Forward-looking statements in this document include discussions relating to persistency rates, default and claim rates, the ongoing effects of the 2005 hurricanes, the seasoning of PMI’s insurance portfolio, the effects of pending or new regulatory requirements relating to the mortgage insurance industry, reserves for losses and LAE, and our liquidity and capital resources.
Other. Our Other segment consists of our holding company and contract underwriting operations, equity in earnings (losses) from our former unconsolidated subsidiary, SPS Holding Corp., or SPS, and certain limited partnerships, and the discontinued operations of our former title insurance subsidiary, American Pioneer Title Insurance Company, or APTIC. Our Other segment generated net losses of $43.9 million in 2005 and $15.8 million in 2004. Our sale of APTIC in 2004 generated an after tax gain of $29.0 million.
premiums earned on our U.S. and international mortgage insurance policies and credit enhancement products;
equity in earnings from our unconsolidated subsidiaries, primarily from FGIC and CMG; and
Our consolidated net income was $409.2 million in 2005 compared to $399.3 million in 2004. Consolidated net income in 2004 included a $29.0 million after tax gain on sale of discontinued operations, partially offset by a $20.4 million (pre-tax) realized capital loss on our equity investment in SPS. Our consolidated net income from continuing operations after taxes in 2005 was $409.2 million compared to $366.5 million in 2004. The increases in net income and net income from continuing operations after taxes in 2005 compared to 2004 were due primarily to higher premiums earned in U.S Mortgage Insurance Operations and PMI Australia in 2005, and increases in our equity in earnings from FGIC in 2005. These increases were partially offset by higher losses and loss adjustment expenses, or LAE, primarily from U.S. Mortgage Insurance Operations in 2005, and an increase in net losses in our Other segment in 2005.
Policy Cancellations and Persistency. Continued low interest rates and home price appreciation have driven heavy mortgage refinance activity and high policy cancellations, which in turn have negatively affected PMI’s insurance in force. While policy cancellations negatively affect PMI’s insurance in force, cancellations due to borrower prepayments positively affect premiums earned on PMI’s non-refundable single and annual premium policies in the year in which the cancellations occur. Upon notification of cancellation of a loan under a non-refundable single and annual premium policy, any unearned premium
with respect to that loan is recognized as earned premium. PMI’s persistency rate, the percentage of insurance in force at the beginning of a 12-month period that remains in force at the end of that period, was 61.9% at December 31, 2005 compared to 60.9% at December 31, 2004. If mortgage interest rates increase, we expect that refinancing activity will slow and, accordingly, that PMI’s persistency rate will improve. If home price appreciation slows, policy cancellations may decline, which would positively affect PMI’s persistency rate.
New Insurance Written (NIW). PMI’s NIW decreased by 12.8% in 2005 compared to 2004. PMI’s ability to write new mortgage insurance is directly affected by, among other factors, the sizes of the U.S. mortgage origination, purchase money mortgage, and private mortgage insurance markets. Increased use of alternatives to private mortgage insurance, such as “simultaneous seconds,” “piggyback,” “80/10/10,” “80/20,” or “80/15/5” loans, continues to negatively affect the size of the private mortgage insurance market and PMI’s NIW. The use of such loans, which include a first mortgage lien with a loan to value, or LTV, of 80% and a second mortgage lien of between 5% and 20%, has increased in the last four years. The size of the private mortgage insurance market is also affected by the number of loans originated and sold to non-agency investors and we believe that the level of non-agency loans increased as a percentage of the total origination market in 2005. We also believe that the 2005 private mortgage insurance market had higher concentrations of loans of a type or credit quality that PMI has traditionally not insured to a great extent, thereby reducing PMI’s NIW.
Credit and Portfolio Characteristics. PMI’s primary NIW and primary risk in force in 2005 consisted of higher percentages of adjustable rate mortgages, or ARMs, Alt-A loans and high LTV loans compared to 2004. We consider a loan Alt-A if it has a credit score of 620 or greater and has certain characteristics such as reduced documentation verifying the borrower’s income, deposit information or employment. We believe that these percentage increases reflect higher concentrations of ARMs, Alt-A and high LTV loans in the current mortgage origination and private mortgage insurance markets. In 2005, interest only loans, also known as deferred amortization loans, and payment option ARMs have been popular with some borrowers and PMI insured an increased amount of these loans in 2005 through its primary flow and structured transactions channels. Interest only loans and payment option ARMs have more exposure to declining home prices than fixed rate loans or traditional ARMs. We expect higher default and claim rates for ARMs, option ARMs, interest only, Alt-A, and high LTV loans and incorporate these assumptions into our underwriting approach, portfolio limits, pricing, and loss and claim estimates. We believe that the market trends discussed above may continue in 2006.
Underwriting and Operating Expenses. The profitability of our business depends in part on our ability to control our underwriting and operating expenses. PMI’s expense ratio, the ratio of total underwriting and operating expenses to net premiums written, was favorably impacted in 2005 by net premiums written associated with two large single premium structured transactions, lower deferred policy acquisition costs and higher average premium rates, partially offset by the increased use of captive reinsurance, which, by ceding portions of risk and premiums written on certain loans, decreases premiums written without fully offsetting decreases in underwriting expenses.
Regulatory and Legislative Environment. At any point in time, there are multiple proposals and initiatives for statutory and regulatory changes that may significantly affect the mortgage insurance industry as well as PMI’s business. We may also be impacted by changes in statutes and regulations affecting the GSEs, financial institutions and capital market participants.
PMI Europe. PMI Europe’s net income was negatively impacted in 2005 as a result of additional provisions for profit sharing obligations associated with the U.K. lenders’ mortgage insurance portfolio acquired by PMI Europe in 2003 from Royal & Sun Alliance (“R&SA”). R&SA and PMI Europe share certain economic benefits if the acquired portfolio’s loss performance reaches agreed-upon levels. Based upon the favorable loss performance of this business to date, PMI Europe increased expenses related to this profit-sharing agreement and will continue to do so in the future unless the loss performance becomes less favorable. PMI Europe’s net income in 2005 was also negatively impacted by a reduction in premiums earned associated with the acquired R&SA portfolio. We recognize premiums associated with this portfolio in accordance with established earnings patterns that are based upon management’s estimation of the expiration of the portfolio’s risk. Accordingly, we expect the premiums earned and risk in force associated with the portfolio to continue to decline through the remaining life of the portfolio.
Foreign Currency Exchange Fluctuations. The performance of our International Operations is subject to fluctuations in exchange rates between the reporting currency of the U.S. dollar and the functional currencies of the Australian dollar and the Euro. The change in the average foreign currency exchange rates from 2004 increased our 2005 International Operations net income by $2.9 million, primarily due to appreciation in the Australian dollar. This foreign currency translation impact is calculated using the year over year change in the average monthly exchange rates to the current period ending net income in the functional currencies. In January 2005, we purchased foreign exchange put options at a pre-tax cost of $1.8 million to partially mitigate the negative effects of a potential strengthening U.S. dollar relative to either the Australian dollar or the Euro in 2005. The net expense recognized related to the acquired options was $1.1 million in 2005 which was less than the total cost due to certain Euro options that settled in the money.
RAM Re. Equity in earnings from RAM Re was $4.8 million in 2005 compared to $6.2 million in 2004. This decrease was due primarily to unrealized losses in certain credit derivatives and increases in operating expenses.
Hurricane Katrina. At December 31, 2005, FGIC insured public finance obligations with a net par in force of approximately $4.0 billion in counties or locations impacted by Hurricane Katrina. Approximately $2.0 billion of this amount relates to areas designated by the Federal Emergency Management Agency (“FEMA”) as eligible for both public and individual assistance (“FEMA dual-designated locations”); the remainder relates to locations designated by FEMA as eligible for individual assistance only. After evaluation, FGIC placed obligations with a net par in force totaling $979.2 million on its credit watchlist. At December 31, 2005, FGIC had case reserves of $8.5 million, watchlist reserves of $13.3 million and an estimated reinsurance recoverable of $1.7 million. FGIC’s loss reserve will likely be adjusted in the future as additional information becomes available. Any such adjustments may have a material impact on its results of operations and our equity in earnings from FGIC. RAM Re’s exposure to obligations in the FEMA dual-designated areas is approximately $119 million. RAM Re has not recorded reserves related to Hurricane Katrina. We cannot predict whether FGIC or RAM Re will ultimately incur losses or will record additional reserves in the future as a result of Hurricane Katrina.
SPS. In October 2005, we sold our interest in SPS to Credit Suisse First Boston (USA), Inc., or CSFB. We received cash payments of approximately $99 million for our holdings in SPS and a $5.1 million repayment of a related party receivable. We expect to receive additional monthly cash payments through the first quarter of 2008 from a residual interest in mortgage servicing assets. Our equity investment in SPS generated losses of $1.7 million in 2005 compared to equity in earnings of $0.4 million in 2004. We recorded $1.8 million after tax of SPS-related losses in 2005 due to a $6.6 million reserve recorded by SPS relating to expected Katrina-related losses on force placed hazard and flood reinsurance. Additional hurricane related reserve increases or losses by SPS in the future could reduce the monthly payments we expect to receive in connection with the sale of our interest in SPS.
Contract Underwriting Services. Due to a decline in customers’ requests for contract underwriting services, our contract underwriting activities and associated revenues decreased in 2005 compared to 2004. We believe our contract underwriting activities and revenues will continue to decline in the future. Total contract underwriting expenses primarily include allocated expenses as well as monetary remedies provided to customers in the event we failed to properly underwrite a loan. Contract underwriting remedy expenses, and accruals thereof, increased from $10.0 million in 2004, to $14.5 million in 2005. We believe these increases were driven by the high levels of contract underwriting activities in 2002 and 2003.
The increase in net investment income in 2005 over 2004 was due primarily to growth in our Australian and European investment portfolios, combined with an increase in our consolidated book yield. As of December 31, 2005, our consolidated pre-tax book yield was 5.18% compared to 5.07% as of December 31, 2004. This increase in our pre-tax book yield was primarily due to the higher interest rate environment in Australia in 2005. The increase in net investment income in 2004 over 2003 was due primarily to growth in our Australian and European investment portfolios, partially offset by a decrease in our book yield related to our U.S. investment portfolio. Our investment portfolio grew in 2005 and 2004 primarily as a result of excess cash flows from operations.
In January 2005, we signed a Summary of Terms with CSFB, pursuant to which CSFB received an option to acquire 100% of our outstanding stock of SPS. As a result of the transaction, for the fourth quarter of 2004 we recorded a pre-tax realized capital loss on equity investment held for sale (SPS) of $20.4 million, or $13.3 million after tax. In October 2005, we sold our interest in SPS to CSFB and received cash payments of approximately $99 million. Simultaneously with the sale, we received a $5.1 million repayment of a related party receivable.
The increases in our losses and LAE in 2005 over 2004, and 2004 over 2003, were due primarily to higher claims paid in our U.S. Mortgage Insurance Operations. U.S. Mortgage Insurance Operation’s claims paid increased in 2005 and 2004 due to the seasoning of PMI’s insurance portfolio, an increased number of claims paid in 2005 that were previously delayed by bankruptcy protection, and higher claim rates associated with the
portion of PMI’s portfolio that contains ARMs, high LTV, Alt-A, and less-than-A quality loans. The 2005 increase in U.S. Mortgage Insurance Operations’ losses and LAE, of which claims paid are a part, was partially offset by the addition of $7.0 million to U.S. Mortgage Insurance Operation’s net loss reserves in 2005 compared to $14.2 million in 2004.
The increase in other underwriting and operating expenses in 2005 over 2004 was due primarily to higher operating expenses in our International Operations. This increase was driven by higher PMI Europe profit sharing commission accruals and increases in expenses related to payroll and regulatory compliance at PMI Australia. The increase in other underwriting and operating expenses in 2004 over 2003 was due primarily to higher operating expenses in our U.S. Mortgage Insurance Operations, including recognition of expenses previously deferred as acquisition costs, additional compensation-related expenses and expenses related to PMI’s field operations restructuring.
The decrease in interest expense and distributions on mandatorily redeemable preferred securities in 2005 compared to 2004 was due to the capitalization of interest expenses related to internally developed software. The increase in interest expense in 2004 compared to 2003 was due to the inclusion of a full year’s interest expense on the equity units we issued in November 2003.
We recognized an extraordinary after-tax gain of $5.4 million in 2003, which was our share of negative goodwill recognized by FGIC resulting from the application of purchase accounting adjustments upon our acquisition of our 42% interest in FGIC.
The following table presents consolidated net income and net income (loss) for each of our segments for the years ended:
The results of U.S. Mortgage Insurance Operations include the operating results of PMI Mortgage Insurance Co. and other U.S. mortgage insurance and reinsurance companies, collectively referred to as PMI. CMG Mortgage Insurance Company, CMG Mortgage Assurance Company and CMG Mortgage Reinsurance Company, collectively referred to as CMG, are accounted for under the equity method of accounting and their results are recorded as equity in earnings from unconsolidated subsidiaries. U.S. Mortgage Insurance Operations’ results are summarized in the table below.
The increases in gross and net premiums written in 2005 compared to 2004 were primarily due to two single premium structured transactions totaling $47.3 million in premiums written in the fourth quarter of 2005, and increases in PMI’s average premium rate and average insured loan balances in 2005. PMI’s average premium rate increased as a result of higher percentages of ARMs, Alt-A loans, and high LTV loans in PMI’s portfolio in 2005 compared to 2004. The decreases in gross and net premiums written in 2004 compared to 2003 were largely due to a non-refundable $114 million single premium policy executed in 2003 pursuant to which PMI restructured the insurance coverage of certain loans under then-existing primary insurance policies. These decreases in gross and net premiums written in 2004 compared to 2003 were partially offset by an increase in PMI’s average premium rate in 2004 caused by higher percentages of polices with deeper coverage and policies on ARMs and high LTV loans.
The increases in ceded premiums in 2005 and 2004 were driven primarily by increases in gross premiums written (excluding the $47 million and $114 million single premium transactions in 2005 and 2003, respectively), higher average premium rates and increasing percentages of primary flow insurance in force subject to captive reinsurance agreements. As of December 31, 2005, 61.7% of primary flow insurance in force and 63.1% of flow risk in force were subject to captive reinsurance agreements, compared to 58.4% and 59.7% at December 31, 2004, respectively. These increases are the result of a higher portion of new insurance written with customers with whom we have captive reinsurance agreements.
Upon cancellation of certain insurance coverage, PMI refunds the portion of premiums that is unearned to the insured. The higher amount of refunded premiums in 2003 was primarily due to high levels of policy cancellations in 2003 resulting from refinance activities (see Insurance and risk in force below).
Losses and LAE-PMI’s total losses and LAE represent claims paid, certain expenses related to default notification and claim processing and changes in loss reserves during the applicable period. Because total losses and LAE includes changes in net loss reserves, it reflects management’s best estimate of PMI’s future claim payments and costs to process those claims relative to PMI’s current inventory of loans in default. Claims paid including LAE includes amounts paid on primary insurance claims, pool insurance claims and LAE. PMI’s total losses and LAE and related claims data are shown in the following table.
increased to $21.6 million in 2005 from $19.4 million in 2004 and $18.0 million in 2003. The increases in claims paid including LAE and the number of primary claims paid in 2004 compared to 2003 were primarily due to the seasoning of PMI’s primary insurance portfolio and higher claim rates associated with Alt-A and less-than-A quality loans.
During the second quarter of 2003, we assessed the reasonableness of our estimate of reserves for LAE. As a result of this assessment, we decreased PMI’s LAE reserves by approximately $14 million and reduced the allocation of claim related expenses from operating expenses to LAE. PMI’s case and incurred but not reported reserves were increased by approximately the same amount of the reduction to LAE reserves according to our best estimate for loss reserves as of June 30, 2003.
PMI’s primary mortgage insurance master policies define “default” as the borrower’s failure to pay when due an amount equal to the scheduled monthly mortgage payment under the terms of the mortgage. Generally, the master policies require an insured to notify PMI of a default no later than the last business day of the month following the month in which the borrower becomes three monthly payments in default. For reporting and internal tracking purposes, we do not consider a loan to be in default until the borrower has missed two consecutive payments. Depending upon its scheduled payment date, a loan delinquent for two consecutive monthly payments could be reported to PMI between the 31st and the 60th day after the first missed payment. PMI’s primary default data are presented in the table below.
The increase in PMI’s primary default rate as of December 31, 2005 compared to December 31, 2004 was due to an increase in the number of primary loans in default and a decline in the number of primary insurance policies in force. The increase in primary loans in default as of December 31, 2005 compared to December 31, 2004 was due to approximately 3,500 primary loans attributable to the 2005 hurricanes. Higher concentrations of Alt-A loans, ARMs and high LTV loans in PMI’s structured portfolio also contributed to the increase in structured loans in default as of December 31, 2005 compared to December 31, 2004, and to the higher default rates generally compared to PMI’s flow channel default rates.
Our policy acquisition costs are costs that are primarily related to our acquisition, underwriting and processing of new mortgage insurance policies, including contract underwriting and sales related activities. To the extent that we are compensated by customers for contract underwriting, those underwriting costs are not deferred. We defer policy acquisition costs when incurred and amortize these costs in proportion to estimated gross profits for each policy year by type of insurance contract (i.e. monthly, annual and single premium). Policy acquisition costs incurred and deferred are variable and fluctuate with the volume of new insurance applications processed and NIW, and can also be reduced by increased use of PMI’s electronic origination and delivery methods.
The decreases in policy acquisition costs incurred and deferred in 2005 and 2004 were primarily the result of lower levels of NIW. PMI’s deferred policy acquisition cost asset decreased by $5.7 million from December 31, 2004 to $48.3 million at December 31, 2005 due to the continued amortization of policies originated in 2003, a decline in NIW compared to prior periods and expense savings realized from the 2004 field restructuring. Continued declines in PMI’s deferred policy acquisition cost asset would reduce future amortization of deferred policy acquisition costs.
PMI incurs underwriting expenses related to contract underwriting services for mortgage loans without mortgage insurance coverage. These costs are allocated to PMI Mortgage Services Co., or MSC, which is reported in our Other segment, thereby reducing PMI’s underwriting and operating expenses. Contract underwriting expenses allocated to MSC were $18.7 million in 2005, $26.1 million in 2004 and $44.3 million in 2003. The declines in allocated expenses were due to continued decreases in contract underwriting activity.
Modified pool insurance-PMI currently offers modified pool insurance products that may be attractive to investors and lenders seeking a reduction of default risk beyond the protection provided by existing primary insurance or with respect to loans that do not require primary insurance, or for capital relief purposes. In 2005, PMI wrote $0.3 billion of modified pool risk, compared to $0.2 billion in 2004 and $0.4 billion in 2003. Modified pool risk in force was $1.8 billion at December 31, 2005, $1.5 billion at December 31, 2004 and $1.4 billion at December 31, 2003.
Credit and portfolio characteristics-PMI insures less-than-A quality loans and Alt-A loans through all of its acquisition channels. PMI defines less-than-A quality loans to include loans with credit scores generally less than 620. PMI considers a loan Alt-A if it has a credit score of 620 or greater and has certain characteristics such as reduced documentation verifying the borrower’s income, assets, deposit information, and/or employment. The following table presents PMI’s less-than-A quality loans and Alt-A loans as percentages of its flow channel and structured channel primary NIW for the years ended:
In 2005 and 2004, interest only loans, also known as deferred amortization loans, and payment option ARMs have been popular with some borrowers and PMI has insured an increased amount of these loans during this period through its primary flow and structured transactions channels. Interest only loans and payment option ARMs have more exposure to declining home prices than fixed rate loans or traditional ARMs. As of December 31, 2005, we estimate that interest only loans and payment option ARMs represented approximately 6% and 3% of PMI’s primary risk in force, respectively. We estimate that interest only loans and payment option ARMs represented approximately 16% and 8% of PMI’s primary NIW in 2005, respectively.
Less-than-A with FICO scores below 575 is a subset of PMI’s less-than-A quality loan portfolio
International Operations includes the results of our Australian holding company, PMI Mortgage Insurance Australia (Holdings) Pty Limited, and operating subsidiaries, PMI Ltd and PMI Indemnity, collectively referred to as PMI Australia; our Irish subsidiaries, PMI Mortgage Insurance Company Limited and TPG Reinsurance Company Limited and its wholly owned subsidiaries, collectively referred to as PMI Europe; and PMI’s Hong Kong branch. Reporting of financial and statistical information for International Operations is subject to foreign currency rate fluctuations in translation to U.S. dollar reporting. International Operations’ results are summarized as follows:
In 2005 and 2004, we purchased Australian dollar and Euro put options designed to partially mitigate the negative financial impact of a potential strengthening of the U.S. dollar relative to the Australian dollar and the Euro in those years. The options had an aggregate pre-tax cost of $1.8 million and $1.1 million in 2005 and 2004, respectively. Net income from International Operations in 2005 and 2004 includes reductions of $1.1 million pre-tax and $0.7 million pre-tax, respectively, related to the cost (including realized gains) of our foreign currency put options.
Underwriting and operating expenses-The increase in underwriting and operating expenses in 2005 compared to 2004 was due primarily to higher levels of insurance in force, increases in payroll and payroll-related expenses driven by increased employee headcount and expenses related to regulatory compliance. The increase in underwriting and operating expenses in 2004 compared to 2003 was due primarily to higher levels of insurance in force and exchange rate fluctuations.
Primary NIW, insurance and risk in force-PMI Australia’s primary NIW includes flow channel insurance and insurance on residential mortgage-backed securities, or RMBS. RMBS transactions include insurance on seasoned portfolios comprised of prime credit quality loans that have LTVs often below 80%. The following table presents the components of PMI Australia’s primary NIW, insurance in force and risk in force for the years ended:
The decrease in primary NIW generated by PMI Australia’s flow channel and RMBS channel in 2005 compared to the corresponding period in 2004 was primarily due to the slowing Australian mortgage origination and residential mortgage backed securities markets, competitive pricing, and the restructuring of a captive reinsurance arrangement causing the customer’s affiliated captive reinsurer to retain more mortgage default risk. The increase in primary NIW in 2004 compared to 2003 was driven primarily by RMBS insurance written and the appreciation of the Australian dollar relative to the U.S. dollar. The increases in primary insurance in force and risk in force at December 31, 2005 compared to December 31, 2004, and December 31, 2003, were driven primarily by NIW.
The average Euro/USD currency exchange rate was 1.2444 in 2005, 1.2443 in 2004, and 1.1329 in 2003. Changes in the average Euro/USD currency exchange rates from 2004 to 2005, and 2003 to 2004, favorably impacted PMI Europe’s net income by $0.1 million in 2005 and $1.5 million in 2004. Net income from PMI Europe in 2005 and 2004 includes a $0.4 million pre-tax realized gain and a $0.1 million pre-tax realized loss related to foreign currency put options, respectively.
Net investment income-Net investment income increased in 2005 and 2004 primarily due to the growth of the investment portfolio. PMI Europe’s net investment income consists primarily of interest income from its investment portfolio, and to a lesser extent, gains and losses on foreign currency re-measurement, realized investment gains and losses from investment activity, and foreign currency exchange gains and losses when investments are sold. PMI Europe’s investment portfolio, including cash and cash equivalents, as of December 31, 2005 was $216.3 million, $229.3 million as of December 31, 2004, and $194.4 million as of December 31, 2003. The decrease in the investment portfolio in 2005 was primarily driven by the change in the Euro year end spot rate relative to the U.S. dollar as of December 2005. However, the Euro equivalent value of the portfolio increased primarily due to positive cash flows from operations and investment income earned. The pre-tax book yield was 4.5% for the years ended December 31, 2005, 2004 and 2003. PMI Europe incurred net realized investment losses of $0.1 million in 2005 compared with $0.5 million net realized investment gains in 2004 and 2003.
Underwriting and operating expenses-The increase in underwriting and operating expenses in 2005 compared to 2004 was due primarily to additional provisions for the R&SA profit-sharing obligation and increases in costs associated with expansion efforts. Under the terms of its agreement with R&SA, PMI Europe and R&SA share certain economic benefits if the loss performance of the U.K. mortgage insurance portfolio acquired by PMI Europe reaches agreed-upon levels. Based upon the favorable loss performance of this business to date, PMI Europe increased expenses related to this agreement in 2005 and will continue to do so in the future unless the loss performance becomes less favorable.
The following table sets forth PMI’s Hong Kong reinsurance revenues for the years ended:
PMI’s Hong Kong branch reinsures mortgage risk primarily for the Hong Kong Mortgage Corporation, or HKMC. The increases in gross reinsurance premiums written and reinsurance premiums earned in 2005 and 2004 were due primarily to an increase in mortgage origination activity and mortgage insurance product expansion. In July 2004, PMI’s Hong Kong branch began reinsuring residential mortgages with LTVs between 90.01% and 95.00%. In addition, premiums earned increased in 2005 compared to 2004 due to reported terminations of coverage for single premium policies. In 2005, the HKMC increased, and will increase further in 2006 and 2007, the percentage of mortgage insurance risk and associated premiums that it retains, negatively impacting PMI’s reinsurance and premiums written.
The decreases in equity in earnings from RAM Re in 2005 compared to 2004 were due primarily to a refinement of market value modeling resulting in unrealized losses of certain credit derivatives and increases in operating expenses. The increase in equity in earnings from RAM Re in 2004 compared to 2003 was largely due to increases in premiums earned and investment income in 2004.
As a result of the acquisition of FGIC on December 18, 2003, purchase accounting adjustments were made to FGIC’s consolidated balance sheet as of December 18, 2003 and are reflected in its consolidated results of operations subsequent to that date. As a result of the effects of these adjustments being included in FGIC’s results, net income and other line items (as discussed below) may not be comparable period over period. All 2003 results discussed below refer to FGIC’s full-year, combined results.
Losses and LAE-The increase in FGIC’s loss and loss adjustment expenses in 2005 compared to 2004 was primarily due to its recording of $20.8 million of loss reserves primarily related to insured obligations in areas affected by Hurricane Katrina. Loss and loss adjustment expenses increased in 2004 compared to 2003 primarily due to a reduction in reserves prior to December 18, 2003.
Interest expense and other operating expenses-FGIC’s interest expense and other operating expenses decreased in 2005 compared to 2004 due to a $3.9 million expense in the second quarter of 2004 related to the establishment of a new soft capital facility. FGIC recorded interest expense of $19.5 million in 2005 related to $325.0 million in senior notes issued in 2004. The senior notes are due January 15, 2034, accrue interest at 6% per annum. Interest is payable on the senior notes semiannually.
Extraordinary gain-FGIC recorded a $13.9 million extraordinary gain as of December 18, 2003 related to negative goodwill. We recognized our proportionate share of FGIC’s extraordinary gain ($5.4 million net of tax) separately from equity in earnings from unconsolidated subsidiaries.
The results of our Other segment include income and related operating expenses of MSC and net investment income, interest expense and corporate overhead of The PMI Group, our holding company. Equity in earnings from SPS in 2004 is included in this segment in equity earnings from unconsolidated subsidiaries. As a result of the sale of our interest in SPS in October 2005, equity in earnings or losses from our investment in SPS in 2005 is
Other income-Other income primarily includes contract underwriting revenue generated by MSC. For 2005, other income includes such revenue, but is offset by $1.7 million of losses relating to our investment in SPS. In 2005, we recorded a $1.8 million after tax charge due to SPS’s $6.6 million reserve increase
relating to expected Katrina-related losses on force placed hazard and flood reinsurance. In addition to the SPS-related losses, other income decreased in 2005 compared to 2004 as a result of a decline in contract underwriting activity and associated revenue. Other income decreased in 2004 compared to 2003 due primarily to a decline in contract underwriting activity related to lower mortgage origination and refinance volume.
Interest expense and distributions on mandatorily redeemable preferred securities-Interest expense decreased in 2005 compared to 2004 due primarily to the capitalization of interest expense related to internally developed software costs. Interest expense and distributions on mandatorily preferred securities increased in 2004 compared to 2003 due primarily to the monthly interest expense relating to the 13.8 million 5.875% equity units we issued in November 2003.
The PMI Group’s principal uses of liquidity are the payment of operating costs, income taxes (which are predominantly reimbursed by its subsidiaries), principal and interest on its debt, payments of dividends to shareholders, repurchases of its common shares, purchases of investments, and capital investments in and for its subsidiaries. In July 2005, our Board of Directors approved a $0.21 per share annual dividend beginning in the third quarter of 2005, representing an annual increase of $0.03 per share.
U.S. Mortgage Insurance Operations Liquidity-The principal uses of U.S. Mortgage Insurance Operations’ liquidity are the payment of operating expenses, claim payments, taxes, dividends to The PMI Group, and the growth of its investment portfolio. We believe that the U.S. Mortgage Insurance Operations’ operating liquidity needs can be funded exclusively from its operating cash flows. The principal sources of U.S. Mortgage Insurance Operations’ liquidity are written premiums and net investment income. We have reached an agreement with CUNA Mutual Group, CMG’s other equity owner, to cause CMG to dividend to its parents approximately $35 million of dividends in 2006, subject to regulatory and rating agency approval. This agreement allows PMI to realize the benefit of a dividend received deduction in 2005 with regard to CMG dividends. PMI will receive 50% of any dividend from CMG.
International Operations Liquidity-The principal uses of International Operations’ liquidity are the payment of operating expenses, claim payments, profit commission obligations, taxes, and growth of its investment portfolio. We believe that International Operations’ operating liquidity needs can be funded exclusively from its operating cash flows. The principal sources of International Operations’ liquidity are written premiums, investment maturities and net investment income.
We have a $175 million revolving credit facility that can be utilized for working capital, capital expenditures and other business purposes. The facility may be increased to $200 million at our request subject to approval by the lenders. The revolving credit facility contains certain financial covenants and restrictions, including a debt-to-capital ratio threshold and a risk-to-capital ratio threshold of 23 to 1. The PMI Group was in compliance with all debt covenants for the year ended December 31, 2005. There are no amounts outstanding related to the revolving credit facility as of December 31, 2005.
PMI’s ability to pay dividends to The PMI Group is affected by state insurance laws, credit agreements, rating agencies, and the discretion of insurance regulatory authorities. The laws of Arizona, PMI’s state of domicile for insurance regulatory purposes, provide that PMI may pay dividends out of any available surplus account, without prior approval of the Director of the Arizona Department of Insurance, during any 12-month period in an amount not to exceed the lesser of 10% of policyholders’ surplus as of the preceding year end or the prior calendar year’s net investment income. A dividend that exceeds the foregoing threshold is deemed an “extraordinary dividend” and requires the prior approval of the Director of the Arizona Department of Insurance. On April 26, 2005, the Director of the Arizona Department of Insurance approved an extraordinary dividend request of $300 million. This dividend was paid to The PMI Group in two equal installments in June and December of 2005.
Corporation’s certificate of incorporation, a stockholder agreement between The PMI Group and the other investors in FGIC Corporation, and its 6.0% senior notes. Under New York insurance law, Financial Guaranty Insurance Company may pay dividends out of statutory earned surplus, provided that statutory surplus after any dividend may not be less than the minimum required paid-in capital and provided that together with all dividends declared or distributed by Financial Guaranty Insurance Company during the preceding 12 months, the dividends do not exceed the lesser of (i) 10% of policyholders’ surplus as of its last statement filed with the New York superintendent or (ii) adjusted net investment income during this period.
In addition, so long as any senior preferred stock or class B common stock issued upon conversion of that preferred stock is outstanding, FGIC Corporation’s certificate of incorporation generally prohibits the payment of dividends or other payments on any of FGIC Corporation’s capital stock, except the senior preferred stock, without the consent of the holder of two-thirds of the outstanding shares of that preferred stock (or the class B common stock issued upon conversion of that preferred stock). This restriction does not apply to cash dividends declared and paid on the class A common stock after the ninth anniversary of the closing of the FGIC investment provided that those dividends are paid from retained earnings in excess of the amount of FGIC’s retained earnings on the closing date of such investment, the amount of the dividends in any fiscal year does not exceed one-third of one percent of FGIC’s stockholders’ equity and equivalent dividends are paid on the class B common stock.
Net investment income increased in 2005 compared to 2004 and in 2004 compared to 2003, due to growth in our investment portfolio and increased book yields in Australia. The Australian book yield increase in 2005 reflects the higher interest rate environment.
Net realized gains decreased by $0.4 million after-tax in 2005 compared with 2004 and increased $1.6 million after-tax in 2004 compared with 2003. During 2005, we recognized a $2.1 million pre-tax realized capital loss on a private equity limited partnership agreement. The increase in 2004 compared to 2003 was due mainly to a reduction in fixed income sales activity in 2003. In addition, other-than-temporary impairment of our equity portfolio was $0.6 million, $0.2 million and $0.3 million in 2005, 2004, and 2003, respectively. During 2003, we sold our ownership interest in Truman Capital Founders, LLC, an unconsolidated subsidiary, and recognized a
The change in unrealized gains and losses in 2005 in comparison to 2004 was due primarily to increases in interest rates that caused market value declines relative to our consolidated fixed income portfolio and our ownership interest in our unconsolidated equity investments. As interest rates, market and other economic conditions change, we expect the market value of the securities in our consolidated investment portfolio and of our unconsolidated equity investments to be affected.
Our consolidated investment portfolio holds primarily investment grade securities comprised of readily marketable fixed income and equity securities. At December 31, 2005, the fair value of these securities in our consolidated investment portfolio was $3.2 billion compared to $3.3 billion at December 31, 2004. The decrease was primarily the result of decreases in foreign currency translation rates in our international operations from December 31, 2005 to December 31, 2004, partially offset by positive cash flows from consolidated operations and a decrease in unrealized gains in our investment portfolio (see above).
The following table summarizes the pre-tax book yield of our consolidated investment portfolio by book yield as of December 31, 2005 and 2004.
The terms of the 2.50% Senior Convertible Debentures due July 15, 2021 provide that the holders of the debentures may require The PMI Group to repurchase outstanding debentures on July 15, 2006, 2008, 2011, and 2016 at a purchase price equal to the principal amount of the debentures to be repurchased plus accrued and unpaid interest. Instead of paying the purchase price in cash, we may pay all or a portion of the purchase price in common stock, valued at 97.5% of the average sale price of the common shares over a specified period, provided that the shares of common shares to be issued are registered under the Securities Act, if required. On July 15, 2004, certain debenture holders required us to repurchase a nominal amount of the debentures. We have the option to redeem some or all of the debentures on or after July 15, 2006 for a price equal to the principal amount of the debentures plus any accrued and unpaid interest. In addition, the debentures may be converted into common shares at the debenture holder’s option, prior to stated maturity, if specified requirements are met (See
Consolidated cash flows generated by investing activities, including purchases and sales of investments, investments in unconsolidated subsidiaries and capital expenditures, was $174.2 million in 2005 as compared to $411.8 million used in investing activities in 2004. The difference was due primarily to our increased purchases of fixed income securities during 2005 compared to 2004. The reduction in investing activity was due primarily to our increases in cash and cash equivalents in order to achieve a higher level of liquidity to fund common share repurchases and an extraordinary dividend to The PMI Group from PMI.
The rating agencies have assigned the following ratings and outlooks to The PMI Group and certain of its wholly owned subsidiaries:
“Management’s Discussion and Analysis of Financial Condition and Results of Operation,” as well as disclosures included elsewhere in this Annual Report on Form 10-K, are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingencies. Actual results may differ significantly from these estimates. We believe that the following critical accounting policies involved significant judgments and estimates used in the preparation of our consolidated financial statements.
We establish reserves for losses and LAE to recognize the liability of unpaid losses related to insured mortgages that are in default. We do not rely on a single estimate to determine our loss reserves and LAE. To ensure the reasonableness of our ultimate estimates, we develop scenarios using generally recognized actuarial projection methodologies that result in a range of possible losses and LAE. Each scenario in the loss and LAE reserve model is assigned different weightings and is based upon actual claims experience in prior years to project the current liability. Our best estimate with respect to our consolidated loss and LAE reserves was approximately the midpoint of our actuarially determined range at December 31, 2005 and December 31, 2004.
The following table shows the reasonable range of loss and LAE reserves, as determined by our actuaries, and recorded reserves for losses and LAE (gross of reinsurance recoverables) as of December 31, 2005 and 2004 on a segment and consolidated basis:
Our increase to the reserve balance at December 31, 2005 was due primarily to the higher proportion of delinquencies developing into claims, and to a lesser extent, an increase in primary loans in default. We believe that the increase in primary loans in default was primarily due to the effects of the 2005 hurricanes. The table below provides a reconciliation of our U.S. Mortgage Insurance segment’s beginning and ending reserves for losses and LAE for each of the last three years:
The $6.3 million increase and $5.9 million and $3.6 million reductions in 2005, 2004 and 2003 over prior years, respectively, were due to re-estimations of ultimate loss rates from those established at the original notice of default, updated through the periods presented. These re-estimations of ultimate loss rates are the result of management’s periodic review of estimated claim amounts in light of actual claim amounts, loss development data or ultimate claim rates. The $6.3 million increase in prior years’ reserves during 2005 was due primarily to an increase in the primary and pool claim rates, partially offset by a reduction in the incurred but not reported estimate. The $5.9 million reduction in prior years’ reserves during 2004 was due primarily to a reduction in the incurred but not reported estimate and to a lesser extent our reallocation of reserves between 2003 and 2002. The $3.6 million reduction in prior years’ reserves during 2003 were due primarily to our reallocation of reserves between accident years combined with more favorable claim size and certain pool portfolio loss development trends.
The following table shows a breakdown of reserves for losses and LAE by primary and pool insurance for the years ended:
To provide a measure of sensitivity on pre-tax income to changes in loss reserve estimates, we estimate that: (i) for every 5% change in our estimate of the future average claim size or every 5% change in our estimate of the future claim rate with respect to the December 31, 2005 reserve for losses and LAE, the effect on pre-tax income would be an increase or decrease of approximately $17 million; (ii) for every 5% change in our estimate
These sensitivities are hypothetical and should be viewed in that light. For example, the relationship of a change in assumption relating to future average claim size, claim rate or cost of claims settlement to the change in value may not be linear. Also, the effect of a variation in a particular assumption on the value of the loss, IBNR and LAE reserves is calculated without changing any other assumption. Changes in one factor may result in changes in another which might magnify or counteract the sensitivities. Changes in factors such as persistency or cure rates can also affect the actual losses incurred. To the extent persistency increases and assuming all other variables remain constant, the absolute dollars of claims paid will increase as insurance in force will remain in place longer, thereby generating a higher potential for future incidences of loss. Conversely, if persistency were to decline, absolute claim payments would decline. In addition, changes in cure rates would positively or negatively affect total losses if rates increased or decreased, respectively.
International Operations-PMI Australia’s reserves for losses and LAE are based upon estimated unpaid losses and LAE on reported defaults and estimated defaults incurred but not reported. The key assumptions we use to derive PMI Australia’s loss and LAE reserves include estimates of PMI Australia’s expected claim rates, average claim sizes, LAE, and net expected future claim recoveries. These assumptions are evaluated in light of similar factors used by PMI. In connection with the preparation and filing of this annual report, our actuaries determined an actuarial range for PMI Australia’s reserves for losses and LAE, at December 31, 2005, of $7.8 million to $9.8 million. In connection with the filing of PMI Australia’s 2005 statutory financial statements with APRA in April 2006, our actuaries must perform an additional actuarial analysis of PMI Australia’s losses and LAE. As a result of this additional analysis, our actuaries may provide a different actuarial range with respect to PMI Australia’s reserves for losses and LAE. As of December 31, 2005, PMI Australia’s recorded reserves for losses and LAE were $8.5 million, which represented our best estimate. In arriving at this estimate, we reviewed the key assumptions described above and the work performed, and being performed, by our actuaries. Our estimate of $8.5 million represents a decrease of $1.3 million from PMI Australia’s reserve balance of $9.8 million at December 31, 2004. This decrease was due in part to foreign currency fluctuations between the Australian and U.S. dollar and our refinement of expected ultimate claim rates and severity.
Our actuaries calculated a range for PMI Europe’s loss reserves at December 31, 2005 of $8.1 million to $26.2 million. The primary drivers of this loss reserve range are the portfolio acquired from R&SA, for which we have limited claim and delinquency history, and our German first loss credit default swap transactions. PMI Europe’s recorded loss reserves at December 31, 2005 were $14.8 million, which represented management’s best estimate and a decrease of $1.6 million from PMI Europe’s reserve balance of $16.4 million at December 31, 2004. PMI Europe increased its reserves by $0.9 million in 2005 as a result of additional delinquencies on its non-derivative credit default swaps. However, this increase was offset by favorable changes to the U.S. dollar to Euro exchange rate and the reserve release related to the R&SA portfolio during 2005. PMI Europe establishes loss reserves for all of its insurance and reinsurance business and for credit default swap transactions consummated before July 1, 2003. Revenue, losses and other expenses associated with credit default swaps executed on or after July 1, 2003 are recognized through derivative accounting treatment. PMI Europe’s loss reserving methodology contains two components: case reserves and IBNR reserves. Case and IBNR reserves are based upon factors which include, but are not limited to, our analysis of arrears and loss payment reports, loss assumptions derived from pricing analyses, our view of current and future economic conditions, and industry information.
Incurred but not reported decreased in 2005 compared to 2004 due primarily to PMI Europe.
If we believe a decline in the value of a particular investment is temporary and we have the ability and intent to hold to recovery, we record the decline as an unrealized loss within our consolidated balance sheet under “accumulated other comprehensive income” in shareholders’ equity. If we believe the decline is other-than-temporary, we write-down the carrying value of the investment and record a realized loss in our consolidated statement of operations under “net realized investment gains”. Our assessment of a decline in value includes management’s current assessment of the factors noted above. If that assessment changes in the future, we may ultimately record a loss after having originally concluded that the decline in value was temporary.
The following table shows our investment portfolio’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005.
Unrealized losses on fixed income securities were primarily due to an increase in interest rates during 2005 and 2004 and are not considered to be other-than-temporarily impaired as we have the intent and ability to hold until such investments recover in value or mature. We determined that the decline in the market value of certain fixed income and equity securities in our investment portfolio met the definition of other-than-temporary impairment and recognized realized losses of $0.6 million in 2005 and $0.2 million in 2004.
We generate a significant portion of our consolidated revenues from mortgage insurance premiums on either a monthly, annual or single payment basis. Premiums written on a monthly basis are earned as coverage is provided. Premiums written on an annual basis are earned on a monthly pro-rata basis over the year of coverage. Primary mortgage insurance premiums written on policies covering more than one year are referred to as single premiums. A portion of the revenue from single premiums is recognized in premiums earned in the current period, and the remaining portion is deferred as unearned premiums and earned over the expected life of the policy. If single premium policies related to insured loans are cancelled due to repayment by the borrower, and the premium is non-refundable, then the remaining unearned premium related to each cancelled policy is recognized as earned premiums upon notification of the cancellation. The earnings pattern for single premium products is based on a range of seven to fifteen years, and the rates used to determine the earnings of single premiums are estimates based on actuarial analysis of the expiration of risk. Single premiums written accounted for 21.5%, 19.0% and 27.8% of gross premiums written from mortgage insurance in 2005, 2004 and 2003, respectively, and come predominantly from PMI Australia in our International Operations segment with the exception of two large single premium policies written in the fourth quarter of 2005 in our U.S. Mortgage Insurance Operations segment. The premium earnings process generally begins upon receipt of the initial premium payment. The earnings pattern calculation is an estimation process and, accordingly, we review the premium earnings pattern for each policy acquisition year (“Book Year”) annually and any adjustments to these estimates are reflected for each Book Year as appropriate.
Our policy acquisition costs are those costs that vary with, and are primarily related to, our acquisition, underwriting and processing of new mortgage insurance policies, including contract underwriting and sales related activities. To the extent that we are compensated by customers for contract underwriting, those underwriting costs are not deferred. We defer policy acquisition costs when incurred and amortize these costs in proportion to estimated gross profits for each policy year by type of insurance contract (i.e. monthly, annual and single premium). The amortization estimates for each underwriting year are monitored regularly to reflect actual experience and any changes to persistency or loss development by type of insurance contract. The rate of amortization is not adjusted for monthly and annual policy cancellations unless it is determined that the policy cancellations are of such magnitude that the recoverability of the deferred costs is not probable. Generally, in order for policy cancellations to create an impairment of policy acquisition costs related to our monthly and annual products, we estimate that, due primarily to scheduled amortization, our annual cancellation rate would need to exceed 60% before it would become probable that deferred policy costs associated with PMI’s monthly and annual premium policies would not be recoverable. Since 1993, PMI’s highest annual cancellation rate was 56% which occurred in 2003. No impairment for monthly or annual policies was recognized for that year. The deferred costs related to single premium policies are adjusted as appropriate for policy cancellations to be
On October 4, 2005, we completed the sale of our equity ownership interest in SPS to CSFB. We received cash payments of approximately $99 million for our holdings in SPS and expect to receive additional monthly cash payments through the first quarter of 2008 from a residual interest in mortgage servicing assets with an estimated fair value at closing of approximately $20.7 million. As of December 31, 2005, the carrying value of the residual interest was $16.4 million. We and SPS’s other former shareholders have agreed to indemnify CSFB for certain liabilities relating to SPS’s operations. As of December 31, 2005, we recorded a liability of $6.4 million with respect to this indemnification. Simultaneously with the sale, we received repayment of the outstanding balance on our related party receivable from SPS in the amount of $5.1 million.
In 2005, we determined that a certain private equity limited partnership investment met the criteria for other-than-temporary impairment. We recorded a $2.1 million pre-tax realized capital loss against our carrying value of this limited partnership.
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Our independent registered public accounting firm has issued an audit report on management’s assessment of our internal control over financial reporting. That report appears below in Item 8.
We have audited the accompanying consolidated balance sheets of The PMI Group, Inc. and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The PMI Group, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We have audited management’s assessment, included in the accompanying report from management, that The PMI Group, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The PMI Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of The PMI Group, Inc. and our report, dated March 8, 2006, expressed an unqualified opinion thereon.
The accompanying consolidated financial statements include the accounts of The PMI Group, Inc. (“The PMI Group” or “TPG”), a Delaware corporation and its direct and indirect wholly-owned subsidiaries, including: PMI Mortgage Insurance Co., an Arizona corporation, and its affiliated U.S. mortgage insurance and reinsurance companies (collectively “PMI”); PMI Mortgage Insurance Ltd and PMI Indemnity Limited, the Australian mortgage insurance companies, and their holding company, PMI Mortgage Insurance Australia (Holdings) Pty Limited (collectively “PMI Australia”); PMI Mortgage Insurance Company Limited and its holding company TPG Reinsurance Company Limited, the Irish insurance companies (collectively “PMI Europe”); American Pioneer Title Insurance Company (“APTIC”), a Florida corporation reported as discontinued operations in the consolidated financial statements and sold by The PMI Group on March 19, 2004; and other insurance, reinsurance and non-insurance subsidiaries. The PMI Group and its subsidiaries are collectively referred to as the “Company.” All material intercompany transactions and balances have been eliminated in the consolidated financial statements.
The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and the requirements of Form 10-K and Article 7 of Regulation S-X. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported amounts of
Risks and Uncertainties-The Company is dependent upon mortgage originators to provide mortgage loans to insure. In the event any of its largest customers choose to stop providing the Company with mortgage loans to insure, the Company’s ability to generate new insurance business could be adversely affected. The Company’s U.S. Mortgage Insurance Operations’ ten largest customers generated 42.8% 42.0% and 42.1% of its premiums earned in 2005, 2004 and 2003, respectively.
The Company’s various U.S., Australian and Irish insurance subsidiaries are subject to comprehensive regulation. These regulations are generally intended to protect policyholders, rather than to benefit investors. Although their scope varies, applicable laws and regulations grant broad powers to supervisory agencies or officials to examine companies and to enforce rules or exercise discretion touching almost every significant aspect of the insurance business. The licensing of the Company’s insurance subsidiaries, their premium rates, their forms and policies offered to customers, their financial statements and periodic financial reporting, and their permissible investments and adherence to financial standards relating to statutory surplus, dividends to the Company and other criteria of solvency are all subjects of detailed regulation.
The Company establishes loss reserves to recognize the liability of unpaid losses related to insured mortgages that are in default. These loss reserves are based upon the Company’s estimates of the claim rate and average claim amounts, as well as the estimated costs of settling claims. These estimates are regularly reviewed and updated using currently available information. Any adjustments due to positive or adverse developments, which may be material, resulting from these reviews would impact current reserve requirements. The Company’s reserves may not be adequate to cover ultimate loss development on incurred defaults. The Company’s consolidated financial condition, results of operations or cash flows could be harmed if the Company’s reserve estimates are insufficient to cover the actual related claims paid and loss-related expenses incurred.
Investments-The Company has designated its entire portfolio of fixed income and equity securities as available-for-sale. These securities are recorded at fair value based on quoted market prices with unrealized gains and losses, net of deferred income taxes, accounted for as a component of accumulated other comprehensive income in shareholders’ equity. The Company evaluates its investments regularly to determine whether there are declines in value and whether such declines meet the definition of other-than-temporary impairment in accordance with Statement of Financial Accounting Standards (“SFAS”) SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and Securities and Exchange Commission (“SEC”) Staff Accounting
Bulletin No. 59, Accounting for Noncurrent Marketable Equity Securities. The fair value of a security below cost or amortized cost for consecutive quarters is a potential indicator of an other-than-temporary impairment. When the Company determines a security has suffered an other-than-temporary impairment, the impairment loss is recognized, to the extent of the decline, as a realized investment loss in the current period’s net income.
Periodically, or as events dictate, the Company evaluates potential impairment of its investments in unconsolidated subsidiaries. Accounting Principles Board (“APB”) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, (“APB No. 18”), provides criteria for determining potential impairment. In the event a loss in value of an investment is determined to be an other-than-temporary decline, an impairment charge would be recognized in the consolidated statement of operations. Evidence of a loss in value that could indicate impairment might include, but would not necessarily be limited to, the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings capacity
The SEC requires public companies to disclose condensed financial statement information in the footnotes for significant equity investees and unconsolidated majority owned subsidiaries, individually or in the aggregate, if (i) the Company’s investments in and advances to the subsidiaries are in excess of 10% of the total consolidated assets of the Company, (ii) the Company’s proportionate share of unconsolidated majority owned subsidiaries’ total assets is in excess of 10% of total consolidated assets of the Company, or (iii) income from continuing operations before income taxes, extraordinary items and the cumulative effect of a change in accounting principle of the unconsolidated subsidiaries is in excess of 10% of such income of the Company. Furthermore, if certain of the above tests exceed 20% with respect to any unconsolidated subsidiary, separate audited financial statements of that unconsolidated subsidiary are required to be included in the registrant’s Form 10-K. Equity investees are not subject to the 20% threshold for the proportionate share of unconsolidated subsidiaries total asset test, and accordingly, separate consolidated financial statements of FGIC are not included in this Form 10-K. As of December 31, 2005, the Company’s equity investees and unconsolidated majority owned subsidiaries on a combined basis exceeded certain of the 10% tests in the aggregate and, accordingly, condensed financial statement information is provided in Note 22. Condensed Financial Statements of Significant Unconsolidated Subsidiaries.
Related Party Receivables-As of December 31, 2005, related party receivables were $2.9 million, which was comprised of non-trade receivables from unconsolidated subsidiaries. As of December 31, 2004, related party receivables were $18.4 million, of which $16.7 million related to SPS. Of this amount, $16.6 million represented the outstanding balance on a $23.0 million subordinated promissory note the Company received from SPS in the third quarter of 2004. The Company received the note in exchange for $23.0 million of subordinated participation interests in SPS debt held by the Company. The note bore interest at 1-month LIBOR plus 2.375% and scheduled principal and interest payments were due monthly through January 2006. Principal payments totaling $11.6 million were received during the first nine months of 2005. Pursuant to the sale of SPS, the balance of $5.1 million was repaid in full. See Note 5. Investments in Unconsolidated Subsidiaries for further details on the closing of the sale of SPS on October 4, 2005.
During the second quarter of 2004, the Company provided SPS with $19.7 million of a $40.0 million redress fund established pursuant to SPS’s settlement with the U.S. Federal Trade Commission (“FTC”) and the Department of Housing and Urban Development (“HUD”). In exchange for providing SPS with $19.7 million, the Company received from SPS a note in the amount of $19.7 million. In September 2004, the $19.7 million note and accrued interest were exchanged by the Company for additional shares of common stock of SPS.
determined that the policy cancellations are of such magnitude that impairment of the deferred costs is probable. The deferred costs related to single premium policies are adjusted as appropriate for policy cancellations to be consistent with the Company’s revenue recognition policy. The amortization estimates for each underwriting year are monitored regularly to reflect actual experience and any changes to persistency or loss development. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed recoverable amounts, after considering investment income.
Derivatives-The Company enters into credit default swap contracts and purchases certain foreign currency put options, both of which are considered derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). The Company has not designated either the credit default swaps or foreign currency put options as SFAS No. 133 hedges. Accordingly, both categories of derivatives are determined to be free standing, with changes in fair values recognized in the current period’s consolidated results of operations.
As of December 31, 2005, PMI Europe had entered into five credit default swaps that were classified as derivatives in accordance with SFAS No. 149. Accordingly, initial fair value gains on these derivatives were deferred in accordance with EITF No. 02-3. As of December 31, 2005, $6.8 million of deferred gains related to the initial fair value of these derivatives were included in other liabilities compared to $6.6 million as of December 31, 2004. Included in other income was $1.6 million (pre-tax) and $1.3 million (pre-tax) of accretion from the deferred gains in 2005 and 2004, respectively. Subsequent changes in the value, exclusive of accretion, of such derivatives resulted in $0.8 million of gains (pre-tax) in 2005 and $5.6 million of gains (pre-tax) in 2004 which were included in other income.
In 2005 and 2004, the Company purchased foreign currency put options to mitigate the negative financial impact of a strengthening U.S. dollar relative to both the Australian dollar and the Euro. These Australian dollar
and Euro put options expired ratably over the calendar years and had combined costs of $1.8 million and $1.1 million in 2005 and 2004, respectively. In 2005, the Company recorded a realized loss of $1.7 million (pre-tax) in other income related to amortization of option costs, partially offset by realized gains of $0.6 million. In 2004, the Company recorded a realized loss of $0.7 million (pre-tax) in other income related to amortization of option costs, partially offset by realized gains of $0.4 million.
Special Purpose Entities-Certain insurance transactions entered into by PMI and PMI Europe require the use of foreign special purpose wholly owned subsidiaries principally for regulatory purposes. These special purpose entities are consolidated in the Company’s consolidated financial statements.
Revenue Recognition-Mortgage guarantee insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide payment of premiums on a monthly, annual or single basis. Upon renewal, the Company is not able to re-underwrite or re-price its policies. SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the earning of insurance
EITF Issue No. 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share, (“EITF No. 04-8”), states that the dilutive effect of contingently convertible debt and other instruments (“CoCo’s”) must be included in dilutive earnings per share. The Company’s $360.0 million 2.50% Senior Convertible Debentures are considered CoCo’s under EITF No. 04-8. For purposes of determining dilutive earnings per share, the interest expense, net of tax, was added back to consolidated net income and an additional 8.2 million common shares were added to diluted shares outstanding for all periods presented. Inclusion of the CoCo’s in diluted shares outstanding resulted in a decrease to diluted earnings per share of $0.28, $0.24 and $0.20 for the years ended December 31, 2005, 2004 and 2003, respectively.
The fair value of stock-based compensation to employees is calculated using an option pricing model developed to estimate the fair value of freely tradable and fully transferable options without vesting restrictions, which differ from the Company’s stock option program. The model also requires considerable judgment, including assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated value of stock option grants.
A pro forma pre-tax charge in the second quarter of 2005 of $18.0 million related to this acceleration is reflected in this footnote as stock-based compensation in accordance with SFAS No. 123. Of this amount, $11.2 million pre-tax would have been recorded as compensation expense in the consolidated statement of operations over a period of 27 months beginning in January 1, 2006 pursuant to SFAS No. 123 (revised 2004), Share-Based Payment, (“SFAS No. 123R”), and the SEC related requirements.
Comprehensive Income-Comprehensive income includes net income, foreign currency translation gains or losses, changes in unrealized gains and losses on investments, and the reclassification of realized gains and losses previously reported in comprehensive income, net of related tax effects. The Company reports the components of comprehensive income in its consolidated statements of stockholders’ equity.
SFAS No. 123R permits public companies to adopt its requirements using one of two methods: (i) a “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date; or (ii) a “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. The Company plans to adopt SFAS No. 123R using the modified prospective method.
On July 14, 2005, the FASB issued an exposure draft on a proposed interpretation of SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 does not explicitly prescribe a confidence threshold to be met for the benefit of an uncertain tax position to be recognized. Thus, diverse accounting practices have developed resulting in inconsistency in the criteria used to recognize, derecognize, or measure benefits related to uncertain tax positions. The proposed interpretation seeks to increase comparability in financial reporting of income taxes by establishing consistent standards for all tax positions. The proposed interpretation would require the Company to recognize the best estimate of the impact of a tax position only when it is probable, defined by SFAS No. 5, Accounting for Contingencies. The proposed interpretation would be effective as of the end of the first fiscal year ending after December 15, 2005. The FASB expects to issue a final interpretation in 2006. The cumulative effect of initially applying the proposed interpretation would be accounted for as a cumulative effect of a change in accounting principle. The interpretation is not currently expected to significantly impact the Company’s consolidated results of operations or consolidated financial condition.
On September 30, 2005, the FASB issued a revision of exposure draft issued on December 15, 2003 related to an amendment of SFAS No. 128, Earnings Per Share (“SFAS No. 128”). This proposed statement clarifies existing EPS computational guidance for mandatorily convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or shares. The proposed statement would be effective for interim and annual periods ending after June 15, 2006. Retrospective application would be required for all changes to SFAS No. 128, except that retrospective application would be prohibited for contracts that were either settled in cash prior to adoption or modified prior to adoption to require cash settlement. The proposed amendment to SFAS No. 128 is not expected to significantly impact the Company’s consolidated results of operations or consolidated financial condition.
Scheduled Maturities-The following table sets forth the amortized cost and fair value of fixed income securities by contractual maturity at December 31, 2005:
Realized Investment Gains and Losses-Realized gains and losses on investments are composed of the following:
Aging of Unrealized Losses-The following table shows the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and the length of time the individual securities have been in a continuous unrealized loss position as of December 31, 2005.
At December 31, 2005, fixed income securities and short-term investments with a fair value of $14.4 million were on deposit with regulatory authorities as required by law. In addition, $19.8 million in cash was held in a bank account in Hong Kong for regulatory purposes.
Investments in the Company’s unconsolidated subsidiaries include both equity investees and unconsolidated majority-owned subsidiaries. The carrying values of the Company’s investments in unconsolidated subsidiaries consisted of the following for the years ended December 31, 2005 and 2004:
Equity in earnings from FGIC for 2003, as presented in the above table, excludes the extraordinary gain of $5.4 million after-tax related to the Company’s share of negative goodwill recognized by FGIC resulting from the application of purchase accounting adjustments. In accordance with APB No. 18, the Company reflected its proportionate share of FGIC’s extraordinary gain as a separate line item in the Company’s consolidated statement of operations. The Company acquired its ownership interest in FGIC as of December 18, 2003. Accordingly, the results of FGIC were not reflected in the Company’s consolidated statement of operations prior to the acquisition date.
On October 4, 2005, the Company completed the sale of SPS to CSFB. The Company received cash payments of approximately $99 million for its holdings in SPS. The Company also received a residual interest in mortgage servicing assets with an estimated fair value at closing of approximately $20.7 million and expects to receive additional monthly cash payments through the first quarter of 2008. As of December 31, 2005, the carrying value of the residual interest was $16.4 million. The Company and SPS’s other shareholders have agreed to indemnify CSFB for certain liabilities relating to SPS’s operations. As of December 31, 2005, the Company has recorded a liability of $6.4 million in respect of this indemnification. Simultaneously with the sale, the Company received repayment of the outstanding balance on its related party receivable from SPS in the amount of $5.1 million. Due to the expected sale of SPS, beginning January 1, 2005, equity in losses from SPS of $1.7 million is included in other income. During the fourth quarter of 2004, as a result of the expected transaction, the Company recorded a pre-tax realized capital loss on equity investment held-for-sale (SPS) of $20.4 million.
Deferred policy acquisition costs are affected by qualifying costs that are deferred in the period and amortization of previously deferred costs in such period. In periods where new business activity is declining, the asset will generally decrease because the amortization of previously deferred policy acquisition costs exceeds the amount of acquisition costs being deferred. Conversely, in periods where there is significant growth in new business, the asset will generally increase because the amount of acquisition costs being deferred exceeds the amortization of previously deferred policy acquisition costs.
Depreciation and amortization expense related to property, equipment and software totaled $28.9 million in 2005, $27.5 million in 2004 and $25.5 million in 2003. Capitalized costs associated with software developed for internal use were $24.9 million in 2005, $29.5 million in 2004 and $22.5 million in 2003.
The increase in loss reserves in 2005 over 2004 was due primarily to the higher proportion of delinquencies developing into claims, and to a lesser extent, an increase in primary loans in default. U.S. Mortgage Insurance Operations primary insurance default inventory was 42,702 at December 31, 2005, 39,054 at December 31, 2004 and 37,445 at December 31, 2003. The default rate was 5.74% at year end 2005, 4.86% at year end 2004, and 4.53% at year end 2003. Generally, it takes approximately 12 to 36 months from the receipt of a default notice to result in a claim payment. Accordingly, most losses paid relate to default notices received in prior years.
Mandatorily Redeemable Preferred Capital Securities and Junior Subordinated Deferrable Interest Debentures-In February 1997, The PMI Group, through a wholly-owned trust, privately issued $100.0 million of 8.309% mandatorily redeemable preferred Capital Securities, Series A (the “Capital Securities”). The Capital Securities were issued by the Issuer Trust. The sole asset of the Issuer Trust consisted of $103.1 million principal amount of Junior Subordinated Deferrable Interest Debentures, Series A (the “Junior Subordinated Debentures”) issued by The PMI Group to the Issuer Trust. The Junior Subordinated Debentures bear interest at the rate of 8.309% per annum paid semiannually and mature on February 1, 2027. In 2001, the Company repurchased $51.5 million of the Capital Securities. The Capital Securities are subject to mandatory redemption upon repayment of the Junior Subordinated Debentures by the Company. The Junior Debentures are redeemable at the option of the Company on or after February 1, 2007 at a premium or upon occurrence of certain tax events and mature on February 1, 2027. The Junior Subordinated Debentures are subordinated to all senior indebtedness of The PMI Group.
Senior Notes-In November 1996, the Company issued $100.0 million in face amount of 6.75% senior notes (the “Notes”). As of December 31, 2005 and 2004, $63.0 million of face amount remained outstanding. The Notes bear interest at the rate of 6.75% per annum paid semiannually and mature on November 15, 2006. No sinking fund is required or provided for the Notes and they are not redeemable prior to maturity. The Notes rank equally with all other senior unsecured debt securities of The PMI Group.
Considerable judgment is required in interpreting market data to develop the estimates of fair value and, therefore, changes in the assumptions may have a material effect on the fair valuation estimates. A number of the Company’s other significant assets and liabilities, including deferred policy acquisition costs, real estate owned, property, equipment and software, loss and LAE reserves, unearned premiums and deferred income taxes are not considered financial instruments.
The components of income tax expense for the years ended are as follows:
Section 832(e) of the Internal Revenue Code permits mortgage guaranty insurers to deduct, within certain limitations, additions to statutory contingency reserves. This provision allows mortgage guaranty insurers to increase statutory unassigned surplus through the purchase of non-interest bearing “tax and loss bonds” from the federal government. The tax and loss bonds purchased are limited to the tax benefit of the deduction for additions to the contingency reserves. The Company purchased tax and loss bonds of $90.0 million in 2005, $87.6 million in 2004 and $67.8 million in 2003. The Company redeemed tax and loss bonds of $29.2 million in 2005. The purchase and redemption of tax and loss bonds are included as a deferred component of income tax expense.
A reconciliation of the statutory federal income tax rate to the effective tax rate reported on income from continuing operations before income taxes is shown in the following table:
Funding Obligations-The Company has invested in certain limited partnerships with ownership interests greater than 3% but less than 50%. As of December 31, 2005, the Company had committed to fund, if called upon to do so, $6.1 million of additional equity in certain limited partnership investments.
On April 26, 2005, the Director of the Arizona Department of Insurance approved PMI’s extraordinary dividend request of $300 million to be paid in two installments. PMI paid the first installment of $150 million on June 30, 2005 and paid the second installment of $150 million on December 30, 2005. In July of 2004, pursuant to approval from the Arizona Department of Insurance, PMI made a $150 million dividend payment to The PMI Group. In 2003, following approval from the Director of the Arizona Department of Insurance, PMI declared and paid an extraordinary dividend of $100 million to The PMI Group. In addition, Residential Guaranty Co., one of the Company’s Arizona domiciled insurance subsidiaries, paid dividends to The PMI Group in the amount of $9.5 million in 2005 and $8.4 million in 2004, which it was able to pay as an ordinary dividend without prior permission from the Arizona Department of Insurance. APTIC paid $13.0 million in dividends to The PMI Group in the first quarter of 2004 prior to the Company’s sale of APTIC. No dividends have been paid to PMI by our international subsidiaries in 2005, 2004 or 2003.
In addition to its consolidated subsidiaries, The PMI Group may in the future derive funds from its unconsolidated equity investments, including its investment in FGIC. FGIC’s ability to pay dividends is subject to restrictions contained in applicable state insurance laws and regulations, FGIC Corporation’s certificate of incorporation, a stockholders’ agreement between The PMI Group and other investors in FGIC, and FGIC Corporation’s 6.0% senior notes. Under New York insurance law, FGIC may pay dividends out of statutory earned surplus, provided that statutory surplus after any dividend may not be less than the minimum required paid-in capital and provided that together with all dividends declared or distributed by FGIC during the preceding 12 months, the dividends do not exceed the lesser of (i) 10% of policyholders’ surplus as of its last statement filed with the New York superintendent or (ii) adjusted net investment income during this period.
The Company provides certain health care and life insurance benefits for retired employees under another post-employment benefit plan (the “OPEB Plan”). Generally, qualified employees may become eligible for these benefits if they retire in accordance with the Company’s established retirement policy and are continuously insured under the Company’s group plans or other approved plans for ten or more years prior to retirement. The Company contributes a fixed dollar subsidy towards the cost of coverage. Retirees are expected to pay all amounts in excess of the Company’s fixed dollar subsidy. The Company assessed the impact on liabilities due to the Medical Prescription Drug, Improvement and Modernization Act of 2003 and determined that it is not material to the Company’s liability under these benefit plans.
The following table presents certain information with respect to the Company’s benefit plans as of and for the years ended:
Refers to The PMI Group’s SERP Plan which does not have plan assets
The weighted-average remaining contractual life of options outstanding as of December 31, 2005 was 6.1 years, and the range of exercise price on those options was $13.19 to $43.96.
Employee Stock Purchase Plan-The PMI Group, Inc. Employee Stock Purchase Plan (“ESPP”) allows eligible employees to purchase shares of the Company’s stock at a 15% discount to fair market value as determined by the plan. The ESPP offers participants the 15% discount to current fair market value or fair market value with a look-back provision of the lesser of the duration an employee has participated in the ESPP or two years. Under the ESPP, the Company issued 139,884 treasury shares in 2005, 96,021 treasury shares in 2004 and 70,493 treasury shares in 2003. The Company applies APB No. 25 in accounting for the ESPP. The Company’s adoption of SFAS No. 123(R) in the first quarter of 2006 will require expense recognition of the amount of the discount to current fair value of ESPP shares purchased by employees. The Company does not expect the effect of the adoption to be material to its consolidated results of operations.
In October 2003, the Company announced that it had reached a definitive agreement to sell APTIC for $115.1 million in cash. In accordance with SFAS No. 144, the results of operations for APTIC were classified as discontinued operations for the fourth quarter of 2003 with prior periods adjusted for comparability. The Company recognized an after-tax gain of $30.1 million upon completion of the sale of APTIC on March 19, 2004. In December 2004, the Company reduced its gain on sale of APTIC by $1.1 million after tax related to the true-up of the Company’s pension liability due to settlement accounting triggered by the sale of APTIC as previously discussed in Note 16. Benefit Plans.
PMI’s statutory net income, statutory surplus and contingency reserve liability as of and for the years ended as follows:
PMI’s financial strength ratings from certain rating agencies have been based on various capital support commitments from Allstate (“Allstate Support Agreements”). On October 27, 1994, the Allstate Support Agreements were terminated with respect to policies issued after October 27, 1994, but continue in modified form (as so modified, the “Runoff Support Agreement”) for policies written prior to such termination. Under the terms of the Runoff Support Agreement, Allstate may, at its option, either directly pay or cause to be paid, claims relating to policies written during the terms of the respective Allstate Support Agreements if PMI fails to pay such claims or, in lieu thereof, make contributions directly to PMI or The PMI Group. In the event any amounts are paid or contributed, which possibility management believes is remote, Allstate would receive subordinated debt or preferred stock of PMI or The PMI Group in return. No payment obligations have arisen under the Runoff Support Agreement. The Runoff Support Agreement provides PMI with additional capital support for rating agency purposes.
The Runoff Support Agreement contains certain covenants, including covenants that (i) PMI will write no new business after its risk-to-capital ratio equals or exceeds 23 to 1; (ii) PMI will pay no dividends if, after the payment of any such dividend, PMI’s risk-to-capital ratio would equal or exceed 23 to 1; and (iii) on the date that any of the following events occur: (a) PMI’s risk-to-capital ratio exceeds 24.5 to 1, (b) Allstate shall have paid any claims relating to PMI policies directly to a policyholder or by paying an amount equal to such claims to PMI, or to The PMI Group for contribution to PMI, pursuant to the Runoff Support Agreement, or (c) any regulatory order is issued restricting or prohibiting PMI from making full or timely payments under policies, PMI will transfer substantially all of its assets in excess of $50.0 million to a trust account established for the payment of claims. As of December 31, 2005, less than $0.2 billion of risk in force was subject to the Runoff Support Agreement.
PMI has entered into capital support agreements with its Australian and European subsidiaries that could require PMI to make additional capital contributions to those subsidiaries in order to maintain their credit ratings. With respect to the Australian and European subsidiaries, the Company guarantees the performance of PMI’s capital support agreements.
The unconsolidated majority owned subsidiaries includes the Company’s equity investment in PMI Capital I. As of December 31, 2005, included in the Company’s retained earnings were $204.8 million of undistributed equity in earnings from existing equity investees with ownership interest of 50% or less.
EITF No. 04-8 requires the dilutive effect of CoCo’s be included in dilutive earnings per share regardless of whether the triggering contingency based on the market price of the issuer’s shares has been satisfied. This change in accounting principle was applied on a retroactive basis for all periods presented. Therefore, the Company restated all prior period dilutive earnings per share.