(In thousands, except per share data) 2020 2019 2018 2017 2016
Diluted income per share $ 1.29 $ 1.85 $ 1.78 $ 0.95 $ 0.86
(1)In 2017, we remeasured our net deferred tax assets at the lower enacted corporate income tax rate under the Tax Act.
Direct primary RIF $ 61,812 $ 57,213 $ 54,063 $ 50,319 $ 47,195
Percentage of loans in default 5.11 % 2.78 % 3.11 % 4.55 % 5.04 %
Underwriting Expense ratio 19.2 % 18.4 % 18.2 % 16.0 % 15.3 %
This Overview of the MD&A highlights selected information and may not contain all of the information that is important to readers of this Annual Report. Hence, this Overview is qualified by the information that appears elsewhere in this Annual Report, including the other portions of the MD&A.
Net income of $446.1 million for 2020 decreased by $227.7 million when compared to the prior year, and diluted income per share of $1.29 decreased by 30% when compared to the prior year. These decreases primarily reflect an increase in losses incurred, a loss on debt extinguishment, a decrease in net premiums earned, and a decrease in investment income, net of expenses. Diluted income per share decreased due to a decline in net income, partially offset by a decrease in the number of diluted weighted average shares outstanding.
We recorded a $26.7 million loss on debt extinguishment associated with the repurchase of a portion of our 5.75% Notes and our 9% Debentures.
Despite the economic effects of the COVID-19 pandemic, there were favorable trends in the housing market in 2020. Low interest rates, increasing household formations and appreciating home values continue to support favorable housing fundamentals.
transmission of COVID-19, have resulted in an increase in the number of loans in our delinquency inventory. Payment forbearance programs are currently in place to assist borrowers experiencing a hardship during the COVID-19 pandemic. Forbearance allows for mortgages to be suspended for up to 360 days. For loans in a COVID-19 forbearance plan as of February 28, 2021, the plan may be extended for an additional three months, subject to certain limits. As of December 31, 2020, 62% of the loans in our delinquency inventory are subject to a forbearance plan.
The COVID-19 pandemic may adversely affect our future business, results of operations, and financial condition. The extent of the adverse effects will depend on the duration and continued severity of the COVID-19 pandemic and its effect on the U.S. economy and housing market.
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 home prices may result in more homeowners defaulting and our losses increasing, with a corresponding decrease in our returns,” “Changes in interest rates, house prices or mortgage insurance cancellation requirements may change the length of time that our policies remain in force," and "The COVID-19 pandemic may continue to materially impact our financial results and may also materially impact our business, liquidity, and financial condition."
The past several years of favorable housing fundamentals and in our view, favorable risk characteristics of our recently insured loans contributed to declining delinquent inventory, and lower losses incurred and claims paid in 2019. While favorable trends continued in the housing market in 2020, we experienced an increase in our losses incurred due to the impacts of the COVID-19 pandemic.
After easing somewhat in 2018, lending standards became tighter again in 2019. The percentage of our NIW with DTI ratios over 45% declined in 2020 and 2019. Change in both years was primarily driven by adjustments to GSE underwriting guidelines for loans with DTI ratios over 45% and our pricing for loans with such DTI ratios. The increase in the percentage of our NIW from refinance transactions in 2020 and 2019 was due to the low interest rate environment and also resulted in a consistently lower percentage of our NIW with LTV ratios over 95% for both years.
Refer to "Mortgage Insurance Portfolio" for additional discussion of changes in our NIW mix during 2020.
of technology and innovation in the delivery and servicing of our mortgage insurance products.
In 2018, the GSEs initiated secondary mortgage market programs with loan level mortgage default coverage provided by various (re)insurers that are not mortgage insurers governed by PMIERs, and that are not selected by the lenders. Due to differences in policy terms, these programs may offer premium rates that are below prevalent single premium LPMI rates. While we view these programs as competing with traditional private mortgage insurance, we participate in these programs from time to time.
The GSEs (and other investors) have also used other forms of credit enhancement that did not involve traditional private mortgage insurance, such as engaging in credit-linked note transactions executed in the capital markets, or using other forms of debt issuances or securitizations that transfer credit risk directly to other investors, including competitors and an affiliate of MGIC; using other risk mitigation techniques in conjunction with reduced levels of private mortgage insurance coverage; or accepting credit risk without credit enhancement.
Government programs. PMI also competes against government mortgage insurance programs such as the FHA, VA, and USDA, primarily for lower FICO score business. The combined market share of primary mortgage insurance written by government programs continues to exceed that written by PMI in 2019 and 2020. The strong refinance markets in 2019 and 2020, and PMI premium rate reductions, have contributed to a PMI market share at its highest levels since the financial crisis.
Premiums. Despite an increase in IIF, we expect our 2021 earned premiums (on a direct basis) to be lower than they were in 2020. Overall, our premium rates have been trending down in recent years, including in 2020, as the books of business written at lower rates represent an increasing percentage of our total IIF.
Our 2021 direct premiums written are expected to be comparable to 2020, while our net premiums earned are expected to decrease in 2021. Our net premiums written and earned will be impacted by the downward trend in premium rates noted above and by the amount of premiums we cede under our quota share and excess
of loss reinsurance transactions. Net premiums earned are also impacted by the amount of accelerated premiums from single premium policy cancellations. Our unearned premium decreased to $287.1 million at December 31, 2020 from $380.3 million at December 31, 2019. 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. In 2020, our profit commission was impacted by the increase in ceded losses incurred. The amount of premiums we cede in 2021 will be affected by any changes in our reinsurance coverage.
Underwriting and operating expenses, net. We expect underwriting and operating expenses, net to increase in 2021 as we invest in our technology infrastructure to execute our strategies.
Income taxes. We expect our 2021 effective tax rate to be approximately 21%.
In the first quarter of 2020 and in the full year of 2019, we repurchased approximately 9.6 million and 8.7 million shares of our common stock, respectively, using approximately $120 million and $114 million, respectively, of holding company resources. As of December 31, 2020, we had $291 million of authorization remaining to repurchase our common stock through the end of 2021 under a share repurchase program approved by our Board of Directors in January 2020. Repurchases may be made from time to time on the open market (including through 10b5-1 plans) or through privately negotiated transactions. The repurchase programs may be suspended for periods or discontinued at any time. Due to the uncertainty caused by the COVID-19 pandemic, we have temporarily suspended stock repurchases, but may resume them in the future.
For information about how the payment of dividends by our holding company will result in an adjustment to the conversion rate and price of our convertible securities, see our risk factor titled “Your ownership in our company may be diluted by additional capital that we raise or if the holders of our outstanding convertible debt convert that debt into shares of our common stock” in Item 1A.
We must comply with a GSE's PMIERs to be eligible to insure loans delivered to or purchased by that GSE. The PMIERs include financial requirements, as well as business, quality control and certain transaction approval requirements. The financial requirements of the PMIERs require a mortgage insurer’s “Available Assets” (generally only the most liquid assets of an insurer) to equal or exceed its “Minimum Required Assets” (which are generally based on an insurer’s book of risk in force and are calculated from tables of factors with several risk dimensions, reduced for credit given for risk ceded under reinsurance transactions).
The PMIERs generally require us to hold significantly more Minimum Required Assets for delinquent loans than for performing loans and the Minimum Required Assets required to be held increases as the number of payments missed on a delinquent loan increases. For delinquent loans whose initial missed payment occurred on or after March 1, 2020 and prior to April 1, 2021 (the "COVID-19 Crisis Period"), the Minimum Required Assets are generally reduced by 70% for at least three months. The 70% reduction will continue, or be newly applied, for delinquent loans that are subject to a forbearance plan that is granted in response to a financial hardship related to COVID-19, the terms of which are materially consistent with terms of forbearance plans offered by Freddie Mac or Fannie Mae. Under the PMIERs, a forbearance plan on a loan with an initial missed payment occurring during the COVID-19 Crisis Period is assumed to have been granted in response to a financial hardship related to COVID-19. Loans considered to be subject to a forbearance plan include those that are in a repayment plan or loan modification trial period following the forbearance plan.
There may be future implications for PMIERs as a result of changes to regulatory capital requirements for the GSEs. In November 2020, the FHFA adopted a rule containing a risk-based capital framework for the GSEs that will increase their capital requirements, effective on the later of (i) the date of termination of the FHFA’s conservatorship of the applicable GSE; (ii) sixty days after publication of the adopted rule in the Federal Register; or (iii) any later compliance date provided in a consent order or other transition order applicable to a GSE. The increase in capital requirements may ultimately result in an increase in the Minimum Required Assets required to be held by mortgage insurers
The insurance laws of 16 jurisdictions, including Wisconsin, our domiciliary state, require a mortgage insurer to maintain a minimum amount of statutory capital relative to its RIF (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the “State Capital Requirements.” While they vary among jurisdictions, the most common State Capital Requirements allow for a maximum risk-to-capital ratio of 25 to 1. A risk-to-capital ratio will increase if (i) the percentage decrease in capital exceeds the percentage decrease in insured risk, or (ii) the percentage increase in capital is less than the percentage increase in insured risk. Wisconsin does not regulate capital by using a risk-to-capital measure but
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.
providing that the federal government is properly compensated for any explicit or implicit support it provides to the GSEs or the secondary housing finance market.
The impact of the Plan on private mortgage insurance is unclear. The plan does not refer to mortgage insurance explicitly; however, it refers to a requirement for credit enhancement on high LTV ratio loans, which is a requirement of the current GSE charters. The Plan also indicates that the FHFA should continue to support efforts to expand credit risk transfer (“CRT”) programs and should encourage the GSEs to continue to engage in a diverse mix of economically sensible CRT programs, including by increasing reliance on institution-level capital (presumably, as distinguished from capital obtained in the capital markets). For more information about CRT programs, see our risk factor titled "The amount of insurance we write could be adversely affected if lenders and investors select alternatives to private mortgage insurance."
•Payment forbearance on federally-backed mortgages (including those delivered to or purchased by the GSEs) to borrowers experiencing a hardship during the COVID-19 pandemic.
•Enhanced unemployment payments for pay periods between December 26, 2020 and March 14, 2021.
Historically, forbearance plans have reduced the incidence of our losses on affected loans. However, given the uncertainty surrounding the long-term economic impact of COVID-19, it is difficult to predict the ultimate effect of COVID-19 related forbearances on our loss incidence. As of December 31, 2020
The GSEs have introduced specific loss mitigation options for borrowers impacted by COVID-19 when their forbearance plans end, including the COVID-19 Payment Deferral solution for borrowers who are unable to immediately or gradually repay their missed loan payments. Under the COVID-19 Payment Deferral solution, the borrower's monthly loan payment would be returned to its pre-COVID amount and the missed payments would be added to the end of the mortgage term without accruing any additional interest or late fees. The deferred payments would be due when the loan is paid off, refinanced or the home is sold.
The foreclosure moratoriums and forbearance plans in place under the GSE initiatives have delayed, and may continue to delay, the receipt and payment of claims.
•Premiums ceded, net of profit commission under our QSR Transactions, and premiums ceded under our Home Re Transactions. The profit commission varies inversely with the level of ceded losses on a “dollar for dollar” basis and can be eliminated at ceded loss levels higher than we experienced in 2020. As a result, lower levels of losses result in a higher profit commission and less benefit from ceded losses; higher levels of losses result in more benefit from ceded losses and a lower profit commission (or for certain levels of accident year loss ratios, its elimination). See Note 9 - “Reinsurance” to our consolidated financial statements for a discussion of our reinsurance transactions.
Premiums earned are generated by the insurance that is in force during all or a portion of the period. A change in the average IIF in
Our investment portfolio is composed principally of investment grade fixed income securities. The principal factors that influence investment income are the size of the portfolio and its yield. As measured by amortized cost (which excludes changes in fair value, such as from changes in interest rates), the size of the investment portfolio is mainly a function of cash generated from (or used in) operations, such as NPW, investment income, net claim payments and expenses, and cash provided by (or used for) non-operating activities, such as debt or stock issuances or repurchases, and dividends.
Losses incurred are the current expense that reflects claim payments, cost of settling claims, and estimated payments that will ultimately be made as a result of delinquencies on insured loans. As explained under “Critical Accounting Policies” below, except in the case of a premium deficiency reserve, we recognize an estimate of this expense only for delinquent loans. The level of new delinquencies has historically followed a seasonal pattern, with new delinquencies in the first part of the year lower than new delinquencies in the latter part of the year, though this pattern can be affected by the state of the economy and local housing markets. Pandemics, including COVID-19, and other natural disasters may result in delinquencies not following the typical pattern. Losses incurred are generally affected by:
•The state of the economy, including unemployment and housing values, each of which affects the likelihood that loans will become delinquent and whether loans that are delinquent cure their delinquency.
Underwriting and other expenses includes items such as employee compensation, fees for professional and consulting services, depreciation and maintenance expense, and premium taxes, and are reported net of ceding commissions associated with our QSR Transactions. Employee compensation expenses are variable due to share-based compensation, changes in benefits, and changes in headcount (which can fluctuate due to volume). See Note 9 - “Reinsurance” to our consolidated financial statements for a discussion of ceding commission on our QSR Transactions.
Interest expense reflects the interest associated with our consolidated outstanding debt obligations discussed in Note 7 - “Debt” to our consolidated financial statements and under “Liquidity and Capital Resources” below.
•Equity securities. Realized investment gains and losses are accounted for as a function of the periodic change in fair 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 incurred losses on delinquencies that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments) and increasing losses. The typical pattern is also a function of premium rates generally resetting to lower levels after ten years. Changes in economic conditions, including those related to pandemics, including COVID-19, and other natural disasters may result in delinquencies not following the typical pattern.
(1)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.
Income before tax / Net income $ 559,263 $ 113,170 $ 446,093 847,977 174,214 673,763
Reconciliation of Net income per diluted share to Adjusted net operating income per diluted share:
The primary mortgage insurance market is affected by total mortgage originations and PMI's market share. Total originations are estimated to have increased in 2020 compared with 2019, due to higher refinance originations, as well as higher purchase originations. Refinance originations increased as a result of lower mortgage interest rates on average; while continued solid housing fundamentals, such as household formations and attractive mortgage rates supported the increase in purchase originations, despite the increase in unemployment. Total mortgage originations in 2021 are forecast to be down compared to 2020 estimated levels, primarily due to an expected decrease in refinancing transactions partially offset by an expected increase in purchase originations. The COVID-19 pandemic, including the related restrictions on business in many parts of the U.S., and its effect on unemployment and consumer confidence, may affect the number of purchase mortgage originations.
Source: GSEs and MBA estimates/forecasts as of January 2021. Amounts represent the average of all sources.
Source: Inside Mortgage Finance - November 13, 2020 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.
Source: Inside Mortgage Finance - November 13, 2020. Includes HARP NIW.
We expect that our market share within the PMI industry increased in 2020 when compared to 2019. For additional discussion of the competitive landscape of the industry refer to "Overview - Business Environment - Competition."
NIW for 2020 continued to have what we believe are favorable risk characteristics. The following tables provide information about characteristics of our NIW.
An increase in the percentage of refinances, discussed below, and home price appreciation have decreased the percentage of our NIW with LTV ratios greater than 95% in 2020 compared to 2019.
In 2020, the percentage of our NIW on loans with DTI ratios over 45% was 11.3%, down from 13.5% in 2019. We believe the decline in 2020 was primarily due to pricing changes associated with such loans.
MGIC has written no new pool insurance since 2008, however, for a variety of reasons, including responding to capital market alternatives to private mortgage insurance and customer demands, MGIC may write pool risk in the future. Our direct pool RIF was $340 million ($210 million on pool policies with aggregate loss limits and $130 million on pool policies without aggregate loss limits) at December 31, 2020 compared to $376 million ($213 million on pool policies with aggregate loss limits and $163 million on pool policies without aggregate loss limits) at December 31, 2019. If claim payments associated with a specific pool reach the aggregate loss limit, the remaining IIF within the pool would be cancelled and any remaining defaults under the pool would be removed from our default inventory.
In connection with the GSEs' CRT programs, an insurance subsidiary of MGIC provides insurance and reinsurance covering portions of the credit risk related to certain reference pools of mortgages acquired by the GSEs. Our RIF, as reported to us, related to these programs was approximately $287 million and $182 million as of December 31, 2020 and December 31, 2019, respectively.
The following section of the MD&A provides a comparative discussion of our Consolidated Results of Operations for the two-year period ended December 31, 2020. For a discussion of the Critical Accounting Policies used by us that affect the Consolidated Results of Operations, see "Critical Accounting Policies" below.
NPW and NPE decreased 7% and 1%, respectively, compared to the prior year, primarily due to lower premium rates on our IIF and an increase in our reduction for ceded premiums due to the decrease in profit commission from our QSR transactions. The decrease in profit commission was a result of higher ceded losses incurred. This was partially offset by higher average insurance. NPE was also impacted by an increase in accelerated premiums from single premium policy cancellations.
Premium yield is NPE divided by average IIF during the year and is influenced by a number of key drivers, which have a varying impact from period to period. The following table provides information related to our premium yield for 2020, and 2019.
Ceded premiums earned, net of profit commission and assumed premiums (2) (7.6) (5.8)
(2) Assumed premiums include those from our participation in GSE CRT programs, of which the impact on the net premium yield was 0.5 bps in 2020 and 0.2 bps in 2019
Changes in our premium yields when compared to the respective prior year periods reflect the following:
A larger percentage of our IIF is from book years with lower premium rates due to a decline in premium rates in recent years resulting from pricing competition, insuring mortgages with lower risk characteristics, lower required capital, certain policies undergoing premium rate resets on their ten-year anniversaries, and the availability of reinsurance.
Premium refunds adversely impact our premium yield and are primarily driven by claim activity and our estimate of refundable premiums on our delinquent inventory.
As discussed in our Risk Factor titled "Competition or changes in our relationships with our customers could reduce our revenues, reduce our premium yields and/or increase our losses," the private mortgage insurance industry is highly competitive and premium rates have declined over the past several years. We expect that our inforce portfolio yield will continue to decline as older insurance policies with higher premium rates run off or have their premium rates reset, and new insurance policies with lower premium rates are written. While our increased use of reinsurance over the past several years has helped to mitigate the negative effect of declining premium rates on our returns, refer to our risk factor titled "Reinsurance may not always be available or affordable" for a discussion of the risks associated with the availability of reinsurance.
è We cede a fixed percentage of losses incurred on insurance covered by the agreements.
The following table provides information related to our quota share agreements for 2020 and 2019.
The NIW subject to quota share reinsurance decreased in 2020 compared to 2019 due to an increase in NIW with LTVs less than or equal to 85% and amortization terms less than or equal to 20 years, which are excluded from the QSR Transactions.
2021 and 2022 QSR Transaction. We have agreed to terms with a group of unaffiliated reinsurers for reinsurance transactions with similar structures to our existing QSR transactions that will cover most of our NIW in 2021 (with an additional 12.5% quota share) and 2022 (with a 15% quota share). This is in addition to the reinsurance agreements executed in 2020 that included a 17.5% quota share on eligible 2021 NIW and the Credit Union QSR Transaction that covers NIW on loans originated by credit unions with a 65% quota share.
Our excess-of-loss reinsurance agreements provide $839.4 million of loss coverage on an existing portfolio of in force policies having an in force dates from July 1, 2016 through March 31, 2019 and January 1, 2020 through July 31, 2020. As of December 31, 2020, the aggregate exposed principal balances under the Home Re 2018-1, 2019-1, and 2020-1 transactions were approximately $3.5 billion, $3.3 billion, and $8.7 billion, respectively, which take into account the mortgage insurance coverage percentage, net retained risk after quota share reinsurance, and the reinsurance inclusion percentage of the unpaid principal balance. Total ceded premiums for 2020 and 2019 were $20.8 million and $17.6 million, respectively.
Net investment income decreased 8% to $154 million in 2020 compared to $167 million in 2019. The decrease in investment income was due to lower investment yields, partially offset by an increase in the investment portfolio balance.
Net realized investment gains (losses) in 2020 and 2019 were $14 million and $5 million, respectively. The increase in net realized investment gains was due to an increase in the sale of fixed income and equity securities.
IBNR reserves are established for delinquencies estimated to have occurred prior to the close of an accounting period, but not yet reported to us. IBNR reserves are established using estimated delinquencies, claim rates and claim severities.
Losses incurred, net increased to $365 million compared to $119 million in 2019. The increase was primarily due to an increase in the delinquency inventory due to the impacts of the COVID-19 pandemic, including unemployment resulting from initiatives intended to reduce the transmission of COVID-19. There were 57,710 loans in our delinquency inventory at December 31, 2020 compared to 30,028 at December 31, 2019. The increase in losses incurred, net was also due to adverse loss reserve development on previously received delinquencies of $20 million in 2020 compared to favorable development of $71 million in 2019.
The table below presents our new notices, delinquency inventory, and the average missed payment of the delinquency inventory by policy year.
è exposure on the loan, which is the unpaid principal balance of the loan times our insurance coverage percentage,
3 payments or less 35 % 18 % 25 % 50 %
12 payments or more 29 % 3 % 13 % 22 %
New delinquency notices increased in 2020 because of the impacts of the COVID-19 pandemic, including the high level of unemployment and economic uncertainty resulting from measures to reduce the transmission of the COVID-19. The number of new delinquency notices received in the second quarter of 2020 was 57,584, but decreased 74% by the fourth quarter to 15,193 new delinquency notices. In the third and fourth quarter of 2020, we experienced an increase in cures, likely associated with our COVID-19 new delinquency notices.
(1)See Note 8 - "Loss Reserves" for additional information on our settlements of disputes for claims paying practices and/or commutations of policies
The primary average claim paid for the top 5 jurisdictions (based on 2020 losses paid) for 2020 and 2019 appears in table below.
The primary average RIF on all loans was $54,891, $52,995 at December 31, 2020 and December 31, 2019, respectively.
The primary and pool loss reserves as of December 31, 2020, and 2019 appear in the table below.
Primary claims received inventory included in ending delinquency inventory 159 538
Pool claims received inventory included in ending delinquency inventory 10 11
(2)Other gross loss reserves includes direct and assumed reserves that are not included within our primary or pool loss reserves.
2004 and prior %: 14 % 3 % 6 % 16 %
2005 - 2008 % 49 % 18 % 30 % 54 %
2016 and later %: 27 % 67 % 52 % 18 %
On our primary business, the highest claim frequency years have typically been the third and fourth year after loan origination. However, the pattern of claim frequency can be affected by many factors, including persistency and deteriorating economic conditions. Deteriorating economic conditions can result in increasing claims following a period of declining claims. As of December 31, 2020, 66% of our primary RIF was written subsequent to December 31, 2017, 74% of our primary RIF was written subsequent to December 31, 2016, and 82% of our primary RIF was written subsequent to December 31, 2015.
Underwriting and other expenses includes items such as employee compensation costs, fees for professional and consulting services, depreciation and maintenance expense, and premium taxes, and are reported net of ceding commissions.
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 two years.
The decrease in our provision for income tax expense for 2020 compared to 2019 was primarily due to a decrease in income before tax. Our effective tax rate for 2020 and 2019 was below the federal statutory income tax rate of 21% primarily due to the benefits of tax-preferenced securities.
Accumulated Other Comprehensive Income (Loss), net of tax 217 73 144
The increase in shareholders' equity in 2020 compared with the prior year was due to net income and an increase in the fair value of our investment portfolio, offset in part by quarterly dividends paid to shareholders and the repurchase of shares of our common stock in the first quarter of 2020.
As of December 31, 2020, total assets were $7.4 billion and total liabilities were $2.7 billion. Compared to year-end 2019, total assets increased by $1.1 billion and total liabilities increased by $0.7 billion.
The following sections focus on the assets and liabilities experiencing major developments in 2020.
The investment portfolio increased 16%, to $6.7 billion as of December 31, 2020 (2019: $5.8 billion), as net cash from operations and proceeds from debt issuances were used in part for additional investment.
Our investment portfolio was invested in comparable security types for the years ended December 31, 2020 and December 31, 2019. See Note 5 - “Investments” to our consolidated financial statements for additional disclosure on our investment portfolio.
Our investment portfolio of fixed income securities is subject to interest rate risk and its fair value is likely to increase in a decreasing interest rate environment. We seek to manage our exposure to interest rate risk and volatility by maintaining a diverse mix of high quality securities with an intermediate duration profile. While higher interest rates may adversely impact the fair values of our fixed income securities, they present an opportunity to reinvest investment income and proceeds from security maturities into higher yielding securities.
As of December 31, 2020, approximately 5% of the fair value of our investment portfolio consisted of securities referencing LIBOR, none of which reference one-week and two-month tenors. As discussed in our risk factor titled "The Company may be adversely impacted by the transition from LIBOR as a reference rate," the ICE Benchmark Administration, the administrator of LIBOR, began consulting on its intention to cease publishing after 2021, with respect to USD LIBOR, only the one-week and two-month tenors and, on June 30, 2023, all other USD LIBOR tenors.
Our unearned premium decreased to $287.1 million as of December 31, 2020 from $380.3 million as of December 31, 2019 primarily due to an increase in single premium policy cancellations.
Home Re 2018-1 Ltd., Home Re 2019-1 Ltd., and Home Re 2020-1 Ltd. are special purpose variable interest entities that are not consolidated in our consolidated financial statements because we do not have the unilateral power to direct those activities that are significant to their economic performance. See Note 9 - "Reinsurance," to our consolidated financial statements for additional information.
Increase (decrease) in cash and cash equivalents and restricted cash and cash equivalents $ 127,624 $ 14,018
In connection with the reinsurance we use to manage the risk associated with our insurance policies, we cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when claims subject to our reinsurance coverage are paid.
è manage our capital to support our business strategies and the competing priorities of relevant stakeholders
è support business opportunities by enabling capital flexibility and efficiently using company resources.
The following table summarizes our capital structure as of December 31, 2020, and 2019.
Common stock, paid-in capital, retained earnings, less treasury stock $ 4,482,165 $ 4,236,526
The increase in total shareholders' equity in 2020 from 2019 was primarily due to net income during 2020, offset by our repurchases of our common stock and an increase in gross unrealized gains. See Note 13 - "Shareholders' Equity" for further information.
In August, 2020, we issued $650.0 million aggregate principal amount of 5.25% Notes due in 2028. We used a portion of the proceeds to repurchase $182.7 million in aggregate principal of our 5.75% Senior notes due in 2023 and $48.1 million in aggregate principal of
In the third quarter of 2020, MGIC distributed to the holding company, as a dividend, its ownership in the 9% Debentures of $132.7 million. In 2019, the $132.7 million was an outstanding obligation of our holding company to MGIC.
In 2020 we used $82 million to pay cash dividends to shareholders. On January 26, 2021, our Board of Directors declared a quarterly cash dividend of $0.06 per common share to shareholders of record on February 17, 2021, payable on March 3, 2021.
Our holding company cash and investments increased $522 million in 2020, to $847 million as of December 31, 2020.
The net unrealized gains on our holding company investment portfolio were approximately $4.7 million at December 31, 2020 and the portfolio had a modified duration of approximately 1.8 years.
We anticipate our delinquency inventory to remain elevated in 2021due to the impacts of the COVID-19 pandemic. The PMIERS generally require us to hold significantly more Minimum Required Assets for delinquent loans than for performing loans and the Minimum Required Assets required to be held increases as the number of payments missed on a delinquent loan increases. For delinquent loans whose initial missed payment occurred on or after March 1, 2020 and prior to April 1, 2021 (the "COVID-19 Crisis Period"), the Minimum Required Assets are generally reduced by 70% for at least three months. The 70% reduction will continue, or be newly applied, for delinquent loans that are subject to a forbearance plan that is granted in response to a financial hardship related to COVID-19, the terms of which are materially consistent with terms of forbearance plans offered by Freddie Mac or Fannie Mae. Under the PMIERs, a forbearance plan on a loan with an initial missed payment occurring during the COVID-19 Crisis Period is assumed to have been granted in response to a financial hardship related to COVID-19. Loans considered to be subject to a forbearance plan include those that are in a repayment plan or loan modification trial period following the forbearance plan.
Forbearance for federally-insured mortgages allows for mortgage payments to be suspended for up to 360 days; an initial forbearance period of up to 180 days and, if requested by the borrower following contact by the servicer, an extension of up to 180 days. The servicer of the loan must begin attempts to contact the borrower no later than 30 days prior to the expiration of any forbearance plan term has expired. If a servicer of a loan is unable to contact the borrower prior to the expiration of the first 180-day forbearance plan term, or, if the forbearance plan reaches its twelve-month anniversary and is not further extended, the forbearance plan will expire. In such case, the 70% reduction in Minimum Required Assets for that loan will no longer be applicable and our Minimum Required Assets will increase.
We compute our risk-to-capital ratio on a separate company statutory basis, as well as on a combined insurance operations basis. The risk-to-capital ratio is our net RIF divided by our policyholders’ position. Our net RIF includes both primary and pool RIF and excludes risk on policies that are currently in default and for which case loss reserves have been established and the risk covered by reinsurance. The risk amount includes pools of loans with contractual aggregate loss limits and without these limits. Policyholders’ position consists primarily of statutory policyholders’ surplus (which increases as a result of statutory net income and decreases as a result of statutory net loss and dividends paid), plus the statutory contingency reserve and a portion of the reserves for unearned premiums. The statutory contingency reserve is reported as a liability on the statutory balance sheet. A mortgage insurance company is required to make annual additions to a contingency reserve of approximately 50% of net earned premiums. These contributions must generally be maintained for a period of ten years. However, with regulatory approval a mortgage insurance company may make early withdrawals from the contingency reserve when incurred losses exceed 35% of net earned premiums in a calendar year.
The table below presents our combined insurance companies’ risk-to-capital calculation (which includes a reinsurance affiliate).
(1)RIF - net, as shown in the table above, is net of reinsurance and exposure on policies currently delinquent ($2.9 billion at December 31, 2020 and $1.5 billion at December 31, 2019) and for which case loss reserves have been established.
The 2020 decrease in MGIC's risk-to-capital and our combined insurance companies' risk to capital was due to an increase in statutory policyholders' position, partially offset by an increase in RIF, net of reinsurance. The increase in statutory policyholders' position was primarily due to an increase in statutory contingency reserves, offset by dividends paid to our holding company of $390 million. The increase in our RIF, net of reinsurance, was due to an increase in our IIF, offset by an increase in our reduction to risk on policies that are currently in default for which loss reserves have been established. Our risk-to-capital ratio will decrease if the percentage increase in capital exceeds the percentage increase in insured risk.
The following table summarizes, as of December 31, 2020, the approximate future payments under our contractual obligations and estimated claim payments on established loss reserves.
Our long-term debt obligations as of December 31, 2020 include their related interest and are discussed in Note 7 - “Debt” to our consolidated financial statements and under “Liquidity and Capital Resources” above. Our operating lease obligations include operating leases on certain office space, data processing equipment and autos, as discussed in Note 16 - “Leases” to our consolidated financial statements. Purchase obligations consist primarily of agreements to purchase items related to our ongoing infrastructure projects and information technology investments in the normal course of business.
Case reserves are established for estimated insurance losses when notices of delinquency on insured mortgage loans are received. Such loans are referred to as being in out delinquency inventory. For reporting purposes, we consider a loan delinquent when it is two or more payments past due and has not become current or resulted in a claim payment. Even though the accounting standard, ASC 944, regarding accounting and reporting by insurance entities specifically excluded mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish loss reserves for future claims on insured loans which are not currently delinquent.
We establish reserves using estimated claim rates and claim severities in estimating the ultimate loss.
The claim rates and claim severities are affected by external events, including actual economic conditions such as changes in unemployment rates, interest rates or housing values, pandemics and natural disasters. Our estimation process does not include a correlation between claim rates and claim severities to projected economic conditions such as changes in unemployment rates, interest rates or housing values. Our experience is that analysis of that nature would not produce reliable results as the change in one economic condition cannot be isolated to determine its specific effect on our ultimate paid losses because each economic condition is also influenced by other economic
(1)A negative number for a prior year indicates a redundancy of loss reserves. A positive number for a prior year indicates a deficiency of loss reserves.
When a policy term ends, the primary mortgage insurance written by us is renewable at the insured’s option through continued payment of the premium in accordance with the schedule established at the inception of the policy life. We are generally obligated to renew the policies and have no ability to re-underwrite or reprice these policies after issuance. Premiums written on monthly premium policies are earned as coverage is provided. Premiums written on single premium policies and annual premium policies are initially deferred as unearned premium reserve and earned over the estimated policy life. Premiums written on policies covering more than one year are amortized over the policy life based on historical experience, which includes the anticipated incurred loss pattern. Premiums written on annual premium policies are earned on a monthly pro rata basis. When a policy is cancelled, all premium that is non-refundable is immediately earned. Any refundable premium is returned to the servicer or borrower. Policies may be cancelled by the insured, or due to rescissions or claim payments. When a policy is rescinded, all previously collected premium is returned to the servicer, and when a claim is paid, all premium collected since the date of default is returned. The liability associated with our estimate of premium to be returned is accrued for separately and this liability is included in “Other liabilities” on our consolidated balance sheets. Changes in these liabilities and the actual return of premium affect premiums written and earned.
Because our insurance premiums are earned over time, changes in persistency result in DAC being amortized against revenue over a longer or shorter period of time. However, even a 10%
change in persistency would not have a material effect on the amortization of DAC in the subsequent year.
Equity securities. Our equity securities reported at fair value are classified as available-for-sale. Equity securities carried at cost, for which the amount approximates fair value, are reported as Other Invested Assets. Realized investment gains and losses on equity securities are reported in income based upon specific identification of securities sold, as well as any change in fair value of equity securities.
è Level 1 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, treasury bills, and certain equity securities.
è Level 3 Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable or, from par values due to restrictions on certain securities that require them to be redeemed or sold only to the security issuer at par value. The inputs used to derive the fair value of Level 3 securities reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Our non-financial assets that are classified as Level 3 securities consist of real estate acquired through claim settlement. The fair value of real estate acquired is the lower of our acquisition cost or a percentage of the appraised value. The percentage applied to the appraised value is based upon our historical sales experience adjusted for current trends.
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.
è adverse conditions specifically related to the security, an industry, or a geographic area.
Based on our evaluation, we will record an OTTI adjustment on a security if we intend to sell the impaired security, if it is more likely than not that we will be required to sell the impaired security prior to recovery of its amortized cost basis, or if the present value of the discounted cash flows we expect to collect is less than the amortized costs basis of the security.
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 2019, our evaluation of whether a decline in fair values is other-than-temporary also included reviewing the extent and duration of the decline. Based on our evaluation, if the fair value of a security is below its amortized cost at the time of our intent to sell, the security is classified as other-than-temporarily
Consolidated statements of shareholders' equity for each of the three years in the period ended December 31, 2020
Reacquisition of convertible junior subordinated debentures-equity component 7 (2,673) - -
Reissuance of treasury stock, net under share-based compensation plans (18,807) (11,715) -
Payment of original issue discount- convertible junior subordinated debentures (15,049) - -
Net cash provided by (used in) financing activities 167,821 (173,406) (171,550)
Through certain non-insurance subsidiaries, we also provide various services for the mortgage finance industry, such as contract underwriting, analysis of loan originations and portfolios, and mortgage lead generation.
At December 31, 2020, our direct primary insurance in force ("IIF") was $246.6 billion, which represents the principal balance in our records of all mortgage loans that we insure, and our direct primary risk in force ("RIF") was $61.8 billion, which represents the IIF multiplied by the insurance coverage percentage.
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), as codified in the Accounting Standards Codification ("ASC"). Our consolidated financial statements include the accounts of MGIC Investment Corporation and its majority-owned subsidiaries. Intercompany transactions and balances have been eliminated. In accordance with GAAP, we are required 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 and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
The COVID-19 pandemic had a material impact on our 2020 financial results. Among other things, the COVID-19 pandemic led to an increase in delinquencies, which increased our capital requirements under PMIERs on those delinquent loans and increased our losses incurred. While uncertain, the future impact of the COVID-19 pandemic on the Company’s business, financial results, liquidity and/or financial condition may also be material. The magnitude of the impact will be influenced by various factors, including the length and severity of the pandemic in the United States, the length of time that measures intended to reduce the transmission of COVID-19 remain in place, the level of unemployment, and the impact of government initiatives and actions taken by Fannie Mae and Freddie Mac (the "GSEs") (including mortgage forbearance and modification programs) to mitigate the economic harm caused by COVID-19.
We have considered subsequent events through the date of this filing. In February 2021, MGIC executed an insurance linked note transaction. In addition, we have agreed to terms on a quota share reinsurance transaction which provides coverage on eligible NIW in 2021 and 2022 (see Note 9 - "Reinsurance").
The fair value of an asset or liability is defined as the price that would be received upon a sale of an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Fair value is based on quoted market prices or inputs, where available. If prices or quotes are not available, fair value is based on valuation models or other valuation techniques that consider relevant transaction characteristics (such as maturity) and use as inputs observable or unobservable market parameters including yield curves, interest rates, volatilities, equity or debt prices, and credit curves. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, as described below.
We use independent pricing sources to determine the fair value of a substantial majority of our financial instruments, which primarily consist of assets in our investment portfolio, but also includes cash and cash equivalents and restricted cash and cash equivalents. A variety of inputs are used; in approximate order of priority, they are: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications.
Fixed income securities. Our fixed income securities are classified as available-for-sale and are reported at fair value. The related unrealized investment gains or losses are, after considering the related tax expense or benefit, recognized as a component of accumulated other comprehensive income (loss) in shareholders' equity. Realized investment gains and losses on fixed income securities are reported in income based upon specific identification of securities sold as well as any credit allowance (2020), and any "other than temporary" impairments ("OTTI") (2019).
Effective January 1, 2020, each quarter we perform reviews of our investments to assess if declines in fair value of available-for-sale securities are impaired. In evaluating the decline in fair value, we consider several factors including, but not limited to:
è failure of the issuer to make scheduled interest or principal payments;
Otherwise, when a security is considered to be other-than-temporarily impaired, the losses are separated into the portion of the loss that represents the credit loss and the portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other factors is recognized in accumulated other comprehensive loss, net of taxes. A credit loss is determined to exist if the present value of the discounted cash flows, using the security’s original yield, expected to be collected from the security is less than the cost basis of the security. If the security is determined to be other-than-temporary-impaired the security is classified as other-than-temporarily impaired and the full amount of the impairment is recognized as a loss in the statement of operations.
Case reserves are established by estimating the number of loans in our inventory of delinquent loans that will result in a claim payment, which is referred to as the claim rate, and further estimating the amount of the claim payment, which is referred to as claim severity. Our case reserve estimates are established based upon historical experience, including rescissions of policies, curtailments of claims, and loan modification activity. Adjustments to reserve estimates are reflected in the financial statements in the years in which the adjustments are made. The liability for reinsurance assumed is based on information provided by the ceding companies.
Incurred but not reported ("IBNR") reserves are established for delinquencies estimated to have occurred prior to the close of an accounting period, but not yet reported to us. Consistent with reserves for reported delinquencies, IBNR reserves are also established using estimated claim rates and claim severities.
After our loss reserves are initially established, we perform premium deficiency tests using our best estimate assumptions as of the testing date. Premium deficiency reserves are established, if necessary, when the present value of expected future losses and expenses exceeds the present value of expected future premium and already established reserves. Products are grouped for premium deficiency testing purposes based on similarities in the way the products are acquired, serviced and measured for profitability.
Assumed reinsurance is based on information received from the ceding company.
Basic earnings per share ("EPS") is calculated by dividing net income by the weighted average number of shares of common stock outstanding. The computation of basic EPS includes as "participating securities" an immaterial number of unvested share-based compensation awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, under the "two-class" method. Our participating securities are composed of vested restricted stock and restricted stock units ("RSUs") with non-forfeitable rights to dividends. 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
Accounting standards effective in 2020, or early adopted, and relevant to our financial statements
Effective January 1, 2020, we adopted ASC 326, Financial Instruments - Credit Losses (“CECL”). This new standard replaced the incurred loss impairment methodology with a methodology that reflects lifetime expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Under CECL, allowances are established by incorporating the forecast of future economic conditions into our loss estimate unless such forecast is not reasonable and supportable, in which case we revert to historical loss experience. Application of the CECL model impacts our reinsurance recoverables and premium receivable. ASC 326 also replaced the OTTI model with an impairment allowance model, subject to reversal, for available-for-sale investments, which are measured at fair value. Our mortgage insurance policies are outside the scope of ASC 326. The new guidance is not prescriptive about certain aspects of estimating expected credit losses, including the specific methodology to use, and therefore requires significant judgment in application. Applying ASC 326, we have determined that an allowance for credit losses related to our premium receivables and reinsurance recoverables was not necessary as of December 31, 2020. At December 31, 2020, we established an allowance for credit losses for available-for-sale securities of $49 thousand. We continue to apply the previous guidance to 2019 and prior periods.
Changes to the Disclosure Requirements for Fair Value Measurement: ASU 2018-13
Changes to the Disclosure Requirements for Defined Benefit Plans: ASU 2018-14
• ASU 2020-01 - Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) January 1, 2021
• ASU 2019-12 - Simplifying the Accounting for Income Taxes January 1, 2021
• ASU 2020-08 - Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable Fees and Other Costs January 1, 2021
Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity: ASU 2020-06
In August 2020, the FASB issued guidance that simplifies the accounting for certain financial instruments with characteristics of liabilities and equity. It also includes amendments to EPS guidance. The updated guidance reduces the number of accounting models for convertible debt instruments and convertible preferred stock. This ASU eliminates the cash conversion and the beneficial conversion models, which will make more instruments eligible for the fair value option. As a result of these changes, more convertible instruments will be reported as a single unit on the balance sheet. The updated guidance also includes updates to the EPS calculation. The ASU requires companies to use the if-converted method, assume share settlement when settlement can be in cash or in shares, use an average market price for the period if the number of shares is based on an entity’s share price, and use the weighted average shares from each quarter to calculate the year to date weighted average shares. The ASU also includes improvements to the disclosures for convertible instruments and EPS. The updated guidance is effective for annual periods beginning after December 15, 2021. Early adoption is permitted for fiscal years beginning after December 15, 2020. The ASU requires adoption to be applied retrospectively or using a modified retrospective basis. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statement disclosures and whether we would early adopt.
Diluted income available to common shareholders $ 463,097 $ 692,027 $ 688,361
For the years ended December 31, 2020, 2019, and 2018, all of our then outstanding 9% Debentures are reflected in diluted earnings per share using the “if-converted” method. Under this method, if dilutive, the common stock related to the outstanding 9% Debentures is assumed issued as of the beginning of the reporting period and the related interest expense, net of tax, is added back to earnings in calculating diluted EPS.
Our fixed income securities consisted of the following as of December 31, 2020 and 2019:
Details of fixed income investment securities by category as of December 31, 2020
Amortized Cost Allowance for Expected Credit Loss Gross Unrealized Gains Gross Unrealized Losses Fair Value
Obligations of U.S. states and political subdivisions 2,083,568 - 166,557 (256) 2,249,869
Debt securities issued by foreign sovereign governments 4,485 - 224 - 4,709
Total fixed income securities $ 6,317,164 $ (49) $ 349,140 $ (4,659) $ 6,661,596
Total fixed income securities $ 5,562,550 $ 185,244 $ (9,902) $ 5,737,892
The increase in gross unrealized gains and the decrease in gross unrealized losses in our fixed income securities from December 31, 2019 to December 31, 2020 were primarily caused by declines in interest rates during that period.
We had $14.1 million and $13.9 million of investments at fair value on deposit with various states as of December 31, 2020 and 2019, respectively, due to regulatory requirements of those states' insurance departments. In connection with our insurance and reinsurance activities, we are required to maintain assets in trusts for the benefit of contractual counterparties. The fair value of the investments on deposit in these trusts was $165.9 million and $88.9 million at December 31, 2020 and 2019, respectively.
Table 5.2 compares the amortized cost and fair values of fixed income securities, by contractual maturity, as of December 31, 2020. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties. Because most mortgage and asset-backed securities provide for periodic payments throughout their lives, they are listed separately in the table.
Tables 5.4a and 5.4b below summarize, for all available-for-sale investments in an unrealized loss position as of December 31, 2020 and 2019, the aggregate fair value and gross unrealized losses by the length of time those securities have been continuously in an unrealized loss position. Gross unrealized losses on our available-for-sale investments amounted to $5 million and $10 million as of December 31, 2020 and 2019, respectively. The fair value amounts reported in tables 5.4a and 5.4b below are estimated using the process described in Note 6 - "Fair Value Measurements" to these consolidated financial statements.
Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses
Unrealized loss aging for securities by type and length of time as of December 31, 2019
U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 57,301 $ (200) $ 5,806 $ (10) $ 63,107 $ (210)
Based on current facts and circumstances, we believe the unrealized losses as of December 31, 2020 presented in table 5.4a above are not indicative of the ultimate collectability of the current amortized cost of the securities. We believe the gross unrealized losses are primarily attributable to widening credit spreads over risk free rates, as a result of economic and market uncertainties arising from the COVID-19 pandemic, which includes demand shocks in multiple sectors that originated in 2020. We also rely upon estimates of several credit and non-credit factors in our review and evaluation of individual investments to determine whether a credit impairment exists. At December 31, 2020 we recorded an allowance for expected credit losses of $49 thousand.
We report accrued investment income separately from fixed income, available-for-sale securities, and we have determined an allowance for credit losses for accrued investment income is not required. Accrued investment income is written off through net realized investment gains (losses) if, and at the time, the issuer of the security defaults or is expected to default on payments
The following describes the valuation methodologies generally used by the independent pricing sources, or by us, to measure financial instruments at fair value, including the general classification of such financial instruments pursuant to the valuation hierarchy.
Other Investments. These securities primarily consist of commercial paper which are valued using market data for comparable instruments of similar maturity and average yield.
Assets carried at fair value included those listed, by hierarchy level, in the following tables as of December 31, 2020 and 2019:
U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 265,693 $ 149,339 $ 116,354 $ -
Obligations of U.S. states and political subdivisions 2,249,869 - 2,249,869 -
Assets carried at fair value by hierarchy level as of December 31, 2019
(1)Consists of commercial paper included in "Investment Portfolio: Fixed income" with original maturities greater than ninety days.
(2)Real estate acquired through claim settlement, which is held for sale, is reported in "Other assets" on the consolidated balance sheets.
For assets measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the years ended December 31, 2020 and 2019 is shown in tables 6.2a and 6.2b below. There were no losses included in earnings for the years ended December 31, 2020 and 2019 attributable to the change in unrealized losses on assets still held at the end of each applicable year.
Additional fair value disclosures related to our investment portfolio are included in Note 5 - “Investments.”
Table 6.3 compares the carrying value and fair value of our financial liabilities disclosed, but not carried, at fair value as of December 31, 2020 and 2019.
Total financial liabilities $ 1,243,193 $ 1,392,635 $ 832,739 $ 974,538
Table 7.1 shows the carrying value of our long-term debt obligations as of December 31, 2020 and 2019.
5.75% Notes, due August 2023 (par value: $242.3 million) 240.6 420.9
5.25% Notes, due August 2028 (par value: $650 million) 638.8 -
The 5.75% Senior Notes (“5.75% Notes”), 5.25% Senior Notes ("5.25% Notes") and 9% Convertible Junior Subordinated Debentures (“9% Debentures”) are obligations of our holding company, MGIC Investment Corporation. The Federal Home Loan Bank Advance (“FHLB Advance”) is an obligation of MGIC.
We repurchased $48.1 million in aggregate principal amount of our 9% Debentures at a purchase price of $61.6 million, plus accrued interest, using proceeds from the 5.25% Notes issuance. The repurchase of 9% Debentures resulted in a $10.2 million loss on debt extinguishment on our consolidated statement of operations; a reduction in our shareholders' equity of $2.7 million related to the reacquisition of the equity component of the 9% Debentures; and a reduction in our potentially dilutive shares by approximately 3.6 million shares.
The 5.25% Notes have covenants customary for securities of this nature, including customary events of default and further provide that the trustee or holders of at least 25% in aggregate principal amount of the outstanding 5.25% Notes may declare them immediately due and payable upon the occurrence of certain events of default after the expiration of the applicable
Interest on the 5.75% Notes is payable semi-annually on February 15 and August 15 of each year. We have the option to redeem these notes, in whole or in part, at any time or from time to time prior to maturity at a redemption price equal to the greater of (i) 100% of the aggregate principal amount of the notes to be redeemed and (ii) the make-whole amount, which is the sum of the present values of the remaining scheduled payments of principal and interest discounted at the treasury rate defined in the notes plus 50 basis points and accrued interest.
Interest on the 9% Debentures is payable semi-annually in arrears on April 1 and October 1 of each year. As long as no event of default with respect to the debentures has occurred and is continuing, we may defer interest, under an optional deferral provision, for one or more consecutive interest periods up to 10 years without giving rise to an event of default. Deferred interest will accrue additional interest at the rate then applicable to the debentures. During an optional deferral period we may not pay or declare dividends on our common stock.
Estimation of losses is inherently judgmental. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment and the current and future strength of local housing markets; exposure on insured loans; the amount of time between delinquency and claim filing; and curtailments and rescissions. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions, including unemployment and the continued impact of the COVID-19 pandemic, leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, the impact of past and future government initiatives and actions taken by the GSEs (including mortgage forbearance programs and foreclosure moratoriums), and a drop in housing values which may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Loss reserves in future periods will also be dependent on the number of loans reported to us as delinquent.
The “Losses incurred” section of table 8.1 below shows losses incurred on delinquencies that occurred in the current year and in prior years. The amount of losses incurred relating to delinquencies that occurred in the current year represents the estimated amount to be ultimately paid on such delinquencies. The amount of losses incurred relating to delinquencies that occurred in prior years represents the difference between the actual claim rate and severity associated with those delinquencies resolved in the current year compared to the estimated claim rate and severity at the prior year-end, as well as a re-estimation of amounts to be ultimately paid on delinquencies continuing from the end of the prior year. This re-estimation of the claim rate and severity is the result of our review of current trends in the delinquency inventory, such as percentages of delinquencies that have resulted in a claim, the amount of the claims relative to the average loan exposure, changes in the relative level of delinquencies by geography and changes in average loan exposure.
The “Losses paid” section of table 8.1 below shows the amount of losses paid on delinquencies that occurred in the current year and losses paid on delinquencies that occurred in prior years. For several years, the average time it took to receive a claim associated with a delinquency had increased significantly from our historical experience of approximately twelve months. This was, in part, due to new loss mitigation protocols established by servicers and to changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation processes. In recent quarters, before the second quarter of 2020, we had begun to experience a decline in the average time it takes servicers to process foreclosures, which had reduced the average time to receive a claim associated with new delinquencies that do not cure. All else being equal, the longer the period between delinquency and claim filing, the greater the severity.
In light of the uncertainty caused by the COVID-19 pandemic, specifically the foreclosure moratoriums and forbearance plans, the average time it takes to receive a claim may increase.
Reserve at beginning of year $ 555,334 $ 674,019 $ 985,635
Losses and LAE incurred in respect of delinquent notices received in:
Reserve at end of year $ 880,537 $ 555,334 $ 674,019
(1)A positive number for prior year loss development indicates a deficiency of prior year reserves. 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.
(Decrease) in estimated claim rate on primary delinquencies $ (2,536) $ (111,848) $ (212,738)
(1)A positive number for prior year loss development indicates a deficiency of prior year loss reserves. A negative number for prior year loss development indicates a redundancy of prior year loss reserves.
For the year ended December 31, 2020, we experienced adverse development on previously received delinquencies primarily related to severity and adjustments to LAE reserves. For the years ended December 31, 2019 and 2018, we experienced favorable development on previously received delinquencies. This development was, in part, due to the resolution of approximately 69% and 73% for the years ended December 31, 2019 and 2018, respectively, of the prior year delinquency inventory, with improved cure rates. During 2019 and 2018, cure activity on loans that were delinquent twelve months or more was significantly higher than our previous estimates. During 2019, the favorable development was offset by adjustments to LAE reserves and amounts paid in settlement of disputes for claim paying practices. See Note 17 - “Litigation and Contingencies.” The favorable development for the year ended 2018 was offset, in part, by an increase in the estimated severity on previously reported delinquencies remaining in the delinquency inventory.
A roll-forward of our primary delinquent inventory for the years ended December 31, 2020, 2019, and 2018 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 delinquency notices increased in 2020 because of the impacts of the COVID-19 pandemic, including the high level of unemployment and economic uncertainty resulting from measures to reduce the transmission of COVID-19. In the last half of 2020, we experienced an increase in cures associated with our COVID-19 new delinquency notices. Government initiatives and actions taken by the GSEs provide for payment forbearance on mortgages to borrowers experiencing hardship during the COVID-19 pandemic. These forbearance plans generally allow for mortgage payments to be suspended for up to 360 days: an initial forbearance period of up to 180 days and, if requested by the borrower, an extension of up to 180 days. For loans in a COVID-19 forbearance plan as of February 28, 2021, the plan may be extended for an additional three months, subject to certain limits.
•2019 - 639 notices removed from delinquent inventory with an amount paid of $30 million,
Primary claims received inventory included in ending delinquent inventory 159 538 809
The increase in delinquency inventory that is 4-11 consecutive months delinquent is primarily due to the number of new delinquency notices received in the second quarter of 2020 resulting from the impacts of the COVID-19 pandemic. This was partially offset by an increase in cures in the third and fourth quarter of 2020.
Our loss reserving methodology incorporates our estimates of future rescissions. A variance between ultimate actual rescission rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses. For information about discussions and legal proceedings with customers with respect to our claims paying practices, see Note 17 - “Litigation and Contingencies.”
Table 9.1 below shows the effect of all reinsurance agreements on premiums earned and losses incurred as reflected in the consolidated statements of operations.
We have entered into quota share reinsurance ("QSR") agreements with panels of third-party reinsurers to cede a fixed quota share percentage on premiums earned and received and losses incurred on insurance covered by the transactions. We receive the benefit of a ceding commission equal to 20% of premiums ceded before profit commission. We also receive the benefit of a profit commission through a reduction of premiums we cede. The profit commission varies inversely with the level of losses on a “dollar for dollar” basis and can be eliminated at annual loss ratios higher than we have experienced on our QSR agreements.
Each of our QSR agreements typically have annual loss ratio caps of 300% and lifetime loss ratios of 200%.
2020 QSR - 1 Year 2020 12.5 % 62.0 % December 31, 2031
(2) Eligible credit union business written before 2020 was covered by our 2019 and prior QSR Transactions.
(2) We can elect to reduce the quota share percentage beginning on this date, and bi-annually thereafter.
Table 9.4 provides a summary of our quota share reinsurance agreements for 2020, 2019, and 2018.
A "Trigger Event" has occurred on each our outstanding ILN transactions. On the 2018 and 2019 ILN transactions a “Trigger Event” has occurred because the reinsured principal balance of loans that were reported 60 or more days delinquent exceeded 4% of the total reinsured principal balance of loans under each transaction. A “Trigger Event” has occurred on our 2020 ILN transaction because the credit enhancement of the most senior tranche is less than the target credit enhancement. While the “Trigger Event” is in effect, payment of principal on the related notes will be suspended and the reinsurance coverage available to MGIC under the transactions will not be reduced by such principal payments.
Table 9.5 provides a summary of our excess of loss reinsurance agreements as of December 31, 2020, December 31, 2019 and December 31, 2018.
Policy Inforce Dates January 1, 2020 - July 31, 2020 January 1, 2018 - March 31, 2019 July 1, 2016 - December 31, 2017
In February 2021, MGIC entered into a $398.8 million excess-of-loss reinsurance agreement (executed through an insurance linked note transaction) that covers policies with inforce dates from August 1, 2020 through December 31, 2020.
We are required to disclose our maximum exposure to loss, which we consider to be an amount that we could be required to record in our statements of operations, as a result of our involvement with the VIEs under our Home Re Transactions. As of December 31, 2020, December 31, 2019 and December 31, 2018, we did not have material exposure to the VIEs as we have no investment in the VIEs and had no reinsurance claim payments due from either VIE under our reinsurance agreements. We are unable to determine the timing or extent of claims from losses that are ceded under the reinsurance agreements. The VIE assets are deposited in reinsurance trusts for the benefit of MGIC that will be the source of reinsurance claim payments to MGIC. The purpose of the reinsurance trusts is to provide security to MGIC for the obligations of the VIEs under the reinsurance agreements. The trustee of the reinsurance trusts, a recognized provider of corporate trust services, has established segregated accounts within the reinsurance trusts for the benefit of MGIC, pursuant to the trust agreements. The trust agreements are governed by, and construed in accordance with, the laws of the State of New York. If the trustee of the reinsurance trusts failed
The reinsurance trust agreements provide 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.
Net unrealized investment gains (losses) on securities without an allowance for credit losses $ 169,135 $ 220,139 $ (81,834)
Total reclassifications, net of tax $ (1,665) $ (3,522) $ (7,323)
(1)(Decreases) increases Net realized investment gains on the consolidated statements of operations.
A roll-forward of AOCI (AOCL) for the years ended December 31, 2020, 2019, and 2018, including amounts reclassified from AOCI (AOCL), is included in table 10.3 below.
(In thousands) Net unrealized gains and losses on available-for-sale securities Net benefit plan assets and obligations recognized in shareholders' equity Total AOCL
Balance, December 31, 2017, net of tax $ 29,275 $ (73,058) $ (43,783)
Cumulative effect of adopting the accounting standard update for financial instruments (18) - (18)
Balance, December 31, 2020, net of tax $ 272,137 $ (55,316) 216,821
3. Expected Return on Assets (22,139) (19,466) (22,250) (7,407) (5,785) (6,359)
8. Total Expense for Year $ 14,939 $ 14,648 $ 9,961 $ (6,044) $ (3,344) $ (8,719)
3. Funded Status - Overfunded/Asset N/A N/A $ 90,310 $ 72,094
Table 11.4 shows the changes in the projected benefit obligation for 2020 and 2019.
1. Benefit Obligation at Beginning of Year $ 413,350 $ 376,153 $ 27,496 $ 28,085
1. Fair Value of Plan Assets at Beginning of Year $ 402,691 $ 359,719 $ 99,590 $ 77,762
1. AOCI in Prior Year $ 98,589 $ 108,808 $ (15,281) $ 3,629
c. Occurring during year - Prior Service Cost 2 (5) - -
d. Occurring during year - Net Actuarial Losses/(Gains) 16,021 (150) (13,342) (18,944)
e. Occurring during year - Net Settlement Losses/(Gains) - (1,933) - -
3. AOCI in Current Year $ 97,911 $ 98,589 $ (27,892) $ (15,281)
1. Discount Rate 2.75 % 3.45 % 2.35 % 3.20 %
2. Rate of Compensation Increase 3.00 % 3.00 % N/A N/A
3. Cash balance interest crediting rate 2.50 % 3.20 % N/A N/A
3. Rate of Compensation Increase 3.00 % 3.00 % N/A N/A
The year-end asset allocations of the plans are shown in table 11.8 below.
2. Debt Securities 79 % 77 % - % - %
è Level 1 Quoted prices for identical instruments in active markets that we can access. Financial assets using Level 1 inputs include equity securities, mutual funds, money market funds, certain U.S. Treasury securities and exchange traded funds ("ETFs").
è Level 2 Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and inputs, other than quoted prices, that are observable in the marketplace for the instrument. The observable inputs are used in valuation models to calculate the fair value of the instruments. Financial assets using Level 2 inputs include certain municipal, corporate and foreign bonds, obligations of U.S. government corporations and agencies, and pooled equity accounts.
Tables 11.9a and 11.9b 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, 2020 and 2019. There were no securities that used Level 3 inputs.
Return seeking growth Funded ratio improvement over the long term ● Global quality growth
Tables 11.10a and 11.10b set forth the other postretirement benefits plan assets at fair value as of December 31, 2020 and 2019. All are Level 1 assets.
Other postretirement benefits plan assets at fair value as of December 31, 2020
Other postretirement benefits plan assets at fair value as of December 31, 2019
We have a profit sharing and 401(k) savings plan for employees. At the discretion of the Board of Directors, we may make a contribution to the plan of up to 5% of each participant's eligible compensation. We provide a matching 401(k) savings contribution for employees of 100% up to the first 4% contributed. We recognized expenses related to these plans of $8.0 million, $7.4 million and $6.0 million in 2020, 2019 and 2018, respectively.
Net deferred tax (liabilities) assets, included on the Consolidated Balance Sheet at December 31, 2020 and 2019 as a component of Other liabilities and Other assets, respectively, are as follows:
We believe that all gross deferred tax assets at December 31, 2019 and 2020 are fully realizable and no valuation allowance has been established.
The CARES Act provides financial relief to individuals and businesses in the form of loans, grants, and tax changes, among other types of assistance. The tax changes in the CARES Act did not materially impact our financial results.
Table 12.4 reconciles the federal statutory income tax rate to our effective tax provision rate.
Additional income tax benefit related to IRS litigation - % - % (0.3) %
Tax exempt municipal bond interest (0.9) % (0.6) % (0.7) %
During 2019, we repurchased approximately 8.7 million shares of our common stock at a weighted average cost per share of $13.13, which included commissions. As of December 31, 2019, the authorized share repurchase program had approximately $111 million remaining.
In 2020, we paid quarterly cash dividends of $0.06 per share to shareholders which totaled $82.6 million. On January 26, 2021, the Board of Directors declared a quarterly cash dividend to holders of the company's common stock of $0.06 per share payable on March 3, 2021, to shareholders of record at the close of business on February 17, 2021.
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. 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 2020, MGIC's withdrew $30.4 million from its contingency reserve. 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.
For the years ended December 31, 2020, 2019, and 2018 there were no surplus contributions made to MGIC or distributions from other insurance subsidiaries to us. Dividends paid by MGIC are shown in table 14.2 below.
(1) Dividends paid in cash and/or investment securities. Also in 2020, MGIC distributed to the holding company, as a dividend, its ownership in the 9% Debentures held at an amortized cost of $139.5 million.
At December 31, 2020, MGIC’s risk-to-capital ratio was 9.2 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements and its policyholder position was $3.2 billion above the required MPP of $1.7 billion. The calculation of our risk-to-capital ratio and MPP reflect credit for the risk ceded under our reinsurance transactions. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the financial requirements of the PMIERs, MGIC may terminate the reinsurance agreements, without penalty. At this time, we expect MGIC to continue to comply with the current State Capital Requirements; however, you should read the rest of these financial statement footnotes for information about matters that could negatively affect such compliance.
At December 31, 2020, the risk-to-capital ratio of our combined insurance operations (which includes a reinsurance affiliate) was 9.1 to 1.
The NAIC has previously announced plans to revise the State Capital Requirements that are provided for in its Mortgage Guaranty Insurance Model Act. In December 2019, a working group of state regulators released an exposure draft of a revised Mortgage Guaranty Insurance Model Act and 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 and minimum capital floors. Currently we believe that the PMIERs contain more restrictive capital requirements than the draft Mortgage Guaranty Insurance Model Act in most circumstances.
Under the PMIERS guidance, any dividend paid by MGIC to our holding company, through June 30, 2021, requires GSE approval.
We have an omnibus incentive plan that was adopted on April 23, 2020. When the 2020 plan was adopted, no further awards could be made under our previous 2015 plan. The purpose of the 2020 plan is to motivate and incentivize performance by, and to retain the services of, key employees and non-employee directors through receipt of equity-based and other incentive awards under the plan. The maximum number of shares of stock that can be awarded under the 2020 plan is 11.0 million. Awards issued under the plan that are subsequently forfeited will not count against the limit on the maximum number of shares that may be issued under the plan. The 2020 plan provides for the award of stock options, stock appreciation rights, restricted stock and restricted stock units, as well as cash incentive awards. No awards may be granted after April 23, 2030 under the 2020 plan. The vesting provisions of options, restricted stock and restricted stock units are determined at the time of grant. Awards forfeited under the 2015 plan after April 23, 2020 will increase the 2020 plan's limit of shares available for future grant. At December 31, 2020, 11.1 million shares were available for future grant under the 2020 plan. The excess of available shares for future grant above the maximum number of shares that may be issued under the 2020 plan is the result of awards under the 2015 plan being forfeited subsequent to April 23, 2020.
Table 15.1 summarizes restricted stock or restricted stock unit (collectively called “restricted stock”) activity during 2020.
At December 31, 2020, the 4.1 million shares of restricted stock outstanding consisted of 3.1 million shares that are subject to performance conditions (“performance shares”) and 1.0 million shares that are subject only to service conditions (“time vested shares”). The weighted-average grant date fair value of restricted stock granted during 2019 and 2018 was $11.92 and $15.69, 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 or previous trading day if the Exchange is closed on the date of grant. The total fair value of restricted stock vested during 2020, 2019 and 2018 was $20.4 million, $13.7 million, and $19.1 million, respectively.
We lease data processing equipment and autos under operating leases that expire during the next four years. Generally, rental payments are fixed.
Table 16.1 shows minimum the future operating lease payments as of December 31, 2020.
Before paying an insurance claim, generally 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 or deny a claim on the loan (both referred to as “rescissions”). In addition, our insurance policies generally provide that we can reduce a claim if the servicer did not comply with its obligations under our insurance policy (such reduction referred to as a "curtailment"). In recent quarters, an immaterial percentage of claims received in a quarter have been resolved by rescissions. In 2020 and 2019 , curtailments reduced our average claim paid by approximately 3.6% and 5.0%, respectively.
Net premiums earned $ 260,901 $ 243,562 $ 256,113 $ 261,367 $ 1,021,943
Net premiums earned $ 249,762 $ 247,102 $ 267,857 $ 266,267 $ 1,030,988
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included
As described in Notes 3 and 8 to the consolidated financial statements, the Company establishes reserves to recognize the estimated liability for losses related to reported defaults on insured mortgage loans. As of December 31, 2020, the Company’s recorded loss reserves were $881 million. A significant portion of total loss reserves relate to primary case reserves established for the Company’s primary insurance business. Case reserves are established by estimating the number of loans in the 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. The Company’s case reserve estimates are established based upon historical experience, including rescissions of policies, curtailments of claims, and loan modification activity. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment and the current and future strength of local housing markets; exposure on insured loans; the amount of time between default and claim filing; and curtailments and rescissions.
The principal considerations for our determination that performing procedures relating to the valuation of loss reserves is a critical audit matter are (i) the significant judgment by management when developing their estimate, which in turn led to a high degree of auditor judgment and subjectivity in performing procedures relating to loss reserves; (ii) there was significant auditor effort and judgment in evaluating the audit evidence relating to the significant assumptions, related to the claim rate and claim severity; and (iii) the audit effort included the involvement of professionals with specialized skill and knowledge.