property and equipment and (3) financing cash flows generally from activities that impact our capital structure, such as changes in debt and shares outstanding and dividend payouts. The following table summarizes these three cash flows on a consolidated basis for the last three years.
Increase (decrease) in cash and cash equivalents and restricted cash and cash equivalents
Our largest source of cash is from premiums received from our insurance policies, which we receive on a monthly installment basis for most policies. Premiums are received at the beginning of the coverage period for single premium and annual premium policies. Our largest cash outflow is for claims that arise when a delinquency results in an insured loss. We invest our claims paying resources from premiums and other sources in various investment securities that earn
interest. We also use cash to pay for our ongoing expenses such as salaries, debt interest, and rent.
We maintain an investment portfolio that is primarily invested in a diverse mix of fixed income securities. As of December 31, 2019, our portfolio had a fair value of $5.8 billion, an increase of $599.3 million, or 11.6% from December 31, 2018. Net cash flows used in investing activities in 2019, 2018, and 2017 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. In addition to investment portfolio activities, our investing activities included investment in our technology infrastructure to enhance our ability to conduct business and execute our strategies, as well as an initiative to update our corporate headquarters building which was substantially complete in 2018.
Net cash flows used in financing activities for 2017 included the repayment at maturity of our 5% Notes, redemption of a portion of our 2% Notes, expenses paid to establish our revolving credit facility and payment of withholding taxes related to share-based compensation net share settlement.
For a further discussion of matters affecting our cash flows, see "Balance Sheet Review" and "Debt at our Holding Company and Holding Company Liquidity" below.
Capital risk is the risk of adverse impact on our ability to comply with capital requirements (regulatory and GSE) and to maintain the level, structure and composition of capital required for meeting financial performance objectives.
assess appropriate uses for capital that cannot be deployed in support of our business strategies, including the size and form of capital return to shareholders and efficiently using company resources, and
support business opportunities by enabling capital flexibility and efficiently using company resources.
The increase in total shareholders' equity in 2019 from 2018 was primarily due to net income during 2019, offset by our repurchases of our common stock and the increase in gross unrealized investment losses. See Note 13 - "Shareholders' Equity" for further information .
The 5.75% Notes and 9% Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. We have no debt obligations due within the next twelve months. As of December 31, 2019, our 5.75% Note had $425 million of outstanding principal, due in August 2023, and our 9% Debentures had $389.5 million of outstanding principal, due in April 2063. MGIC's ownership of $132.7 million of our holding company's 9% Debentures is eliminated in consolidation, but they remain outstanding obligations owed by our holding company to MGIC. 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.
See Note 7 - "Debt" for further information on our outstanding debt obligations and transactions impacting our consolidated financial statements in 2019 and 2018.
As of December 31, 2019, and December 31, 2018, we had approximately $325 million and $248 million, respectively, in cash and investments at our holding company. These resources are maintained primarily to service our debt interest expense, pay debt maturities, repurchase shares, pay dividends to shareholders, and to settle intercompany obligations. 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
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 have received the appropriate approvals for MGIC to pay our holding company, in the first quarter or 2020, a special dividend of $320 million and a quarterly dividend of $70 million. We expect MGIC to pay quarterly dividends totaling at least $280 million per year. We believe our holding company has sufficient sources of liquidity to meet its payment obligations for the foreseeable future.
We may use additional holding company cash to repurchase additional shares or to repurchase our outstanding debt obligations. Such repurchases may be material, may be made for cash (funded by debt) and/or exchanges for other securities, and may be made in open market purchases (including through 10b5-1 plans), privately negotiated acquisitions or other transactions. See "Overview-Capital" of this MD&A for a discussion of the approval to repurchase up to an additional $300 million of our common stock through the end of 2021.
Our holding company cash and investments increased by $77 million in 2019, to $325 million as of December 31, 2019. Cash inflows included $280 million of dividends received from MGIC and $25 million of other inflows, which included intercompany activity. Cash outflows included $126 million used to repurchase shares of our common stock, $60 million of interest payments, of which approximately $12 million was paid to MGIC for the portion of our 9% Debentures owned by MGIC, and $42 million in common stock dividends.
Although not anticipated in the near term, we may also contribute funds to our insurance operations to comply
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 outstanding a $155.0 million fixed rate advance from the FHLB. Interest on the advance is payable monthly at a fixed annual rate of 1.91%. The principal of the advance matures on February 10, 2023 but may be prepaid 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 a minimum of 102% of the principal balance of the advance.
As of December 31, 2019, MGIC’s Available Assets under PMIERs totaled approximately $4.6 billion, an excess of approximately $1.2 billion over its Minimum Required Assets; and MGIC is in compliance with the requirements of the PMIERs and eligible to insure loans delivered to or purchased by the GSEs.
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 case loss reserves have been established and the risk 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.
RIF - net, as shown in the table above, is net of reinsurance and exposure on policies currently delinquent and for which case loss reserves have been established.
RIF - net, as shown in the table above, is net of reinsurance and exposure on policies currently delinquent ($1.5 billion at December 31, 2019 and $1.6 billion at December 31, 2018) and for which case loss reserves have been established.
The 2019 increase in risk-to-capital of MGIC is due to an increase in net RIF, offset by an increase in statutory policyholders' position, primarily due to an increase in statutory contingency reserves. The reductions in the risk-to-capital of our combined insurance companies were due to an increase in statutory policyholders' position, primarily due to an increase in statutory contingency reserves, partially offset by an increase in net RIF. Our RIF, net of reinsurance, increased in 2019, due to an increase in our IIF and a reduction in our ceded RIF under our 2015 QSR Transaction. Our risk-to-capital ratio will decrease if the percentage increase in capital exceeds the percentage increase in insured risk.
In the first quarter of 2020, we received the appropriate approvals for MGIC to pay our holding company a special dividend of $320 million. The $320 million special dividend will reduce the statutory policyholder's position of MGIC, which will result in an increase to the risk-to-capital.
The following table summarizes, as of December 31, 2019, the approximate future payments under our contractual obligations and estimated claim payments on established loss reserves.
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. We did not have a minimum funding requirement for the defined benefit pension plan for 2019 or 2018 and do not anticipate having a minimum funding requirement in 2020. We have significant discretion in making contributions above those necessary to satisfy the minimum funding requirements. In 2019 and 2018, we voluntarily made contributions totaling $7.1 million, and $10.0 million, respectively. We plan to make a voluntary contribution of approximately $6.5 million to the defined benefit pension plan in 2020. In determining future contributions, we will consider the performance of the plan's investment portfolio, the effects of interest rates on the projected benefit obligation of the plan and our other capital requirements. As of December 31, 2019, we had accrued a liability of $3.1 million related to our defined benefit pension plan as the projected obligation was in excess of plan assets. The supplemental executive retirement plan benefits are accrued for and are paid from MGIC assets following employee retirements. We plan to pay benefits of approximately $6 million under the supplemental executive retirement plan in 2020.
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.
Case reserves are established for estimated insurance losses when notices of delinquency on insured mortgage loans are received. For reporting purposes, we consider a loan delinquent when it is two or more payments past due. Even though the accounting standard, ASC 944, regarding accounting and reporting by insurance entities specifically excluded mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish loss reserves for future claims on insured loans which are not currently delinquent.
The estimated claim rates and claim severities are used to determine the amount 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 through a successful loan modification, the cure reduces the historical claim rate used in establishing reserves. Our methodology to estimate claim rates and claim severities 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 claims paid compared to our loan exposures, 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.
Our estimate of loss reserves is sensitive to changes in claim rate and claim severity; 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, as of December 31, 2019, assuming all other factors remain constant, a $1,000 increase/decrease in the average severity reserve factor would change the reserve amount by approximately +/- $10 million. A one percentage point increase/decrease in the average claim rate reserve factor would change the reserve amount by approximately +/- $17 million. 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 established for estimated IBNR, which results from delinquencies occurring prior to the close of an accounting period, but which have not been reported to us. Consistent with reserves for reported delinquencies, IBNR reserves are established using estimated claim rates and claim severities for the estimated number of delinquencies not reported. As of December 31, 2019 and 2018, we had IBNR reserves of approximately $23 million and $29 million, respectively.
When a policy term ends, the primary mortgage insurance written by us is renewable at the insured’s option through continued payment of the premium in accordance with the schedule established at the inception of the policy life. We are generally obligated to renew the policies and have no ability to re-underwrite or reprice these policies after issuance. 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 policies
covering more than one year are amortized over the policy life based on historical experience, which includes the anticipated incurred loss pattern. Premiums written on annual premium policies are earned on a monthly pro rata basis. When a policy is cancelled, all premium that is non-refundable is immediately earned. Any refundable premium is returned to the servicer or borrower. Policies may be cancelled by the insured, or due to rescissions or claim payments. When a policy is rescinded, all previously collected premium is returned to the servicer and when a claim is paid, all 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 this liability is included in “Other liabilities” on our consolidated balance sheets. Changes in these liabilities and the actual return of premium affect premiums written and earned.
Equity securities. At December 31, 2017, equity securities were classified as available-for-sale and were reported at fair value, except for certain equity securities that were carried at cost, for which the amount reported approximated fair value. These equity securities carried at cost were reported as Other invested assets at December 31, 2018, as required under ASU 2016-01. The updated guidance also requires, effective January 1, 2018, the periodic change in fair value of equity securities to be recognized as realized investment gains and losses. For periods prior, realized investment gains and losses on equity securities were a function of the difference between the amount received on the sale of an equity security and the equity security's cost basis, as well as any OTTI recognized in earnings.
For the years ended December 31, 2019, 2018, and 2017, 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.
Consolidated statements of comprehensive income for each of the three years in the period ended December 31, 2019
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2019 - 371,353; 2018 - 371,353; outstanding 2019 - 347,308; 2018 - 355,371)
Treasury stock (shares at cost 2019 - 24,045; 2018 - 15,982)
Cash and cash equivalents and restricted cash and cash equivalents at end of year
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. 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. MGIC Assurance Corporation ("MAC"), an insurance subsidiary of MGIC, provides insurance for certain mortgages under Fannie Mae and Freddie Mac (the "GSEs") credit risk transfer programs and is a participant in the Fannie Mae Enterprise-Paid Mortgage Insurance program.
At December 31, 2019, our direct primary insurance in force ("IIF") was $222.3 billion, which represents the principal balance in our records of all mortgage loans that we insure, and our direct primary risk in force ("RIF") was $57.2 billion, which represents the IIF multiplied by the insurance coverage percentage.
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of
Certain reclassifications to 2018 and 2017 amounts have been made in the accompanying consolidated financial statements to conform to the 2019 presentation. See Note 3 - "Significant Accounting Policies" for a discussion of our adoption of accounting guidance in 2019 that resulted in other reclassifications.
The fair value of an asset or liability is defined as the price that would be received upon a sale of an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Fair value is based on quoted market prices or inputs, where available. If prices or quotes are not available, fair value is based on valuation models or other valuation techniques that consider relevant transaction characteristics (such as maturity) and use as inputs observable or unobservable market parameters including yield curves, interest rates, volatilities, equity
or debt prices, foreign exchange rates and credit curves. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, as described below.
We use independent pricing sources to determine the fair value of a substantial majority of our financial instruments, which primarily consist of assets in our investment portfolio, but also includes amounts included in cash and cash equivalents and restricted cash and cash equivalents. A variety of inputs are used; in approximate order of priority, they are: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications.
The independent pricing sources used for our Level 2 investments vary by type of investment. See Note 6 - "Fair Value Measurements" for further information.
Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable or, from par values due to restrictions on certain securities that require them to be redeemed or sold only to the security issuer at par value. The inputs used to derive the fair value of Level 3 securities reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Financial assets using Level 3 inputs include obligations of U.S. states and political subdivisions and certain equity securities (2017 only). Our non-financial assets that are classified as Level 3 securities consist of real estate acquired through claim settlement. The fair value of real estate acquired is the lower of our acquisition cost or a percentage of the appraised value. The percentage applied to the appraised value is based upon our historical sales experience adjusted for current trends.
Equity securities. Equity securities are reported at fair value, except for certain securities that are carried at cost. Equity securities carried at cost are reported as Other invested assets. Effective January 1, 2018, realized investment gains and losses, after considering the related tax expense or benefit, are accounted for as
a function of the periodic change in fair value. For 2017, realized investment gains and losses were accounted for as a function of the difference between the amount received on the sale of an equity security and the equity security’s cost basis, as well as any OTTI recognized in earnings.
Based on our evaluation, we will record an OTTI adjustment on a security if we intend to sell the impaired security, if it is more likely than not that we will be required to sell the impaired security prior to recovery of its amortized cost basis, or if the present value of the discounted cash flows we expect to collect is less than the amortized cost basis of the security. If the fair value of a security is below its 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 $43.0 million, $38.1 million and $33.9 million as of December 31, 2019, 2018 and 2017, respectively. Depreciation expense for the years ended December 31, 2019, 2018 and 2017 was $6.5 million, $6.0 million and $5.4 million, respectively.
Case reserves and loss adjustment expenses ("LAE") reserves are established when we receive notices of delinquency on insured mortgage loans. We consider a loan delinquent when it is two or more payments past due. Even though the accounting standard, ASC 944, regarding accounting and reporting by insurance entities specifically excludes mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish case reserves for future claims on insured loans which are not currently delinquent. Case reserves are established by estimating the number of loans in our inventory of delinquent loans that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity. Our case reserve estimates are established based upon historical experience, including rescissions of policies, curtailments of claims, and loan modification activity. Adjustments to reserve estimates are reflected in the financial statements in the years in which the adjustments are made. The liability for reinsurance
Loss reserves are ceded to reinsurers under our reinsurance agreements. (See Note 8 - “Loss Reserves” and Note 9 - “Reinsurance.”)
The recognition of a tax position is determined using a two-step approach. The first step applies a more-likely-than-not threshold for recognition and derecognition. The second step measures the tax position as the greatest amount of benefit that is cumulatively greater than 50% likely to be realized. When evaluating a tax position for recognition and measurement, we presume that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information. We recognize interest accrued and penalties related to unrecognized tax benefits in our provision for income taxes.
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.”)
Adoption impact: The adoption of the updated guidance did not have a material effect on our consolidated results of operations or liquidity.
ASU 2018-13 - Changes to the Disclosure Requirements for Fair Value Measurements
ASU 2018-14 - Changes to the Disclosure Requirements for Defined Benefit Plans
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. We have concluded that our mortgage insurance policies are outside the scope of this ASU, however, the provisions of this guidance do apply to our reinsurance transactions, which are highly rated, as discussed in Note 9 - “Reinsurance” to our consolidated financial statements. Entities are required to incorporate their forecast of future economic conditions into their loss estimate unless such forecast is not reasonable and supportable, in which case the entity will revert to historical loss experience. The allowance for current expected credit losses (“CECL”) generally reduces the amortized cost basis of the financial instrument to the amount an entity expects to collect, however, credit losses relating to available-for-sale fixed maturity securities are to be recorded through an allowance for credit losses, 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. In May 2019, the
FASB amended this guidance to provide entities with an option to irrevocably elect the fair value option for eligible instruments in order to provide targeted transition relief that is intended to increase comparability of financial statement information for some entities that otherwise would have measured similar financial instruments using different measurement methodologies. We have evaluated the impacts the adoption of this guidance will have on our consolidated financial statements, and determined it will not have a material impact.
In August 2018, the FASB issued amendments to modify the disclosure requirements for defined benefit plans. The updated guidance removed the requirements to identify amounts that are expected to be reclassified out of accumulated other comprehensive income and recognized as components of net periodic benefit cost in the coming year and the effects of a one-percentage-point change in assumed health care cost trend rates on service and interest cost and on the postretirement benefit obligation. The updated guidance added disclosure requirements for the weighted-average interest crediting rates for cash balance plans and other plans with interest crediting rates and explanations for significant gains and losses related to changes in the benefit obligation for the period. The updated guidance is effective for annual periods beginning after December 15, 2020. Early adoption is permitted. An entity should apply the amendments on a retrospective basis to all periods presented. We are currently evaluating the
impacts the adoption of this guidance will have on our consolidated financial statement disclosures, but do not expect it to have a material impact.
In December 2019, the FASB issued guidance which simplifies Accounting for Income Taxes (Topic 740). The ASU intends to reduce complexity through clarification and amendments of existing guidance. The updated guidance is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted in any interim periods for which financial statements have not been issued. 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.
Interest expense for the years ended December 31, 2019, 2018 and 2017 has been tax effected at a rate of 21%, 21%, and 35%, respectively.
Details of fixed income investment securities by category as of December 31, 2018
There were no OTTI losses recorded in other comprehensive (loss) income as of December 31, 2019 and 2018.
The increase in gross unrealized gains and the decrease in gross unrealized losses in our fixed income securities from December 31, 2018 to December 31, 2019 were primarily caused by declines in interest rates during that period.
We had $13.9 million and $13.5 million of investments at fair value on deposit with various states as of December 31, 2019 and 2018, respectively, due to regulatory requirements of those states' insurance departments. In connection with our insurance and reinsurance activities, we are required to maintain assets in trusts for the benefit of contractual counterparties. The fair value of the investments on deposit in these trusts was $89.9 million and $26.3 million at December 31, 2019 and 2018, respectively.
For the years ended December 31, 2019 and December 31, 2018, we recorded $0.1 million and $1.8 million of OTTI losses in earnings, respectively. For the year ended December 31, 2017, there were no OTTI losses in earnings.
The cost and fair value of investments in equity securities as of December 31, 2019 and December 31, 2018 are shown in tables 5.3a and 5.3b below. Under updated guidance regarding the "Recognition and Measurement of Financial Assets and Financial Liabilities" which became effective on January 1, 2018, the amount of our FHLB stock investment has been reclassified and presented in "Other invested assets" on our consolidated balance sheet.
Proceeds from the sale of equity securities were $1.7 million and $4.9 million during the years ended December 31, 2019 and 2018, respectively. Gross gains of $1.6 million and $3.7 million were realized on those sales during the year ended December 31, 2019 and 2018, respectively. There were no sales of equity securities in 2017. For the year ended December 31, 2019 and December 31, 2018, we recognized $201 thousand and $84 thousand of net losses on equity securities still held as of December 31, 2019 and December 31, 2018, respectively, which are reported in Net realized investment (losses) gains on our consolidated statements of operations.
Other invested assets include an investment in Federal Home Loan Bank ("FHLB") stock that is carried at cost, which due to its nature approximates fair value. Ownership of FHLB stock provides access to a secured lending facility, and our current FHLB Advance amount is secured by eligible collateral whose fair value is maintained at a minimum of 102% of the outstanding principal balance of the FHLB Advance. As of December 31, 2019, that collateral consisted of fixed income securities included in our total investment portfolio, and cash and cash equivalents, with a total fair value of $165.7 million.
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, 2019 and 2018 were primarily caused by changes in interest rates between the time of purchase and the respective year end. There were 217 and 721 securities in an unrealized loss position as of December 31, 2019 and 2018, respectively. As of December 31, 2019, the fair value as a percent of amortized cost of the securities in an unrealized loss position was 99% and approximately 28% of the securities in an unrealized loss position were backed by the U.S. Government.
Obligations of U.S. States & Political Subdivisions are valued 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.
Asset-Backed Securities ("ABS") are valued using spreads and other information solicited from market buy-and-sell-side sources, including primary and secondary dealers, portfolio managers, and research analysts. Cash flows are generated for each tranche, benchmark yields are determined, and deal collateral performance and tranche level attributes including trade activity, bids, and offers are applied, resulting in tranche specific prices.
See "Reconciliation of Level 3 assets" below for information regarding a change in presentation of amounts previously included in Level 3 Equity securities.
Other invested assets include an investment in FHLB stock that is carried at cost, which due to restrictions that require it to be redeemed or sold only to the security issuer at par value, approximates fair value. The fair value of other invested assets is categorized as Level 2.
Table 6.3 compares the carrying value and fair value of our financial liabilities disclosed, but not carried, at fair value as of December 31, 2019 and 2018.
The 5.75% Notes and 9% Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries.
MGIC borrowed $155.0 million in the form of a fixed rate advance from the Federal Home Loan Bank of Chicago ("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.
Interest on the 5.75% Notes is payable semi-annually on February 15 and August 15 of each year. We have the option to redeem these notes, in whole or in part, at any
time or from time to time prior to maturity at a redemption price equal to the greater of (i)100% of the aggregate principal amount of the notes to be redeemed and (ii) the make-whole amount, which is the sum of the present values of the remaining scheduled payments of principal and interest discounted at the treasury rate defined in the notes plus 50 basis points and accrued interest.
and the number of outstanding shares is determined as of the date of our most recent publicly released financial statements.
The provisions of the 9% Debentures are complex. The description above is qualified in its entirety by the terms of the 9% Debentures, including their covenants and events of default. We were in compliance with all covenants at December 31, 2019. The 9% Debentures rank junior to all of our existing and future senior indebtedness.
In May 2019, we terminated our $175 million unsecured revolving credit facility. At the time of termination there were no amounts drawn on the credit facility. The unused portion of our revolving credit facility was subject to recurring commitment fees, which are reflected in interest payments.
Losses incurred on delinquencies that occurred in the current year decreased in 2019 compared to 2018 and in 2018 compared to 2017, in each case, primarily due to a decrease in the number of new delinquencies, net of cures, as well as a decrease in the estimated claim rate on recently reported delinquencies.
New delinquent notice activity increased in 2017 (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 declared Individual Assistance Disaster Areas ("IADA") which we used 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. Loans in our ending delinquent inventory within the IADAs were 12,446 as of December 31, 2017. The majority of notices of delinquency received from the IADAs due to the hurricane activity cured during 2018.
During 2019, 2018, and 2017 our losses paid included amounts paid upon commutation of coverage on policies . The impacts of the commutations of coverage on policies and/or settlements in each of the past three years were as follows:
2018 - 1,578 notices removed from delinquent inventory with an amount paid of $50 million,
Historically as a delinquency ages it becomes more likely to result in a claim. The new notice activity from hurricane impacted areas in the fourth quarter of 2017 increased the percentage of our delinquent inventory that had been delinquent for three months or less (table 8.4) as of December 31, 2017.
For information about discussions and legal proceedings with customers with respect to our claims paying practices, see Note 17 - “Litigation and Contingencies.”
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 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 and excess of loss basis, but we also have immaterial captive reinsurance agreements that remain in effect.
2019 QSR Transaction. We entered into a QSR transaction with a group of unaffiliated reinsurers with an effective date of January 1, 2019 (“2019 QSR Transaction”), which provides coverage on eligible NIW in 2019. Under the 2019 QSR Transaction, we will cede losses and premiums on or after the effective date through December 31, 2030, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021 or bi-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, full financial statement credit or full credit under applicable regulatory capital requirements for the risk ceded in any required calculation period.
Under our QSR Transactions, premiums are ceded on an earned and received basis as defined in our agreements.
The reinsurance recoverable on loss reserves was $21.6 million as of December 31, 2019 and $33.2 million as of December 31, 2018.The reinsurance recoverable balance is secured by funds on deposit from the
reinsurers, the amount of which is based on the funding requirements of PMIERs.
2020 QSR Transaction. We have agreed to terms on a QSR Transaction with a group of unaffiliated reinsurers with an effective date of January 1, 2020 ("2020 QSR Transaction"), which provides coverage on eligible NIW in 2020
The structure of the 2021 QSR Transaction is a 17.5% quota share on 2021 NIW, with an option to reduce the cede rate to either 14.5% or 12% effective July 1, 2022 or semiannually thereafter. Generally, under the 2021 QSR Transaction, we will receive an annual profit commission provided the annual loss ratio on the loans covered under the transactions remains below 62%.
Transactions under certain circumstances. The Home Re entities financed the coverages by issuing mortgage insurance-linked notes (“ILNs”) to unaffiliated investors in an aggregate amount equal to the initial reinsurance coverage amounts. The ILNs each have ten-year legal maturities and are non-recourse to any assets of MGIC or affiliates. The proceeds of the ILNs, which were deposited into reinsurance trusts for the benefit of MGIC, will be the source of reinsurance claim payments to MGIC and principal repayments on the ILNs.
Table 9.3 provides a summary of our excess of loss reinsurance agreements as of December 31, 2019 and December 31, 2018.
We have the right to terminate the excess-of-loss reinsurance agreements under certain circumstances and on any payment date on or after the respective termination option date.
The reinsurance premiums ceded to each Home Re Entity are composed of coverage, initial expense and supplemental premiums. The coverage premiums are generally calculated as the difference between the amount of interest payable by the Home Re Entity on the unpaid portion of the ILNs it issued to raise funds to collateralize its reinsurance obligations to us, and the investment income collected on the collateral assets. The amount of monthly reinsurance coverage premium ceded will fluctuate due to changes in one-month LIBOR, (or the fallback reference rate, as applicable) and changes in money market rates that affect investment income collected on the assets in the reinsurance trust. As a result, we concluded that each reinsurance agreement contains an embedded derivative that is accounted for separately as a freestanding derivative. The fair values of the derivatives at December 31, 2019, were not material to our consolidated balance sheet, and the change in fair values during the year ended December 31, 2019 were not material to our consolidated statements of operations. Total ceded premiums were $17.6 million and $2.8 million for the years ended December 31, 2019 and December 31, 2018, respectively.
We are required to disclose our maximum exposure to loss, which we consider to be an amount that we could
be required to record in our statements of operations, as a result of our involvement with the VIEs under our Home Re Transactions. As of December 31, 2019, and December 31, 2018, we did not have material exposure to the VIEs as we have no investment in the VIEs and had no reinsurance claim payments due from either VIE under our reinsurance agreements. We are unable to determine the timing or extent of claims from losses that are ceded under the reinsurance agreements. The VIE assets are deposited in reinsurance trusts for the benefit of MGIC that will be the source of reinsurance claim payments to MGIC. The purpose of the reinsurance trusts is to provide security to MGIC for the obligations of the VIEs under the reinsurance agreements. The trustee of the reinsurance trusts, a recognized provider of corporate trust services, has established segregated accounts within the reinsurance trusts for the benefit of MGIC, pursuant to the trust agreements. The trust agreements are governed by, and construed in accordance with, the laws of the State of New York. If the trustee of the reinsurance trusts failed to distribute claim payments to us as provided in the reinsurance trusts, we would incur a loss related to our losses ceded under the reinsurance agreements and deemed unrecoverable. We are also unable to determine the impact such possible failure by the trustee to perform pursuant to the reinsurance trust agreements may have on our consolidated financial statements. As a result, we are unable to quantify our maximum exposure to loss related to our involvement with the VIEs. MGIC has certain termination rights under the reinsurance agreements should its claims not be paid. We consider our exposure to loss from our reinsurance agreements with the VIEs to be remote.
The assets of the Home Re Entities provide capital credit under the PMIERs financial requirements (see Note 1 - "Nature of Business"). A decline in the assets available to pay claims would reduce the capital credit available to MGIC.
The pretax and related income tax benefit (expense) components of the amounts reclassified from our accumulated other comprehensive income (loss) ( "AOCI", "AOCL") to our consolidated statements of operations for the years ended December 31, 2019, 2018 and 2017 are included in table 10.2 below.
(Decreases) increases Net realized investment gains on the consolidated statements of operations.
Tables 11.5 and 11.6 shows the changes in the fair value of the net assets available for plan benefits, and changes in other comprehensive income (loss) during 2019 and 2018.
2. Rate to Which the Cost Trend Rate is Assumed to Decline (Ultimate Trend Rate)
To determine the fair value of securities in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been used. 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 used 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, 2019 and 2018. There were no securities that used Level 3 inputs.
è Total return should exceed growth in the Consumer Price Index by 5.75% annually
Investment in international mutual funds is limited to a maximum of 30% of the equity range. The allocation as of December 31, 2019 included 3% that was primarily invested in equity securities of emerging market countries and another 19% was invested in securities of companies primarily based in Europe and the Pacific Basin.
Assumed health care cost trend rates have a significant effect on the amounts reported for the other postretirement benefits plan. A one percentage point change in the health care trend rate assumption would have the following effects on other postretirement benefits:
We have a profit sharing and 401(k) savings plan for employees. At the discretion of the Board of Directors, we may make a contribution to the plan of up to 5% of each participant's eligible compensation. We provide a matching 401(k) savings contribution for employees of 100% up to the first 4% contributed. We recognized expenses related to these plans of $7.4 million, $6.0 million and $6.0 million in 2019, 2018 and 2017, respectively.
Net deferred tax assets and liabilities as of December 31, 2019 and 2018 are as follows:
We used the remaining balance of our Federal net operating loss carryforward to offset taxable income during 2018. We believe that all gross deferred tax assets at December 31, 2018 and 2019 are fully realizable and no valuation allowance has been established.
Our income tax expense for 2017 reflects the remeasurement of our net deferred tax assets to reflect the lower corporate tax rate of 21% under the Tax Act. As a result of the lower tax rate, we recorded a decrease to our net deferred tax assets of $133 million with a corresponding increase to our deferred income tax expense for the year ended December 31, 2017.
Current federal income tax payments were $158.3 million, $12.2 million, and $22.0 million in 2019, 2018 and 2017, respectively. At December 31, 2019 we owned $176.0 million of tax and loss bonds.
Additional income tax provision (benefit) related to the rate decrease included in the Tax Act
We have no unrecognized tax benefits at December 31, 2018 and December 31, 2019. We have not recorded any uncertain tax positions during 2019. We recognize interest accrued and penalties related to unrecognized tax benefits in income taxes. The statute of limitations related to the consolidated federal income tax return is closed for all years prior to 2015.
In September 2019 and November 2019, we paid a quarterly cash dividend of $0.06 per share to shareholders which totaled $42 million. On January 28, 2020, the Board of Directors declared a quarterly cash dividend to holders of the company's common stock of $0.06 per share payable on February 28, 2020, to shareholders of record at the close of business on February 11, 2020.
In 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.
In addition to the typical adjustments from statutory to GAAP, mortgage insurance companies are required to maintain contingency loss reserves equal to 50% of premiums earned under SSAP and principles prescribed by the OCI, and such amounts cannot be withdrawn for a period of ten years except as permitted by insurance regulations. With regulatory approval, a mortgage guaranty insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net premiums earned in a calendar year. For the year ended 2019, MGIC's losses incurred were 12% of net premiums earned. Changes in contingency loss reserves impact the statutory statement of operations. Contingency loss reserves are not reflected as liabilities under GAAP and changes in contingency loss reserves do not impact the GAAP statements of operations.
As a mortgage guaranty insurer, we are eligible for a tax deduction, subject to certain limitations, under Section 832(e) of the IRC for amounts required by state law or regulation to be set aside in statutory contingency reserves. The deduction is allowed only to the extent that we purchase tax and loss bonds (“T&L Bonds”) in an amount equal to the tax benefit derived from deducting any portion of our statutory contingency reserves. Under statutory accounting practices, purchases of T&L Bonds are accounted for as investments. Under GAAP, purchases of T&L Bonds are accounted for as a payment of current taxes.
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, 2019, MGIC’s risk-to-capital ratio was 9.7 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements and its policyholder position was $3.0 billion above the required MPP of $1.7 billion. The calculation of our risk-to-capital ratio and MPP reflect credit for the risk ceded under our QSR Transactions and Home Re Transactions 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 agreements, 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.
pay our holding company a special dividend of $320 million. The $320 million special dividend will reduce the statutory policyholder's position of MGIC, which will result in an increase to the risk-to-capital.
In 2019, MGIC paid a total of $280 million in dividends to our holding company. We received the appropriate approvals for MGIC to pay our holding company, in the first quarter of 2020, a special dividend of $320 million and a quarterly dividend of $70 million. We expect MGIC to continue to pay dividends of at least $280 million per year.
The OCI recognizes only statutory accounting principles prescribed, or practices permitted, by the State of Wisconsin for determining and reporting the financial condition and results of operations of an insurance company. The OCI has adopted certain prescribed accounting practices that differ from those found in other states. Specifically, Wisconsin domiciled companies record changes in the contingency reserves through the income statement as a change in underwriting deduction. As a result, in periods in which MGIC is increasing contingency reserves, statutory net income is reduced. For the year ended December 31, 2019, MGIC’s increase in contingency reserves was $556 million and statutory net income was $273 million. As of December 31, 2019, MGIC's statutory policyholders' surplus was $1,619 million.
We have an omnibus incentive plan that was adopted on April 23, 2015. The purpose of the 2015 plan is to motivate and incentive 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. At December 31, 2019,
The compensation cost that has been charged against income for share-based plans was $18.9 million, $20.9 million, and $14.9 million for the years ended December 31, 2019, 2018 and 2017, respectively. The related income tax benefit recognized for share-based plans was $2.7 million, $3.0 million, and $5.2 million for the years ended December 31, 2019, 2018, and 2017, respectively.
Table 15.1 summarizes restricted stock or restricted stock unit (collectively called “restricted stock”) activity during 2019.
As of December 31, 2019, there was $30.7 million of total unrecognized compensation cost related to non-vested share-based compensation agreements granted under the plans. Of this total, $20.2 million of unrecognized compensation costs relate to performance shares and $10.5 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 1.8 years.
Total lease expense under operating leases was $2.1 million in 2019, $1.9 million in 2018, and $2.0 million in 2017.
reduced our average claim paid by approximately 5.0% and 5.8%, 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 may be determined by legal proceedings.
effect on us. To the extent that we are construed to make independent credit decisions in connection with our contract underwriting activities, we also could be subject to increased regulatory requirements under the Equal Credit Opportunity Act (“EOCA”), FCRA, and other laws. Under ECOA, examination may also be made of whether a mortgage insurer’s underwriting decisions have a disparate impact on persons belonging to a protected class in violation of the law.
Due to the use of weighted average shares outstanding when calculating earnings per share, the sum of the quarterly per share data may not equal the per share data for the year.
The principal considerations for our determination that performing procedures relating to the valuation of loss reserves is a critical audit matter are (i) there was significant judgment by management when developing their estimate, which in turn led to a high degree of auditor judgment and subjectivity in performing procedures relating to loss reserves; (ii) there was significant auditor effort and judgment in evaluating the audit evidence relating to the significant assumptions, including the claim rate and claim severity; and (iii) the audit effort included the involvement of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained.