Consolidated net income for 2004 increased by 33.4% over 2003 due primarily to increases in 2004 in premiums earned in our U.S. Mortgage Insurance Operations and International Operations, equity in earnings from FGIC Corporation of $61.6 million in 2004, and our 2004 gain on the sale of APTIC. These factors were partially offset by higher 2004 losses and LAE and other underwriting and operating expenses, primarily from
PMI incurs underwriting expenses related to contract underwriting services for mortgage loans without mortgage insurance coverage. These costs are allocated to PMI Mortgage Services Co., or MSC, which is reported in our Other segment, thereby reducing PMI’s underwriting and operating expenses. Contract underwriting expenses allocated to MSC were $26.1 million in 2004, $44.3 million in 2003 and $46.1 million in 2002. The decline in allocated expenses in 2004 compared to 2003 was caused by a decrease in contract underwriting activity, which decreased primarily as a result of a decrease in refinancing activity and mortgage originations.
Less-than-A with FICO scores below 575 is a subset of PMI’s less-than-A quality loan portfolio.
In the second quarter of 2004, we purchased Australian dollar and Euro put options designed to partially mitigate the negative financial impact of a potential strengthening of the U.S. dollar relative to the Australian dollar and the Euro in 2004. The options expired ratably over the calendar year 2004 and had a net cost of $0.7 million (including realized gains).
Amortization of deferred policy acquisition costs decreased in 2004 to $2.0 million from $15.6 million in 2003 as a result of purchase accounting adjustments recorded as of December 18, 2003 which do not allow deferred acquisition costs to be acquired. The deferred policy acquisition cost asset was $71.4 million at December 31, 2002 compared to $2.9 million at December 31, 2003.
Our consolidated contractual obligations include reserves for losses and LAE, long-term debt obligations, capital lease obligations, operating lease obligations and purchase obligations. Cash payments related to our
PMI’s insurance written includes less-than-A quality loans and Alt-A loans. The credit quality, loss development and persistency on these loans can vary significantly from PMI’s traditional A quality loan business. For example, PMI’s primary bulk portfolio is experiencing higher delinquency and claims rates, and higher average claims paid amounts, than PMI’s primary flow portfolios due, in part, to the higher concentration of less-than-A quality and Alt-A loans in the bulk portfolio. We expect that PMI will continue to experience higher default rates for less-than-A quality and Alt-A loans than for its A quality loans. We cannot be sure that the premiums that PMI charges on less-than-A quality loans and Alt-A loans will adequately offset the associated risk.
The U.S. mortgage insurance industry and PMI are subject to litigation and regulatory risk.
PMI and the mortgage insurance industry are subject to comprehensive, detailed regulation by state insurance departments. Although their scope varies, state insurance laws generally grant broad powers to
The implementation of the Basel II Capital Accord may limit the domestic and international use of mortgage insurance.
Servicing, a third-party servicer of single-family residential mortgages; and RAM Holdings Ltd. and RAM Holdings II Ltd., which are the holding companies for RAM Re, a financial guaranty reinsurance company based in Bermuda.
The Company has made significant investments in the equity securities of several privately-held companies including FGIC. The business conducted by FGIC differs significantly from the Company’s core business of providing residential mortgage insurance. FGIC is subject to a number of significant risks that arise from the nature of its business. Accordingly, the Company is subject to all the risks and uncertainties associated with that business. In addition, the Company has limited ability to control FGIC and, accordingly, may be unable to take actions unilaterally to avoid or mitigate those risks. A significant portion of the Company’s consolidated net income is derived from FGIC and its financial guaranty business. The financial guaranty business is subject to extensive regulation. Future legislative, regulatory or judicial changes may affect the financial guaranty industry or municipal or asset-backed obligations or markets. Any expansion by FGIC into other markets and other asset classes will entail risks and uncertainties associated with its ability to maintain a triple-A rating and to compete with other monoline financial guaranty insurance companies.
Related Party Receivables-As of December 31, 2004, related party receivables were $18.4 million consisting of non-trade receivables from an equity investee and unconsolidated subsidiaries, of which $16.7 million relates to SPS. The largest component of this amount was the outstanding balance of $16.6 million from a $23.0 million subordinated promissory note the Company received from SPS in the third quarter of 2004. The Company received the note in exchange for $23.0 million of subordinated participation interests in SPS debt held by the Company. The note bears interest at 1-month LIBOR plus 2.375% and scheduled principal and interest payments are due monthly through January 2006. All principal and interest payments related to this note are current. Pursuant to the Summary of Terms with CSFB, this note will be payable in full at closing if CSFB exercises its option to purchase all of the Company’s shares in SPS. As of December 31, 2003, related party receivables were $27.8 million consisting primarily of $23.0 million of subordinated participation interests in SPS and $3.1 million of advances that the Company made to SPS pursuant to a promissory note related to other matters. The $3.1 million of SPS advances were repaid in full during the third quarter of 2004.
In 2002, the Company entered into an agreement with a customer to provide mortgage insurance coverage for a three-year period on a pool of loans. The Company received funds to cover future claim payments on these loans. The transaction does not transfer insurance risk. Accordingly, the contract is being accounted for under the guidelines of SOP No. 98-7, Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk. As of December 31, 2004, $4.7 million of deposits received under this agreement were included in cash and cash equivalents and can only be utilized to pay claims related to the agreement.
The unconsolidated majority owned subsidiaries are comprised of the Company’s equity investment held for sale (SPS) and PMI Capital I. As of December 31, 2004, included in the Company’s retained earnings were $121.0 million of undistributed equity in earnings from existing equity investees with ownership interest of 50% or less.