Through our subsidiary, MGIC, we are a leading provider of PMI in the United States, as measured by $209.7 billion of primary IIF on a consolidated basis at December 31, 2018.
years. Adjusted net operating income of $668.7 million for 2018 (2017: $517.7 million) and adjusted net operating income per diluted share of $1.78 (2017: $1.36) each increased from the prior year primarily for the same reasons.
During 2018, MGIC paid $220 million in dividends to our holding company. During 2018, we repurchased approximately 16.0 million shares of our common stock for approximately $175 million.
in a modest increase in our NIW in 2018 when compared to 2017.
The level of unemployment, interest rates, and home prices may change in the future. For the possible effects of such changes, see our risk factors titled "If the volume of low down payment home mortgage originations declines, the amount of insurance that we write could decline,” “Downturns in the domestic economy or declines in the value of borrowers’ homes from their value at the time their loans closed may result in more homeowners defaulting and our losses increasing, with a corresponding decrease in our returns,” and “Changes in interest rates, house prices or mortgage insurance cancellation requirements may change the length of time that our policies remain in force."
These recent years of favorable housing fundamentals and in our view, favorable risk characteristics of insured loans, has provided a favorable credit backdrop for the business we have written in recent years. In that regard, we have experienced a declining delinquent inventory, and lower losses incurred and claims paid. Our most recent book years continue to experience a low level of losses.
Much of the competition in the industry in the last few years has centered on pricing practices which have included: (i) reductions in standard filed rates for borrower-paid mortgage insurance policies ("BPMI"); (ii) use by competitors of a spectrum of filed rates to allow for formulaic, risk-based pricing that may be adjusted more frequently within certain parameters (referred to as "loan level pricing systems"); and (iii) use of customized rates (discounted from standard rates) that are made available to lenders that meet certain criteria.
In response to industry competition, and changing customer preferences, the delivery of premium rates has continued to migrate from standard rate cards, to use of loan level pricing systems; and use of customized rates (discounted from standard rates) that are made available to lenders that meet certain criteria. Loan level pricing systems incorporate more loan attributes than standard rate cards. They are considered more dynamic pricing models that can react faster to changing market conditions, including those conditions that increase or decrease risk, and they assist in managing risk and shaping the insured portfolio. We expect the adoption of mortgage insurers' loan level pricing systems by lenders to continue to increase.
Government programs. PMI also competes against government mortgage insurance programs such as the FHA, VA, and USDA, primarily for lower FICO score business. The market share of primary mortgage insurance written by government programs continued to exceed that written by PMI in 2018, however PMI recaptured share from those programs due in part to a reduction in refinance originations in 2018. Generally, PMI industry share is 3-4 times higher for purchase originations than refinance originations. The increase in the percentage of originations from purchase transactions along with the PMI premium rate reductions, have contributed to a PMI market share at its highest level since the financial crisis.
Refer to "Mortgage Insurance Portfolio" for additional discussion of the 2018 business environment and the impact it had on operating measures including NIW, IIF and RIF.
Since December 31, 2015 we have operated under the requirements of the PMIERs of the GSEs in order to insure loans delivered to or purchased by them. The PMIERs include financial requirements that require an approved mortgage insurer to have Available Assets that meet or exceed its Minimum Required Assets. MGIC's Available Assets under PMIERs totaled $4.8 billion, an excess of $1.4 billion over its Minimum Required Assets at December 31, 2018.
Revised PMIERs were published in September 2018 and will become effective March 31, 2019. See "Revised PMIERs" below for additional information on the changes made to the PMIERs and their impact on MGIC's excess of Available Assets over its Minimum Required Assets.
Our 2019 direct premiums written and net premiums earned are expected to be comparable to 2018. Our net premiums earned will be impacted by the decrease in premium rates noted above and by the amount of premiums we cede under our quota share and excess of loss reinsurance transactions. The amount of profit commission we receive, which reduces the amount of premiums we cede, is variable year-to-year and is dependent on the amount of losses ceded. Our profit commission in recent years has benefited from favorable loss reserve development associated with delinquency notices received in prior years. Further, 2019 will include a full year of premiums ceded under our excess of loss reinsurance transaction that went into effect in the fourth quarter of 2018. The actual amount of premiums we cede in 2019 will also be affected by any changes in the structure of our reinsurance coverage, such as termination of existing quota share reinsurance or additional excess of loss coverage.
Factors that affect the amount of premiums we earn from our IIF are further discussed in our "Consolidated Results of Operations - Premium yield."
Losses. We expect 2019 losses incurred with respect to delinquency notices received in 2019 to be lower than the comparable amount for 2018 as we expect to receive fewer new delinquency notices in 2019. Overall, however, 2019 losses incurred, net are expected to increase compared to 2018 if we experience no favorable loss reserve development associated with delinquency notices received in prior years.
Based on our interpretation of the PMIERs, as of December 31, 2018, MGIC’s Available Assets totaled $4.8 billion, or $1.4 billion in excess of its Minimum Required Assets. If the revised PMIERs discussed above had been effective as of December 31, 2018, we estimate that MGIC’s pro forma excess of Available Assets over Minimum Required Assets would have been approximately $1 billion.
At December 31, 2018, MGIC’s risk-to-capital ratio was 9.0 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements, and its policyholder position was $2.6 billion above the required MPP of $1.3 billion. Our risk-to-capital ratio and MPP reflect full credit for the risk ceded under our quota share reinsurance transactions with unaffiliated reinsurers. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the PMIERs, MGIC may terminate the reinsurance transactions, without penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, you should read our risk factors for information about matters that could negatively affect such compliance.
The NAIC plans to revise the minimum capital and surplus requirements for mortgage insurers that are provided for in its Mortgage Guaranty Insurance Model Act. A working group of state regulators has been considering since 2016 a risk-based capital framework to establish capital requirements for mortgage insurers, although no date has been established by which the NAIC must propose revisions to the capital requirements and certain items have not yet been completely addressed by the framework, including the treatment of ceded risk, minimum capital floors, and action level triggers. Currently we believe that the PMIERs contain the more restrictive capital requirements in most circumstances.
The FHFA has been the conservator of the GSEs since 2008 and has the authority to control and direct their operations. The increased role that the federal government has assumed in the residential housing finance system through the GSE conservatorship may increase the likelihood that the business practices of the GSEs change, including through administrative action, in ways that have a material adverse effect on us and that the charters of the GSEs are changed by new federal legislation. In the past, members of Congress have introduced several bills intended to change the business practices of the GSEs and the FHA; however, no legislation has been enacted.
The Administration issued a June 2018 report indicating that the conservatorship of the GSEs should end and that the GSEs should transition to fully private entities, competing on a level playing field with private issuers of MBS (such issuers, collectively with the GSEs, referred to in the report as the "guarantors"). The report further indicated that a federal entity should regulate the guarantors, including their capital adequacy, and that guarantors should have access to an explicit federal guarantee on the MBS that is exposed only after substantial losses are incurred by the private market, including the guarantors. The report also indicated that a fee on the outstanding volume of MBS would be transferred to the Department of Housing and Urban Development (of which the FHA is a part) to be used for affordable housing purposes. As a result of the matters referred to above, it is uncertain what role the GSEs, FHA and private capital, including private mortgage insurance, will play in the residential housing finance system in the future. The timing and impact on our business of any resulting changes is uncertain. Most meaningful changes would require Congressional action to implement and it is difficult to estimate when Congressional action would be final and how long any associated phase-in period may last.
Premiums ceded, net of a profit commission, under our quota share reinsurance transactions, and premiums ceded under our excess of loss reinsurance transaction. See Note 9 - “Reinsurance” to our consolidated financial statements for a discussion of our reinsurance transactions.
Fixed income securities. Realized investment gains and losses are a function of the difference between the amount received on the sale of a fixed income security and the fixed income security’s cost basis, as well as any “other than temporary” impairments (“OTTI”) recognized in earnings. The amount received on the sale of fixed income securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale.
At times, we may undertake activities to enhance our capital position, improve our debt profile and/or reduce potential dilution from our outstanding convertible debt. Extinguishing our outstanding debt obligations early through these discretionary activities may result in losses primarily driven by the payment of consideration in excess of our carrying value.
In general, the majority of any underwriting profit that a book generates occurs in the early years of the book, with the largest portion of any underwriting profit realized in the first year following the year the book was written. Subsequent years of a book may result in either underwriting profit or underwriting losses. This pattern of results typically occurs because relatively few of the claims that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments) and increasing losses. The typical pattern is also a function of premium rates generally resetting to lower levels after ten years.
Adjusted net operating income (loss) is defined as GAAP net income (loss) excluding the after-tax effects of net realized investment gains (losses), gain (loss) on debt extinguishment, net impairment losses recognized in income (loss), and infrequent or unusual non-operating items, where applicable, which include the effects of changes in our deferred tax valuation allowance. The amounts of adjustments to components of pre-tax operating income (loss) are tax effected using a federal statutory income tax rate of 21% for 2018 and 35% for 2017 and 2016.
Although adjusted pre-tax operating income (loss) and adjusted net operating income (loss) exclude certain items that have occurred in the past and are expected to occur in the future, the excluded items represent items that are: (1) not viewed as part of the operating performance of our primary activities; or (2) impacted by both discretionary and other economic or regulatory factors and are not necessarily indicative of operating trends, or both. These excluded items, along with the reasons for their treatment, are described below. Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these excluded items.
Net realized investment gains (losses). The recognition of net realized investment gains or losses can vary significantly across periods as the timing of individual securities sales is highly discretionary and is influenced by such factors as market opportunities, our tax and capital profile, and overall market cycles.
Source: Inside Mortgage Finance - February 15, 2019 or SEC filings. Includes HARP NIW.
We compete against five other private mortgage insurers, as well as government mortgage insurance programs, including those offered by the FHA, VA, and USDA. Refer to "Overview - Business Environment - Competition" for a discussion of our competitive position.
The PMI industry increased its share of the primary mortgage insurance market in 2018 and 2017, each when compared to the respective prior year. PMI's share increased primarily due to a higher percentage of purchase originations; an increase in 97% LTV loan offerings from lenders that sell loans to the GSEs, which provided an alternative to similar FHA loan programs for qualified borrowers; and PMI premium rate reductions in recent periods, which increases PMI's competitiveness compared to government programs.
Source: Inside Mortgage Finance - February 15, 2019. Includes HARP NIW.
NIW for 2018 continued to have what we believe are favorable risk characteristics. The following tables provide information about characteristics of our NIW.
To mitigate our risk from the increase in NIW written on loans with DTI ratios over 45%, effective in March 2018 we changed our underwriting guidelines to generally require such loans to have a FICO score of at least 700. Further, effective in July 2018, we added risk-based adjustments to our premium rates for loans with DTI ratios greater than 45%. We are continuing to monitor our exposure to such loans and may take further action.
Our IIF grew 7.6% in 2018, compared to growth of 7.1% in 2017, as NIW more than offset policy cancellations. Cancellations are primarily due to refinances, but also result from rescissions, claim payments, and policy cancellations when borrowers achieve the required amount of home equity. Refinancing activity has historically been affected by the level of mortgage interest rates and the level of home price appreciation. Cancellations generally move inversely to the change in the direction of interest rates, although they generally lag a change in direction.
Persistency. Our persistency at December 31, 2018 was 81.7% compared to 80.1% at December 31, 2017. Since 2000, our year-end persistency ranged from a high of 84.7% at December 31, 2009 to a low of 47.1% at December 31, 2003.
2017 compared to 2016. NPW increased 2% from the prior year, due to an increase in our average IIF, a decline in premium refunds and lower ceded premiums, net as the increase in profit commission more than offset the increase in gross ceded premiums. Premium refunds declined due to lower claim activity and our profit commission increased due a decrease in ceded losses. NPE increased slightly from the prior year due to the decline in premium refunds and lower ceded premiums, net, which offset lower earned premiums from our IIF during the year as our premium yield decreased.
The declines in our premium yield in each of 2018 and 2017 compared to the respective prior years reflect:
lower amounts of accelerated earned premium from cancellations on single premium policies prior to their estimated policy life, primarily due to less refinancing activity.
less of an adverse impact from our reinsurance due to lower ceded losses, which resulted in a higher profit commission, and
We cede a fixed percentage of premiums earned and received on insurance covered by the transactions.
The blended pre-tax cost of reinsurance under our different quota share transactions is less than 6% (but will decrease if losses are materially higher than we expect). This blended pre-tax cost is derived by dividing the reduction in our pre-tax net income on loans covered by reinsurance by our direct (that is, without reinsurance) premiums from such loans. Although the pre-tax cost of the reinsurance under each transaction is generally constant, the effect of the quota share reinsurance on the various components of pre-tax income discussed above will vary from period to period, depending on the level of ceded losses.
The amount of our NIW (and, consequently, our NIW) subject to our QSR transactions as shown in the following table will vary from period to period in part due to coverage limits that may be triggered depending on the mix of our risk written during the period.
The percentage of our 2018 NIW covered by our 2018 QSR Transaction decreased when compared to the percentage of 2017 and 2016 NIW covered by our 2017 QSR Transaction and 2015 QSR Transaction, respectively, primarily due to the following factors.
Despite the 2018 transaction's increased coverage limit for risk written on loans with (1) LTV ratios of 95% and greater, and (2) DTI ratios greater than 45%, the risk written in 2018 exceeded these coverage limits.
Despite the 2017 transaction allowing some risk written on loans with DTI ratios greater than 45%; the percentage of such risk written in 2017 exceeded the coverage limit.
2019 QSR Transaction. The transaction covering our 2019 NIW will include increased coverage limits for risk written on loans with LTV ratios of 95% or greater and loans with DTI ratios greater than 45%, each when compared to our 2018 QSR Transaction.
The following table provides information related to our captive reinsurance agreements for 2018, 2017, and 2016.
The loss ratio is the ratio, expressed as a percentage, of the sum of incurred losses and LAE, net to net premiums earned. The decline in the loss ratio in 2018 when compared to 2017, and in 2017 compared to 2016, reflects the lower level of losses incurred, net and an increase in earned premiums.
Our estimated claim rate on new notices declined in 2018 compared to 2017, and in 2017 compared to 2016, in each case reflecting the economic environment and our expectation of cure activity on the new notices received. We also estimated a materially lower new notice claim rate for those notices received in the fourth quarter of 2017 that we estimated to have been caused by hurricane activity that occurred in the third quarter of 2017. When excluding our estimate of new notices caused by hurricanes, our 2017 new notice claim rate approximated 10.5%, marginally higher than the actual full-year rate.
The majority of loans from 2005 through 2008 (which represent 60% of the loans in the delinquent inventory) are covered by master policy terms that, except under certain circumstances, do not limit the number of years that an insured can include interest when filing a claim. Under our current master policy terms, an insured can include accumulated interest when filing a claim only for the first three years the loan is delinquent. In each case, the insured must comply with its obligations under the terms of the applicable master policy.
Note: Table excludes material settlements. Settlements include amounts paid in settlement of disputes for claims paying practices and NPL commutations.
This section provides information on our claim payment trends and exposure on our outstanding RIF for each of the three years in the period ended December 31, 2018. The table below presents our net losses and LAE paid for each of those years.
Net losses and LAE paid decreased 34% in 2018 compared to 2017 primarily due to lower claim activity on our primary business. Net losses and LAE paid decreased 28% in 2017 compared to 2016 due to lower claim activity on our primary business and the completion of our settlement payments to Freddie Mac in 2016 related to our pool business. During each of 2018, 2017 and 2016, losses paid included settlement payments under commutations of coverage on pools of NPLs and/or related to disputes concerning our claims paying practices. We believe losses and LAE paid will be lower in 2019 compared to 2018.
The primary average claim paid for the top 5 jurisdictions (based on 2018 losses paid, excluding settlement amounts) for each of the three years in the period ended December 31, 2018 appears in table below. The primary average claim paid can vary materially from period to period based upon a variety of factors, including the local market conditions, average loan amount, average coverage percentage, time between default and claim payment and loss mitigation efforts on loans for which claims are paid.
The primary and pool loss reserves as of December 31, 2018, 2017 and 2016 appear in table below.
Florida, Puerto Rico, and Texas each experienced an increase in their delinquent inventory as of December 31, 2017 compared to December 31, 2016. The increases were driven by hurricanes in the third quarter of 2017, which resulted in significant new notice activity in the fourth quarter of 2017. Primarily due to 2018 cure activity on hurricane-related notices, each of those jurisdictions had significant reductions in their delinquent inventory in 2018.
The delinquent inventory as of December 31, 2017 for most policy years included new notices from hurricane impacted areas that had not cured. As a result, delinquencies, including in the most recent policy years, were greater than they otherwise would have been as of December 31, 2017. The majority of the notices received in the hurricane impacted areas cured during 2018.
The losses we have incurred on our 2005 through 2008 books have exceeded our premiums from those books. Although uncertainty remains with respect to the ultimate losses we will experience on these books of business, as we continue to write new insurance on high-quality loans, those books are a declining percentage of our total mortgage insurance portfolio. Our 2005 through 2008 books of business represented approximately 15% and 19% of our total primary RIF at December 31, 2018 and 2017, respectively. Approximately 39% of the remaining primary RIF on our 2005 through 2008 books of business benefited from HARP as of both December 31, 2018 and 2017.
2017 compared to 2016. Underwriting and other expenses for 2017 increased when compared to 2016, primarily due to higher compensation, professional services, and depreciation expenses.
The underwriting expense ratio is the ratio, expressed as a percentage, of the underwriting and operating expenses, net and amortization of DAC of our combined insurance operations (which excludes underwriting and operating expenses of our non-insurance operations) to NPW, and is presented in the table below for the past three years.
Loss on debt extinguishment in 2016 reflects the repurchases of a portion of our outstanding 2% and 5% Notes at amounts above our carrying values. The loss on debt extinguishment from MGIC's purchase of a portion of our 9% Debentures represents the difference between the fair value and carrying value of the liability component on the purchase date.
2017 compared to 2016. The increase in income tax expense in 2017 compared to 2016 was due to the 2017 remeasurement of net deferred tax assets at the lower corporate income tax rate under the Tax Act, the 2017 increase in income before tax, and an additional tax provision recorded for the expected settlement of our IRS litigation. The difference between the federal statutory income tax rate of 35% and our effective tax provision rate of 54.7% in 2017 was primarily due to the remeasurement of deferred tax assets at the lower corporate tax rate and the additional tax provision recorded for the settlement of our IRS litigation. The difference between the federal statutory income tax rate of 35% and our effective tax provision rate of 33.5% in 2016 was primarily due to the benefits of tax- preferenced securities.
As of December 31, 2018, total assets were $5.7 billion and total liabilities were $2.1 billion. Compared to year-end 2017, total assets increased by $58.3 million and total liabilities decreased by $369.1 million.
The investment portfolio increased 3%, to $5.2 billion as of December 31, 2018 (2017: $5.0 billion), as net cash from operations was used in part for additional investment.
The average duration and embedded investment yield of our investment portfolio as of December 31, 2018, 2017, and 2016 is shown in the following table.
percentage of “BBB” rated securities when compared to the prior year.
See Note 5 - “Investments” to our consolidated financial statements for additional disclosure on our investment portfolio.
Deferred income taxes, net decreased 70%, to $69 million as of December 31, 2018 (2017: $234 million), primarily through the continued use of our net operating loss carryforwards to offset taxable income. We had no remaining net operating loss carryforwards as of December 31, 2018.
Loss reserves, which represent our estimated liability for losses and settlement expenses under our mortgage guaranty insurance policies, net of related reinsurance balances recoverable, decreased 32% to $641 million as of December 31, 2018 from $937 million as of December 31, 2017. This decrease was driven by the payment of claims during 2018 and favorable development on previously received delinquencies, offset in part by losses incurred on new delinquency notices received in 2018 that remain in inventory.
Other liabilities decreased 30% to $180 million as of December 31, 2018 (2017: $256 million), primarily due to a decrease in our income taxes payable due to payments associated with the settlement of our IRS litigation and a decline in our premium refund accrual due to lower estimated claim rates.
Our largest source of cash is from premiums received from our insurance policies, which we receive on a monthly installment basis for most policies. Premiums are received at the beginning of the coverage period for single premium and annual premium policies. Our largest cash outflow is for claims that arise when a delinquency results in an insured loss. We invest our claims paying resources from premiums and other sources in various investment securities that earn interest. We also use cash to pay for our ongoing expenses such as salaries, debt interest, and rent.
We maintain an investment portfolio that is primarily invested in a diverse mix of fixed income securities. As of December 31, 2018, our portfolio had a fair value of $5.2 billion, an increase of $168.5 million, or 3.4% from December 31, 2017. In addition to investment portfolio activities, our investing activities included additions to property and equipment. Beginning in 2016, we began an initiative to update our corporate headquarters building, which is substantially complete, and continued our investment in our technology infrastructure to enhance our ability to conduct business and execute our strategies.
Payment of withholding taxes related to share-based compensation net share settlement
Cash flows used in financing activities for 2016 included the repurchase of a portion of the outstanding principal on our 5% Notes and 2% Notes, the purchase by MGIC of a portion of the outstanding principal on our 9% Debentures, and payment of withholding taxes related to share-based compensation net share settlement. MGIC's ownership of our 9% Debentures is eliminated in consolidation. These transactions were offset in part by cash inflows from the issuance of long-term debt, including an FHLB borrowing and our 5.75% Notes, net of related issuance fees.
The increase in total shareholders' equity in 2018 from 2017 was primarily due to net income during 2018, offset by our repurchases of our common stock and the increase in unrealized investment losses. The increase in shareholders' equity in 2017 from 2016 was primarily due to net income in 2017 and conversion of substantially all of our then-remaining 2% Notes into shares of common stock. See Note 13 - "Shareholders' Equity" for further information on the 2% Note conversion.
See Note 7 - "Debt" for further information on our outstanding debt obligations and transactions impacting our consolidated financial statements in 2018 and 2017.
As of December 31, 2018, we had approximately $248 million in cash and investments at our holding company. These resources are maintained primarily to service our debt interest expense, pay debt maturities, and to settle intercompany obligations. While these assets are held, we generate investment income that serves to offset a
Over the next twelve months the principal demand on holding company resources will be interest payments on our 5.75% Notes and 9% Debentures approximating $60 million. We expect MGIC will continue to pay dividends of at least $60 million per quarter in 2019. Our unsecured revolving credit facility provides $175 million of borrowing capacity, of which no amount is currently drawn. We believe our holding company has sufficient sources of liquidity to meet its payment obligations for the foreseeable future.
MGIC is a member of the FHLB. Membership in the FHLB provides MGIC access to an additional source of liquidity via a secured lending facility. MGIC has outstanding a $155.0 million fixed rate advance from the FHLB. Interest on the advance is payable monthly at a fixed annual rate of 1.91%. The principal of the advance matures on February 10, 2023, but may be prepaid at any time. Such prepayment would be below par if interest rates have risen after the advance was originated, or above par if interest rates have declined. The advance is secured by eligible collateral in the form of pledged securities from the investment portfolio, whose market value must be maintained at a minimum of 102% of the principal balance of the advance.
We operate under the PMIERs of the GSEs that became effective December 31, 2015. Revised PMIERs were published in September 2018 and will become effective March 31, 2019. Refer to "Overview - Capital - GSEs" of this MD&A for further discussion of PMIERs.
Maintaining a sufficient level of excess Available Assets will allow MGIC to remain in compliance with the PMIERs financial requirements. Our reinsurance transactions provided an aggregate of approximately $1.2 billion of PMIERs capital credit as of December 31, 2018. Our 2019 QSR transaction terms are expected to be no less favorable than our existing QSR transactions and will also provide PMIERs capital credit. Refer to Note 9 - "Reinsurance" to our consolidated financial statements for additional information on our reinsurance transactions.
We compute our risk-to-capital ratio on a separate company statutory basis, as well as on a combined insurance operations basis. The risk-to-capital ratio is our net RIF divided by our policyholders’ position. Our net RIF includes both primary and pool RIF, and excludes risk on policies that are currently in default and for which loss reserves have been established and the risk covered by quota share reinsurance. The risk amount includes pools of loans with contractual aggregate loss limits and without these limits. Policyholders’ position consists primarily of statutory policyholders’ surplus (which increases as a result of statutory net income and decreases as a result of statutory net loss and dividends paid), plus the statutory contingency reserve and a portion of the reserves for unearned premiums. The statutory contingency reserve is reported as a liability on the statutory balance sheet. A mortgage insurance company is required to make annual additions to a contingency reserve of approximately 50% of net earned premiums. These contributions must generally be maintained for a period of ten years. However, with regulatory approval a mortgage insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net earned premiums in a calendar year.
RIF - net, as shown in the table above, is net of quota share reinsurance and exposure on policies currently delinquent ($1.6 billion at December 31, 2018 and $2.3 billion at December 31, 2017) and for which loss reserves have been established.
The 2018 reductions in the risk-to-capital of MGIC and our combined insurance companies were due to an increase in statutory policyholders' position, primarily due to an increase in statutory contingency reserves, partially offset by an increase in net RIF. Our RIF, net of reinsurance, increased in 2018, due to an increase in our IIF. Our risk-to-capital ratio will decrease if the percentage increase in capital exceeds the percentage increase in insured risk.
For additional information regarding regulatory capital see Note 14 - “Statutory Information” to our consolidated financial statements as well as our risk factor titled “State capital requirements may prevent us from continuing to write new insurance on an uninterrupted basis” in Item IA.
For further information about the importance of MGIC’s ratings, see our risk factor titled “Competition or changes in our relationships with our customers could reduce our revenues, reduce our premium yields and/or increase our losses” in Item 1A.
Our estimate of loss reserves is sensitive to changes in claim rate and claim severity; it is possible that even a relatively small change in our estimated claim rate or severity could have a material impact on reserves and, correspondingly, on our consolidated results of operations even in a stable economic environment. For example, as of December 31, 2018, assuming all other factors remain constant, a $1,000 increase/decrease in the average severity reserve factor would change the reserve amount by approximately +/- $12 million. A 1 percentage point increase/decrease in the average claim rate reserve factor would change the reserve amount by approximately +/- $19 million. Historically, it has not been uncommon for us to experience variability in the development of the loss reserves through the end of the following year at this level or higher, as shown by the historical development of our loss reserves in the table below:
When a policy term ends, the primary mortgage insurance written by us is renewable at the insured’s option through continued payment of the premium in accordance with the schedule established at the inception of the policy life. We are generally obligated to renew the policies and have no ability to reunderwrite or reprice these policies after issuance. Premiums written under policies having single and annual premium payments are initially deferred as unearned premium reserve and earned over the policy life. Premiums written on policies covering more than one year are amortized over the policy life based on historical experience, which includes the anticipated incurred loss pattern.. Premiums written on annual policies are earned on a monthly pro rata basis. Premiums written on monthly policies are earned as the monthly coverage is provided. When a policy is cancelled, all premium that is non-refundable is immediately earned. Any refundable premium is returned to the servicer or borrower. Policies may be cancelled by the insured, or due to rescissions or claim payments. When a policy is rescinded, all previously collected premium is returned to the servicer and when a claim is paid, all premium collected since the date of default is returned. The liability associated with our estimate of premium to be returned is accrued for separately and this liability is included in “Other
liabilities” on our consolidated balance sheets. Changes in these liabilities and the actual return of premium affect premiums written and earned.
To determine the fair value of securities available-for-sale in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the
pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized; in approximate order of priority, they are: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including data published in market research publications.
the impairment is recognized as a loss in the statement of operations. Otherwise, when a security is considered to be other-than-temporarily impaired, the losses are separated into the portion of the loss that represents the credit loss; and the portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other factors is recognized in accumulated other comprehensive income (loss), net of taxes. A credit loss is determined to exist if the present value of the discounted cash flows, using the security’s original yield, expected to be collected from the security is less than the cost basis of the security.
For the years ended December 31, 2018, 2017, and 2016, we did not elect the fair value option for any financial instruments acquired, or issued, such as our outstanding debt obligations, for which the primary basis of accounting is not fair value.
Consolidated statements of shareholders' equity for each of the three years in the period ended December 31, 2018
Consolidated statements of cash flows for each of the three years in the period ended December 31, 2018
Equity securities, at fair value (cost, 2018 - $3,993; 2017 - $7,223)
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2018 - 371,353; 2017 - 370,567; outstanding 2018 - 355,371; 2017 - 370,567)
At December 31, 2018, our direct domestic primary insurance in force ("IIF") was $209.7 billion, which represents the principal balance in our records of all mortgage loans that we insure, and our direct domestic primary risk in force ("RIF") was $54.1 billion, which represents the IIF multiplied by the insurance coverage percentage.
Substantially all of our insurance written since 2008 has been for loans purchased by the GSEs. We operate under the Private Mortgage Insurer Eligibility Requirements ("PMIERs") of the GSEs that became effective December 31, 2015 and which have been amended from time to time. The financial requirements of the PMIERs require a mortgage insurer’s "Available Assets" (generally only the most liquid assets of an insurer) to equal or exceed its "Minimum Required Assets" (which are based on an insurer's book, calculated from tables of factors with several risk dimensions and subject to a floor amount). Based on our interpretation of the PMIERs, as of December 31, 2018, MGIC’s Available Assets are in excess of its Minimum Required Assets; and MGIC is in compliance with the financial requirements of the PMIERs and eligible to insure loans purchased by the GSEs.
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), as codified in the Accounting
Certain reclassifications to 2017 and 2016 amounts have been made in the accompanying consolidated financial statements to conform to the 2018 presentation. See Note 3 - "Significant Accounting Policies" for a discussion of our adoption of accounting guidance in 2018 that resulted in other reclassifications.
We carry certain financial instruments at fair value and disclose the fair value of all financial instruments. Our financial instruments carried at fair value are predominantly measured on a recurring basis. Financial instruments measured on a nonrecurring basis are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment).
We use independent pricing sources to determine the fair value of a substantial majority of our financial instruments, which primarily consist of assets in our investment portfolio, but also includes amounts included in cash and cash equivalents and restricted cash. A variety of inputs are used; in approximate order of priority, they are: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications.
Quoted prices for identical instruments in active markets that we can access. Financial assets using Level 1 inputs primarily include U.S. Treasury securities, money market funds, and certain equity securities.
Other invested assets. Other invested assets are carried at cost. These assets represent our investment in Federal Home Loan Bank of Chicago ("FHLB") stock, which due to restrictions, is required to be redeemed or sold only to the security issuer at par value.
the present value of the discounted cash flows we expect to collect compared to the amortized cost basis of the security;
Reserves are established for insurance losses and loss adjustment expenses ("LAE") when we receive notices of delinquency on insured mortgage loans. We consider a loan in default when it is two or more payments past due. Even though the accounting standard, ASC 944, regarding accounting and reporting by insurance entities specifically excludes mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish loss reserves for future claims on insured loans which are not currently delinquent. Loss reserves are established by estimating the number of loans in our inventory of delinquent loans that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity. Our loss estimates are established based upon historical experience, including with rescissions of policies, curtailments of claims, and loan modification activity. Adjustments to
Loss reserves and unearned premiums are reported before taking credit for amounts ceded under reinsurance agreements. Ceded loss reserves are reflected as "Reinsurance recoverable on loss reserves." Ceded unearned and prepaid reinsurance premiums are included in “Other assets.” Amounts due from reinsurers on paid claims are reflected as “Reinsurance recoverable on paid losses.” Ceded premiums payable are included in “Other liabilities.” Any profit commissions are included with “Premiums written - Ceded” and any ceding commissions are included with “Other underwriting and operating expenses, net.” We remain liable for all insurance ceded. (See Note 9 - “Reinsurance.”)
Diluted EPS includes the components of basic EPS and also gives effect to dilutive common stock equivalents. We calculate diluted EPS using the treasury stock method and if-converted method. Under the treasury stock method, diluted EPS reflects the potential dilution that could occur if our unvested restricted stock units result in the issuance of common stock. Under the if-converted method, diluted EPS reflects the potential dilution that could occur if our convertible debt instruments result in the issuance of common stock. The determination of potentially issuable shares does not consider the satisfaction of the conversion requirements and the shares are included in the determination of diluted EPS as of the beginning of the period, if dilutive. In addition to our 9% Debentures, of which a portion remain outstanding, we previously had several convertible senior note debt issuances that could have resulted in contingently issuable shares and we considered each potential issuance of shares separately to reflect the maximum potential dilution for the period the debt issuances were outstanding.
For purposes of calculating basic and diluted EPS, vested restricted stock and RSUs are considered outstanding.
There were no related party transactions during 2018, 2017 or 2016.
Table 3.1 shows the relevant amendments to accounting standards that have been implemented for the fiscal year beginning January 1, 2018; none had a material impact on our consolidated financial statements or disclosures.
ASU 2016-01 - Recognition and Measurement of Financial Assets and Financial Liabilities
Adoption impact: The statements of cash flows presented for the three years ended December 31, 2018 are in accordance with the guidance of this updated standard.
In May 2017, the FASB issued updated guidance related to a change in the terms or conditions (modification) of a share-based award. The updated guidance provides that an entity should account for the effects of a modification unless the fair value and vesting conditions of the modified award and the classification of the award (equity or liability instrument) are the same as the original award immediately before the modification. The updated guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods.
In March 2017, the FASB issued updated guidance to amend the amortization period for certain purchased callable debt securities held at a premium, shortening the amortization period to the earliest call date. This updated guidance aligns with how callable debt securities, in the United States, are generally quoted, priced, and traded, which incorporates consideration of calls (also referred to as “yield-to-worst” pricing). The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, but allows for early adoption.
Adoption impact: We adopted this guidance as of January 1, 2018 with no impact to our consolidated financial statements or disclosures as our accounting policy adhered to the updated guidance.
periods beginning after December 15, 2017, including interim periods within those annual periods.
Adoption impact: The adoption of this guidance resulted in an immaterial cumulative effect adjustment to our 2018 beginning accumulated other comprehensive (loss) income and retained earnings to recognize unrealized gains on equity investments. At December 31, 2017, equity investments were classified as available-for-sale on the consolidated balance sheet. Upon adoption, the updated guidance eliminated the available-for-sale balance sheet classification for equity securities.
In February 2018, the FASB issued a separate update for technical corrections and improvements to clarify certain aspects of the guidance described above. This update clarifies the presentation of investments in, among other things, Federal Home Loan Bank stock and prohibits those investments from being shown with equity securities.
In June 2016, the FASB issued updated guidance that requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial instruments. Entities will be required to utilize a current expected credit losses (“CECL”) methodology that incorporates their forecast of future economic conditions into their loss estimate unless such forecast is not reasonable and supportable, in which case the entity will revert to historical loss experience. Any allowance for CECL reduces the amortized cost basis of the financial instrument to the amount an entity expects to collect. Credit losses relating to available-for-sale fixed maturity securities are to be recorded through an allowance for credit losses, rather than a write-down of the asset, with the amount of the allowance limited to the amount by which fair value is less than amortized cost. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. The updated guidance is not prescriptive about certain aspects of estimating expected credit losses, including the specific methodology to use, and therefore will require significant judgment in application. The updated guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted for annual and interim periods in fiscal years beginning after December 15, 2018. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures.
The amortized cost, gross unrealized gains and losses and fair value of our fixed income securities as of December 31, 2018 and 2017 are shown below:
There were no OTTI losses recorded in other comprehensive (loss) income as of December 31, 2018 and 2017.
We had $13.5 million and $13.6 million of investments at fair value on deposit with various states as of December 31, 2018 and 2017, respectively, due to regulatory requirements of those state insurance departments. In connection with our insurance and reinsurance activities, we are required to maintain assets in trusts for the benefit of contractual counterparties. The fair value of the investments on deposit in these trusts was $26.3 million and $7.7 million at December 31, 2018 and 2017, respectively.
Table 5.2 compares the amortized cost and fair values of fixed income securities, by contractual maturity, as of December 31, 2018. The analysis is based upon contractual maturity. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties. Because most mortgage and asset-backed securities provide for periodic payments throughout their lives, they are listed separately in the table.
Proceeds from the sale of fixed income securities classified as available-for-sale were $365.6 million, $246.9 million, and $728.0 million during the years ended December 31, 2018, 2017, and 2016, respectively. Gross gains of $0.7 million, $1.6 million, and $11.9 million and gross losses of $3.8 million, $1.4 million and $3.0 million were realized on those sales during the years ended December 31, 2018, 2017, and 2016, respectively.
For the year ended December 31, 2018, we recorded $1.8 million of OTTI losses in earnings. For the years ended December 31, 2017 and 2016, there were no OTTI losses in earnings.
Proceeds from the sale of equity securities were $4.9 million during the year ended December 31, 2018. Gross gains of $3.7 million were realized on those sales during the year ended December 31, 2018. There were no sales of equity securities in 2017 or 2016. For the year ended December 31, 2018, we recognized $84 thousand of net losses on equity securities still held as of December 31, 2018, which are reported in Net realized investment (losses) gains on our consolidated statements of operations.
Unrealized loss aging for securities by type and length of time as of December 31, 2018
securities covered, including executed trades, broker quotes, credit information, collateral attributes and/or cash flow waterfall as applicable.
Equity securities (2017): FHLB stock valued at par value due to restrictions that require it to be redeemed or sold only to the security issuer at par value.
Real estate acquired through claim settlement, which is held for sale, is reported in "Other assets" on the consolidated balance sheets.
Equity securities in Level 3 are carried at cost, which approximates fair value. See "Reconciliation of Level 3 assets" below for information regarding a change in presentation of amounts previously included in Level 3 Equity securities.
Certain financial instruments, including insurance contracts, are excluded from fair value disclosure requirements. The carrying values of cash and cash equivalents (Level 1) and accrued investment income (Level 2) approximated their fair values.
For assets and liabilities measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the years ended December 31, 2018, 2017, and 2016 is shown in tables 6.2a, 6.2b and 6.2c below. As described in Note 3 - "Significant Accounting Policies," under updated guidance regarding the "Recognition and Measurement of Financial Assets and Financial Liabilities" which became effective on January 1, 2018, our investment in FHLB stock is no longer presented with equity securities. Prior to the updated guidance, the FHLB stock was included in our Level 3 equity securities. As shown in table 6.2a below, for the year ended December 31, 2018, we have transferred the FHLB stock out of Level 3 assets, and it is carried at cost, which approximates fair value, on our consolidated balance sheet in "Other invested assets" as of December 31, 2018. There were no transfers into or out of Level 3 for the years ending December 31, 2017 and 2016. There were no losses included in earnings for the years ended December 31, 2018, 2017, and 2016 attributable to the change in unrealized losses on assets still held at the end of each applicable year.
Fair value roll-forward for financial instruments classified as Level 3 for the year ended December 31, 2018
Table 7.1 shows the carrying value of our long-term debt obligations as of December 31, 2018 and 2017.
description is not intended to be complete in all respects and is qualified in its entirety by the terms of the 5.75% Notes, including their covenants and events of default. We were in compliance with all covenants as of December 31, 2018.
The 9% Debentures include a conversion feature that allows us, at our option, to make a cash payment to converting holders in lieu of issuing shares of common stock upon conversion of the 9% Debentures. We may redeem the 9% Debentures in whole or in part from time to time, at our option, at a redemption price equal to 100% of the principal amount of the 9% Debentures being redeemed, plus any accrued and unpaid interest, if the closing sale price of our common stock exceeds $17.55 for at least 20 of the 30 trading days preceding notice of the redemption.
When interest on the 9% Debentures is deferred, we are required, not later than a specified time, to use reasonable commercial efforts to begin selling qualifying securities to persons who are not our affiliates. The specified time is one business day after we pay interest on the 9% Debentures that was not deferred, or if earlier, the fifth anniversary of the scheduled interest payment date on which the deferral started. Qualifying securities are common stock, certain warrants and certain non-cumulative perpetual preferred stock. The requirement to use such efforts to sell such securities is called the Alternative Payment Mechanism.
Losses incurred on delinquencies that occurred in the current year decreased in 2018 compared to 2017 and in 2017 compared to 2016, in each case, primarily due to a decrease in the number of new delinquencies, net of cures, as well as a decrease in the estimated claim rate on recently reported delinquencies.
A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves. See table 8.2 below for more information about prior year loss development.
A roll-forward of our primary delinquent inventory for the years ended December 31, 2018, 2017, and 2016 appears in table 8.3 below. The information concerning new notices and cures is compiled from monthly reports received from loan servicers. The level of new notice and cure activity reported in a particular month can be influenced by, among other things, the date on which a servicer generates its report, the number of business days in a month and transfers of servicing between loan servicers.
New delinquent notice activity increased in 2017 compared to 2016 (particularly in the fourth quarter) because of hurricane activity that primarily impacted Puerto Rico, Texas, and Florida in the third quarter of 2017. In response to the hurricanes, the Federal Emergency Management Agency declared Individual Assistance Disaster Areas ("IADA") which we used to identify new notices of delinquency for reserving and loss mitigation purposes. We received 9,294 new notices of delinquency on loans in the IADAs in the fourth quarter of 2017, which compares to 1,968 new notices in the same areas in the fourth quarter of 2016. Loans in our ending delinquent inventory within the IADAs were 12,446 and 7,162 as of December 31, 2017 and 2016, respectively. The majority of notices of delinquency received from the IADAs due to the hurricane activity cured during 2018.
with settlements for disputes concerning our claims paying practices. The impacts of the commutations of coverage on NPLs and/or settlements in each of the past three years were as follows:
2017 - 1,337 notices removed from delinquent inventory with an amount paid of $54 million,
2016 - 1,273 notices removed from delinquent inventory with an amount paid of $53 million. In addition, we made a final payment of $42 million in connection with a 2012 settlement agreement with Freddie Mac regarding the aggregate loss limit under certain pool insurance policies.
Historically as a delinquency ages it becomes more likely to result in a claim. The new notice activity from hurricane impacted areas in the fourth quarter of 2017 increased the percentage of our delinquent inventory that has been delinquent for three months or less (table 8.4) as of December 31, 2017 when compared to December 31, 2016.
Approximately 38%, 45%, and 47% of the primary delinquent inventory delinquent for 12 consecutive months or more has been delinquent for at least 36 consecutive months as of December 31, 2018, 2017 and 2016, respectively.
Pool insurance default inventory decreased to 859 at December 31, 2018 from 1,309 at December 31, 2017 and 1,883 at December 31, 2016.
Each of the reinsurers under our quota share reinsurance agreements described below has an insurer financial strength rating of A- or better by Standard and Poor's Rating Services, A.M. Best, or both.
The structure of the 2018 QSR Transaction is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2018 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 62%.
2017 QSR Transaction. Our 2017 quota share reinsurance agreement ("2017 QSR Transaction") provides coverage on eligible new business written in 2017. Under our 2017 QSR Transaction we cede losses incurred and premiums on or after the effective date through December 31, 2028, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.
2015 QSR Transaction. Our 2015 quota share reinsurance agreement ("2015 QSR Transaction") provides coverage on eligible business written before 2017. Under the 2015 QSR Transaction we cede losses incurred and premiums through December 31, 2024, at which time the agreement expires. Early termination of the agreement can be elected by us for a fee on a bi-annual basis, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period. Our next early termination option is at June 30, 2019 and requires 90 days' prior written notice.
The structure of both the 2017 QSR Transaction and 2015 QSR Transactions is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2017 and 2015 QSR Transactions, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%.
Table 9.2 provides a summary of our quota share reinsurance agreements, excluding captive agreements, for 2018, 2017 and 2016.
The structure of the 2019 QSR Transaction is a 30% quota share, with a one-time option, elected by us, to reduce the cede rate to either 25% or 20% effective July 1, 2020, or bi-annually thereafter, for a fee, for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2019 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 62%.
collateralize its reinsurance obligations to us, and the investment income collected on the collateral assets.
We are required to disclose our maximum exposure to loss, which we consider to be an amount that we could be required to record in our statement of operations, as a result of our involvement with this VIE. As of
The reinsurance trust agreement provides that the trust assets may generally only be invested in certain money market funds that (i) invest at least 99.5% of their total assets in cash or direct U.S. federal government obligations, such as U.S. Treasury bills, as well as other short-term securities backed by the full faith and credit of the U.S. federal government or issued by an agency of the U.S. federal government, (ii) have a principal stability fund rating of “AAAm” by S&P or a money market fund rating of “Aaa-mf” by Moody’s as of the Closing Date and thereafter maintain any rating with either S&P or Moody’s, and (iii) are permitted investments under the applicable credit for reinsurance laws and applicable PMIERs credit for reinsurance requirements.
Cumulative effect of adopting the accounting standard update for financial instruments
We have a non-contributory defined benefit pension plan covering substantially all domestic employees, as well as a supplemental executive retirement plan. We also offer both medical and dental benefits for retired domestic employees, their eligible spouses and dependents under a postretirement benefit plan. The following tables 11.1, 11.2, and 11.3 provide the components of aggregate annual net periodic benefit cost for each of the years ended December 31, 2018, 2017, and 2016 and changes in the benefit obligation and the funded status of the pension, supplemental executive retirement and other postretirement benefit plans as recognized in the consolidated balance sheets as of December 31, 2018 and 2017.
The decrease in our pension and supplemental executive retirement plans obligation in 2018 compared to 2017 was primarily due to an increase in the discount rate used to calculate the obligation and a higher amount of benefits paid from the fund. The increase in our other postretirement plan obligation was primarily due to a plan amendment, offset by an increase in the discount rate used to calculate the obligation. Table 11.8 below includes the actuarial assumptions used to calculate the benefit obligations of our plans for 2018 and 2017.
Tables 11.10a and 11.10b set forth by level, within the fair value hierarchy, the pension plan assets and related accrued investment income at fair value as of December 31, 2018 and 2017. There were no securities that used Level 3 inputs.
Tables 11.11a and 11.11b set forth the other postretirement benefits plan assets at fair value as of December 31, 2018 and 2017. All are Level 1 assets.
Other postretirement benefits plan assets at fair value as of December 31, 2017
Investment in international mutual funds is limited to a maximum of 30% of the equity range. The allocation as of December 31, 2018 included 3% that was primarily invested in equity securities of emerging market countries and another 19% was invested in securities of companies primarily based in Europe and the Pacific Basin.
Assumed health care cost trend rates have a significant effect on the amounts reported for the other postretirement benefits plan. A 1 percentage point change in the health care trend rate assumption would have the following effects on other postretirement benefits:
We used the remaining balance of our Federal net operating loss carryforward to offset taxable income during 2018. We believe that all gross deferred tax assets at December 31, 2018 are fully realizable and no valuation allowance has been established.
As of January 1, 2018, the updated guidance of "Recognition and Measurement of Financial Assets and Financial Liabilities" became effective. The application of this guidance resulted in an immaterial cumulative effect adjustment to our 2018 beginning accumulated other comprehensive (loss) income and retained earnings to recognize unrealized gains on equity securities.
As of January 1, 2017, we adopted the updated guidance of "Improvements to Employee Share-Based Compensation Accounting." The adoption of this guidance resulted in an immaterial cumulative effect adjustment to our 2017 beginning retained earnings. For the year ending December 31, 2017, we adopted the updated guidance of "Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." The adoption of this guidance resulted in a $10.4 million reclassification from accumulated other comprehensive loss to retained earnings in the fourth quarter of 2017.
The statutory financial statements of our insurance companies are presented on the basis of accounting principles prescribed, or practices permitted, by the Office of the Commissioner of Insurance of the State of Wisconsin (the "OCI"), which has adopted the National Association of Insurance Commissioners ("NAIC") Statements of Statutory Accounting Principles ("SSAP") as the basis of its statutory accounting principles. In converting from statutory to GAAP, typical adjustments include deferral of policy acquisition costs, the inclusion of net unrealized holding gains or losses in shareholders' equity relating to fixed income securities and the inclusion of statutory non-admitted assets.
In addition to the typical adjustments from statutory to GAAP, mortgage insurance companies are required to maintain contingency loss reserves equal to 50% of premiums earned under SSAP and principles prescribed by the OCI, and such amounts cannot be withdrawn for a period of ten years except as permitted by insurance regulations. With regulatory approval, a mortgage guaranty insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net premiums earned in a calendar year. For the year ended 2018, MGIC's losses incurred were 4% of net premiums earned. Changes in contingency loss reserves impact the statutory statement of operations. Contingency loss reserves are not reflected as liabilities under GAAP and changes in contingency loss reserves do not impact the GAAP statements of operations.
The surplus contributions made to MGIC, dividends paid by MGIC, and distributions from other insurance subsidiaries to us, are shown in table 14.2 below.
While MGIC currently meets the State Capital Requirements of Wisconsin and all other jurisdictions, it could be prevented from writing new business in the future in all jurisdictions if it fails to meet the State Capital Requirements of Wisconsin, or it could be prevented from writing new business in a particular jurisdiction if it fails to meet the State Capital Requirements of that jurisdiction and in each case MGIC does not obtain a waiver of such requirements. It is possible that regulatory action by one or more jurisdictions, including those that do not have specific State Capital Requirements, may prevent MGIC from
continuing to write new insurance in such jurisdictions. If we are unable to write business in all jurisdictions, lenders may be unwilling to procure insurance from us anywhere. In addition, a lender’s assessment of the future ability of our insurance operations to meet the State Capital Requirements or the PMIERs may affect its willingness to procure insurance from us. A possible future failure by MGIC to meet the State Capital Requirements or the PMIERs will not necessarily mean that MGIC lacks sufficient resources to pay claims on its insurance liabilities. While we believe MGIC has sufficient claims paying resources to meet its claim obligations on its IIF on a timely basis, you should read the rest of these financial statement footnotes for information about matters that could negatively affect MGIC’s claims paying resources.
MGIC is subject to statutory regulations as to payment of dividends. The maximum amount of dividends that MGIC may pay in any twelve-month period without regulatory approval by the OCI is the lesser of adjusted statutory net income or 10% of statutory policyholders' surplus as of the preceding calendar year end. Adjusted statutory net income is defined for this purpose to be the greater of statutory net income, net of realized investment gains, for the calendar year preceding the date of the dividend or statutory net income, net of realized investment gains, for the three calendar years preceding the date of the dividend less dividends paid within the first two of the preceding three calendar years. The OCI recognizes only statutory accounting principles prescribed, or practices permitted, by the State of Wisconsin for determining and reporting the financial condition and results of operations of an insurance company. The OCI has adopted certain prescribed accounting practices that differ from those found in other states. Specifically, Wisconsin domiciled companies record changes in the contingency reserves through the income statement as a change in underwriting deduction. As a result, in periods in which MGIC is increasing contingency reserves, statutory net income is reduced. For the year ended December 31, 2018, MGIC’s increase in contingency reserves was $484 million and statutory net income was $325 million. As of December 31, 2018, MGIC's statutory policyholders' surplus was $1,682 million.
At December 31, 2018, the 3.6 million shares of restricted stock outstanding consisted of 2.7 million shares that are subject to performance conditions (“performance shares”) and 0.9 million shares that are subject only to service conditions (“time vested shares”). The weighted-average grant date fair value of restricted stock granted during 2017 and 2016 was $10.41 and $5.66, respectively. The fair value of restricted stock granted is the closing price of the common stock on the New York Stock Exchange on the date of grant. The total fair value of restricted stock vested during 2018, 2017 and 2016 was $19.1 million, $15.3 million, and $12.2 million, respectively.
Before paying an insurance claim, we review the loan and servicing files to determine the appropriateness of the claim amount. When reviewing the files, we may determine that we have the right to rescind coverage on the loan. We refer to insurance rescissions and denials of claims collectively as “rescissions” and variations of that term. In addition, our insurance policies generally provide that we can reduce or deny a claim if the servicer did not comply with its obligations under our insurance policy. We call such reduction of claims “curtailments.” In recent quarters, an immaterial percentage of claims received in a quarter have been resolved by rescissions. In 2017 and 2018, curtailments reduced our average claim paid by approximately 5.6% and 5.8%, respectively.
In addition to matters for which we have recorded a probable loss, we are involved in other discussions and/or proceedings with insureds with respect to our claims paying practices. Although it is reasonably possible that when these matters are resolved we will not prevail in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. We estimate the maximum exposure associated with matters where a loss is reasonably possible to be approximately $279 million. This estimate of maximum exposure is based upon currently available information and is subject to significant judgment, numerous assumptions and known and unknown uncertainties. The matters underlying the estimate of maximum exposure will change from time to time. This estimate of our maximum exposure does not include interest or consequential or exemplary damages.
Through a non-insurance subsidiary, we utilize our underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. As part of the contract underwriting activities, that subsidiary is responsible for the quality of the underwriting decisions in accordance with the terms of the contract underwriting agreements with customers. That subsidiary may be required to provide certain remedies to its customers if certain standards relating to the quality of our underwriting work are not met, and we have an established reserve for such future obligations. Claims for remedies may be made a number of years after the underwriting work was performed. The related contract underwriting remedy expense for each of the years ended December 31, 2018, 2017, and 2016, was immaterial to our consolidated financial statements.
We have audited the accompanying consolidated balance sheets of MGIC Investment Corporation and its subsidiaries as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes and financial statement schedules listed in the index appearing under Item 15 (a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).